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Taking Advantage of Contract Manufacturing Resources – Part 2

April 24, 2012 at 4:40 PM

Fixed Costs versus Variable Costs

Defining factory costs as fixed or variable (meaning they vary in proportion with production volume) is a useful convention for modeling your cost structure or budgeting.  But when examining individual product lines, or, in the extreme, individual products, the model breaks down.  At that grainy level, it is important to think about exactly which costs are really fixed, and over what time frame.

Examples of costs that are typically considered to be Fixed

  • Engineering, design and development
  • Procurement and production planning
  • Machinery and equipment depreciation
  • Building expense (rent or depreciation, building maintenance)
  • Quality and inspection
  • Supervisory wages

Examples of costs that are typically considered Variable

  • Raw materials
  • Direct labor
  • Direct labor benefits
  • Supplies and consumables
  • Freight

Costs that could be classified as either Fixed or Variable

  • Indirect labor
  • Indirect labor benefits
  • Equipment maintenance
  • Energy costs or other utilities

As one of my old accounting professors used to say:  Over a long time horizon, all costs are variable.  In other words, if you think about the long haul, then most of your “fixed” costs (buildings or equipment, for example) are sized to fit the volume of business you expect to capture.  They become variable.

How do Fixed and Variable costs apply to the decision to use Contract Manufacturing?

Your decision to use a contract manufacturer over the short term, medium term, or as part of your long term strategy will determine which costs are relevant to making a smart “make versus buy” decision.   Companies that seem to achieve the greatest benefits from partnering with a contract manufacturer, tend to make the
arrangements for the long haul.  This allows them to better manage their “fixed” costs, minimizing them, and at the same time maximizing profit by transferring tasks (or even entire product lines) to a contract manufacturer specializing in the needed type of work.

Some Typical Scenarios

Strategically utilizing a contract manufacturing firm as a partner usually reduces your costs.  Below are a few examples where we’ve seen clients successfully take advantage of the cost structure and expertise of our contract manufacturing business.

  • A company identifies a type of work that they are not particularly good at performing (typically because of lack of expertise, equipment, or competitive volumes), and shifts that work to a contract manufacturer with the proper expertise.
  • A company starts up a new product with a contract manufacturer until the market can generate enough volume to justify investment for in-house production.
  • A client transfers production of products nearing the end of their useful lives to a contract manufacturer to make room new models.
  • A client utilizes a contract manufacturer to supplement their internal production assets, allowing them to effectively increase their capacity during the peak of their seasonal/cyclical business with minimal
    additional investment.
  • A manufacturer wants to take advantage of the low cost structure (labor costs, overheads, purchasing leverage, high volume production equipment) of a contract manufacturer, and places key products and/or
    subassemblies with that firm.
  • A manufacturer has higher priority uses for its engineering or design resources, and outsources the development and production of an entire product line to a contract manufacturer.

TEK Services is a contract manufacturing company located in Eastern Nebraska specializing in metal working (laser machining, CNC, welding, laser cutting, metal cutting and other services), wiring work (wire end
terminals, small wire terminals, wiring harnesses, circuit board assembly and other services), and electro-mechanical assembly.  Our website is, and our phone number is 402-727-0262.

Tags: contract manufacturing fixed costs variable costs fixed versus variable cost make versus buy make versus buy decision partnering manufacturing partnership partnership cost structure end of lifecycle centers of excellence start-up manufacturing start of lifecycle beginning of lifecycle supplemental capacity seasonal capacity cyclical capacity low overhead rate low cost outsourced engineering
Category: Contract Manufacturing

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