Brand owners and contract manufacturers (CMs) often treat each other more like frenemies than true partners—talking behind each other’s backs, being less than truthful, not trusting that the other has its best interests at heart. It’s been this way since the dawn of contract manufacturing, but now, friends, that needs to stop.

Certainly, CMs have played a central role in manufacturing for decades—and for good reason. Original equipment manufacturers (OEMs) and brands have used CM partners for decades to make everything from components and subsystems to finished products. Whether onshore or offshore, manufacturing with CM partners allowed OEMs to keep fixed costs low, shift work to favorable geographic locations, and adjust output to meet demand.

That doesn’t mean OEMs have always paid close attention to CMs’ every move; supply chain visibility used to get murky or even peter out. These days, though, companies can’t afford such a blind spot. They must work toward ever greater visibility into every corner of their supply chains, including CMs, because collaboration and sharing information—and all the benefits that flow from this—are the pathway to winning. LNS Research survey data shows 22% of companies view proactive data collaboration with suppliers, including CMs, as an important risk management strategy. This is clearer than ever since the pandemic, and now competition is increasingly occurring between and among whole supply chains as opposed to individual companies. Amazon, for example, dominates e-commerce first and foremost because of the strength and resilience of its vast supply chain. Limited visibility into assets, materials, shop floor, forecasts, and all the rest just isn’t good enough anymore.

Still not convinced? Better think again if you have operations in Germany or any part of the EU. The Supply Chain Due Diligence Act—or as one might expect from the German language, “das Lieferkettensorgfaltspflichtengesetz” (LkSG)—came into force in Germany in January 2023, and is expected to see broader EU applicability before long. The new law aims to improve and protect the environment and human rights along the global supply chain by ensuring compliance with basic human rights standards and prohibiting child and forced labor. Violation of the LkSG could result in fines up to 8 million euros or 2% of average annual sales.

Under pressure from both regulations and competitive market forces, OEMs need to gain clear views into their CMs’ operations. What’s the problem? Trust! A big challenge in implementing LkSG requirements is rooted in often-contentious bargaining over the “contract” element of contract manufacturing.

“The technology exists to share the information—the infrastructure is there; the connectivity is there. So it's really a business question. And a trust question,” says Matt Littlefield, president and research lead for LNS Research. CMs are leery of sharing information that could lead to demands for more price cuts. It doesn’t help that OEMs often have not done enough to convince their CMs that two-way information-sharing benefits both sides.

The writing is on the wall: if you work with contracting partners but have limited visibility into their processes and assets, now is the time to fix the problem. Companies can use this moment not only for regulatory compliance but for business payoff too—increased efficiency, better quality, improved responsiveness to customers and markets, and more accurate forecasts. But don’t be tempted to start with mandates, experts agree. Start instead by building trust. While the regulation is aimed at eliminating abuses, companies should build from the ground up, strengthening relationships with CM partners to shine light into every previously dark corner of the supply chain.

What lurks in the contract manufacturing blind spot?

For decades, many OEMs did not pay close attention to how CMs got work done; they just tossed orders over the wall and demanded timely fulfillment. This wasn’t purely an issue of lacking data or failing to invest in shared systems; sometimes it was a more willful form of ignorance. After all, if you delve too deeply, you might find some unsavory labor practices or less-than-top materials sourcing that could explode into the next headline-grabbing quality issue. This is, of course, a long-standing issue in outsourcing, particularly to less-developed countries, although the U.S. Department of Labor regularly cites domestic occurrences of forced labor or child labor as well.

Consider the case of Apple. The more the tech company looked, the more it discovered exploitive labor practices at Foxconn, its massive manufacturing partner in China, whose factory was unaffectionately dubbed “iPhone City.” The pandemic rendered the conditions more dire, with lockdowns leading to widespread protests and unrest. The situation became too serious to ignore, with human rights violations threatening the brand and losses of up to US$1 billion per week during work interruptions. Subsequently, Apple has been working to improve conditions at its CM partner sites as well as its own retail stores.

