SRCSourcing & procurementStop 7 of 9
Make vs buy & contract manufacturing
When to make something yourself, when to outsource it, and how to plan volume and capacity with co-packers.
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Every company decides what to make itself and what to buy. The usual reasons to make something in-house are that it’s core to your advantage (a secret formula, a key technology), that quality or intellectual property needs tight control, or that you have spare capacity. The usual reasons to buy are that a specialist does it cheaper or better, that you’d rather not tie up capital in plants, or that demand is too uncertain to justify your own capacity.
In FMCG this often means contract manufacturing: a co-packer or co-manufacturer makes or packs products under your brand. A shampoo company might make its core packs in its own plants and use co-packers for:
- seasonal peaks and promotions, when its own plants are full,
- new products not yet proven enough to justify a new line,
- regional supply close to a market,
- special formats such as sachets or gift packs.
Two decisions follow. Allocation: how much volume each co-packer gets, weighing their price, capacity, quality and minimum volumes against your own plants. Capacity reservation: good co-packers are busy before festive seasons, so companies often book capacity months ahead, paying a reservation or commitment fee in exchange for guaranteed slots.
The risks of outsourcing are real: less control over quality and timing, leaked know-how, weaker bargaining power if you depend on one partner, and lost internal skills.
Words to use
- Co-packer / co-manufacturer
- A third party that makes or packs products under your brand.
- Core competence
- A capability that gives a company its competitive advantage and is hard to copy.
- Capacity reservation
- Paying in advance to guarantee a partner’s production capacity.
Count only the costs that change
A make-or-buy comparison should include only relevant costs: those that differ between the options.
- Make: variable production cost, plus the fixed costs that exist only if you make (new equipment, extra staff), plus the opportunity cost of capacity that could make something else.
- Buy: the supplier’s price, plus freight, quality checks, supplier management and any tooling you pay for.
- Leave out costs that stay the same either way, such as the plant manager’s salary or existing building depreciation.
A company needs 1 crore sachets a year.
- Make: materials and variable conversion ₹1.20 a sachet; a new sachet line costs ₹2 crore, spread over 5 years (₹40 lakh a year), plus ₹20 lakh a year of extra staff. Fixed: ₹60 lakh a year, or ₹0.60 a sachet. Total ₹1.80.
- Buy: a co-packer charges ₹1.65, plus ₹0.05 freight and ₹0.03 for quality oversight: ₹1.73.
At 1 crore sachets, buying is cheaper. The make cost falls as volume grows, because the fixed cost is spread wider. Break-even is where , so crore sachets. If volume is expected to grow well beyond that, the decision may flip.
Strategic factors, scored alongside cost
- Is it core to our advantage (formula, technology, brand experience)?
- Do we need tight control of quality, intellectual property or speed?
- How uncertain is demand? Outsourcing avoids investing in capacity that may sit idle.
- How many capable suppliers exist? Depending on one partner moves power to them.
Reserving co-packer capacity
Good co-packers fill up before peak seasons. Companies often pay a reservation fee for guaranteed slots, which works like an option: pay a small amount now for the right to produce later. If a ₹5 lakh fee secures 20 lakh units of festive capacity that would otherwise be unavailable, the decision compares the fee with the margin at risk if the extra volume can’t be made.
Two classic lenses
- Transaction cost economics (Williamson): buying from the market works best for standard, frequent transactions. When an activity needs specific investments (special tooling, dedicated know-how), faces high uncertainty, or is hard to specify and monitor, the cost of contracting rises, and making in-house or a close partnership becomes more attractive.
- Core competence (Prahalad and Hamel, 1990): keep and invest in the capabilities that create your advantage and are hard for others to copy; outsource activities that aren’t.
The risk of hollowing out
Outsourcing manufacturing can gradually remove the engineering and process knowledge a company needs to design good products, judge suppliers and bring work back if needed. Boeing’s 787 programme, which outsourced the design and building of major sections to partners, suffered long delays when integration problems surfaced. The lesson is not “never outsource” but “keep the knowledge needed to specify, integrate and evaluate what you outsource.”
Managing contract manufacturers well
- Technology transfer with complete specifications, trials and sign-off.
- Quality agreements stating who tests what, release responsibilities and audit rights.
- Plan them in S&OP: share forecasts and reserve capacity like your own plants.
- Open-book costing where volumes are large, so price changes are explained by cost changes.
- Consigned materials: buy key materials yourself, using your scale, and supply them to the manufacturer.
- Protect intellectual property through contracts, split processes or keeping critical steps in-house.
When to bring work back
Insourcing or reshoring becomes worth reviewing when volumes grow past the break-even, when quality or delivery problems persist, when the activity becomes strategic, or when the supply base becomes too concentrated or risky.
Interview kit
Practise it out loud
Answer each question yourself before opening the model answer.
Make-or-buy depends on strategic importance, cost and capability, capacity and risk. I’d keep core, differentiating or IP-sensitive production in-house and outsource where partners are cheaper, better or more flexible. With co-manufacturers, volume allocation and capacity reservation become planning decisions: allocate by cost, capacity and quality within S&OP, and book capacity ahead of peaks, while managing quality, dependency and know-how risks.
When would you use a co-packer instead of building a new line?
When demand is seasonal or uncertain, such as a new product or a festive peak, when you need capacity faster than you can build it, when a partner offers a special format or a location near the market, or when the capital is better spent elsewhere.
What are the risks of relying heavily on contract manufacturers?
Quality and delivery are less under your control, know-how can leak to competitors, you lose internal skills, and you become dependent. If capacity is tight industry-wide, partners may favour bigger clients. Contracts, audits, dual partners and capacity reservations reduce these risks.
Connected stops
Where this idea feeds in, or gets its inputs from.
Sources and further reading
- Chopra, S. & Meindl, P. Supply Chain Management: Strategy, Planning, and Operation. Pearson. Chapter on sourcing decisions in a supply chain.
- Van Weele, A. J. Purchasing and Supply Chain Management. Cengage Learning.
- Williamson, O. E. (1985). The Economic Institutions of Capitalism. Free Press.
- Prahalad, C. K., & Hamel, G. (1990). The core competence of the corporation. Harvard Business Review, 68(3), 79–91.