Franchising and contract manufacturing can be difficult to understand. Contract manufacturing is essentially an outsourcing contract. A company contracts with a manufacturer to make a product for them. Companies that are faced with limited resources and high start-up costs can turn to a third-party manufacturer to address these issues.

Basics of Contract Manufacturing

When looking for a contract manufacturer, businesses need to look for:

  • A clean facility that is well-managed
  • ISO-certified quality standards
  • Good distribution capabilities with the flexibility to handle demand changes
  • Excellent communication with the business
  • Good reputation (especially financially) in the market
  • Ability to solve production problems

There are numerous companies worldwide that handle contract manufacturing. One example is Flextronics Corporation, which makes Xbox games for Microsoft.

There are numerous advantages to outsourcing your manufacturing, such as:

  • Delegating design, production, assembly, and distribution tasks
  • Avoiding risk due to little international investment concerns
  • Being able to assemble product at lower costs
  • Being able to take advantage of local markets
  • Taking advantage of manufacturing knowledge without having to duplicate that yourself (massive cost savings)

There are some disadvantages to contract manufacturing, however. They include:

  • Potential quality control issues by local producers
  • Loss of control over the manufacturing process
  • Sales may not match production
  • Cultural differences, including language barriers

Franchising and Licensing

In a licensing agreement, a business, known as the licensee, pays a license fee (royalty) to a parent company, the licensor, who then gives access to technology, patents, and other trade secrets. In this arrangement, a company can license its manufacturing, enabling another company to make an unlimited number of product copies. The manufacturer assumes all the risk.

This is a good arrangement if you expect to manufacture large product volume. Keep in mind that you will have to make less per product so that the manufacturer makes money as well.

There are disadvantages to licensing, including licensees who begin to market their own product, business secrets that are revealed publicly, and the potential for disagreements between the licensee and licensor.

In a franchise agreement, a business (the franchisee) pays a fee to a parent company (the franchisor), which allows the use of its brand name and logo. The franchisee agrees to abide by quality principles in the product. McDonalds utilizes a franchise agreement with its stores to great success.

Franchising is very affordable and can allow for growth into foreign markets without significant funds. Licensing involves even lower financial risk and takes greater advantage of local business knowledge. In both arrangements, the business is local and runs without international hurdles. Without a license/franchise agreement, no one else is eligible to utilize the business secrets.

Distribution Explained

Being a manufacturer doesn't necessarily mean you are a distributor. If you contract with a manufacturer that can also distribute your product, the licensing agreement should reflect payment even if the contract manufacturer can't move product. If the manufacturer can't distribute, you should use the distribution agreement to sway your manufacturer, showing them a ready market.

Cautionary Words

It's not uncommon to feel nervous about giving your ideas to an outside source. You need to have a solid legal contract detailing your rights and any punitive action you can pursue should an unethical contract manufacturer alter your ideas just enough to make them their own or share with another one of their clients.

Frequently Asked Questions

  • How are commitments and contracts different? Commitments generally are verbal agreements, while contracts are a signed and dated legal document.
  • How are tort and contract damages different? Tort damages restore to position prior to tort and are punitive in nature. Contract damages look to restore to where they would have been had contract been performed or not breached and are not punitive in nature.
  • How are contracts and agreements different? A contract is a legally binding document signaling an agreement between parties. An agreement does not necessarily signal having a contract.
  • How are expand and contract different? When something expands, it grows bigger, while contracting means something get smaller.
  • How are a patent and franchise different? A patent provides an inventor with a monopoly for a specified period of time. Patents may be licensed for use to a franchise.

If you need help with franchising and contract manufacturing, you can post your legal need on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Stripe, and Twilio.