The tools for more visibility have been available for some time, but the incentive to build it wasn’t always sufficient. Experts agree that the cloud and industrial Internet of things (IIoT) have enabled much more fluid and cost-effective collaboration than was previously possible. While in past years, CMs might not have bothered to outfit their production assets with sensors, today it is much more common for them to extract, analyze, and use process data for decision support. And from a technical standpoint, sharing that data with OEMs can be a trivial matter of giving them access to a data stream in the cloud. No fuss, no hardware, and (assuming sufficient security and access control, of course) no muss.

There is even evidence that close data-sharing between partners throughout the supply chain creates more innovation. Haier Group, a home appliance manufacturer based in China, mobilized its supply chain, including CMs, during the pandemic to share information through a homegrown cloud application called COSMOPlat in order to become more responsive to disruption and to seizing new opportunities. According to a report in Harvard Business Review, many of Haier’s CMs experienced dramatic improvements as a result, including reduction of cycle time, reduced procurement costs, and increased customer orders. (Haier is in the process of spinning out a business based on COSMOPlat.)

In our experience, CMs sharing data with their clients is hardly prevalent, despite the benefits.

“OEMs spent 20 years getting rid of manufacturing and building a relatively fragile supply chain and now are wondering and scrambling—‘How do I gain back that visibility?’ It's not an easy question to answer,” Littlefield agrees. In a nutshell, the CMs see their process data as their precious intellectual property. How do they manufacture; who do they manufacture for? That’s considered their special recipe. “They don’t want to let that information out,” he says.

“The issue is that people think their supply chain is their secret sauce,” says Simon Wardley, a researcher at DXC Leading Edge, in a value chain discussion with SAP Insights. Wardley says he saw a vibrant illustration of this pre-pandemic when a number of companies in one industry were exploring the use of blockchain to verify custody of goods so that they could trace the origins of problems.

“There was a lot of resistance,” he recalls, “because companies were concerned about sharing information they thought provided them with a competitive advantage.” In reality, the companies had poor market visibility from their own systems and instead relied on data that they all purchased independently from the same market research company. “They all had the same data, yet they were worried about sharing it via blockchain,” he says.

The same phenomenon exists even with established CM relationships—some spanning 20 years or more—where mistrust can reign. “Contract manufacturers are always fearful that if they share information, that information will be used against them a year or two from now when they’re renegotiating. This is on top of the 2% to 3% cost improvements OEMs typically require annually,” says Littlefield.

Even for the hugest and most powerful brand owners in the world, it’s not so easy to dictate the sharing of data, Littlefield says. Despite recent high-profile disruptions, think of what it would take for Apple to let go of a high-capacity partner like Foxconn, which is based in Taiwan and has roughly 1.3 million employees. This type of reliance gives contractors some leverage in the relationship.

How to build trust with your contract manufacturing network

It’s long past time to get over the oppositional mindset. As noted, if the carrot of innovation value won’t get you over the hump, consider the stick. Germany’s LkSG law covers any business that has operations there, but other EU nations are adding similar requirements. And given those eventual developments, will the United States and North America be far behind? Better to start preparing now.

Here are three strategies that can apply across a business network of suppliers as well as manufacturing partners:

• The OEM/brand owner should offer the CM information of demonstrable value from its own side, says Littlefield. For example, the OEMs generally are situated closer to consumers and understand them better than CMs, he says. But CMs usually have a keen interest in knowing consumers better. OEMs could share some of that data to grease the wheels of mutual trust. Acting first to share data as opposed to strong-arming the CMs to do it is a trust-builder.
• Share technology platforms and process expertise is another “give to get” strategy, says Littlefield. CMs in general are not as sophisticated in their implementation of technology platforms or tools. OEMs could help CM partners improve their own operations by offering to install advanced systems in exchange for more open data-sharing.
• Consider using a contract that formally spells out how the parties will work together in a mutually beneficial way as opposed to just defining a transactional model. For example, a Harvard Business Review article details an approach to contracting that uses a “vested sourcing model,” under which the parties share risk and reward for delivering mutually defined desired outcomes. This new approach stokes feelings of trust, according to the authors.

Taking these steps will bring you closer to true partnership with your CMs—and out of that messy frenemy zone.

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