Purchasing Contractors - Developing Contract Manufacturing Agreements in the Food Industry



Title:        “Developing Contract Manufacturing Agreements in the Food Industry”

 

Article Summary

This article describes a contracting procedure as applied by a Greek Subsidiary of a large multinational. The company is a leader with a tradition of more than 80 years in olive oil related products. Today, its product portfolio includes a wide range of edibles, such as oleaginous and culinary products, frozen food and beverages.

Over the last years, it has started the implementation of a contracting procedure with manufacturers of finished products. These producers have full control of most supply chain activities. Outcome of the contracting procedure is long-term agreements with local enterprises/contractors.  Contractors are responsible for the whole value chain of the product they produce, with the exception of marketing and distribution. The most common supply chain activities controlled by a typical contractor are:

• Preparation of the mutually agreed product recipe.
• Supply of raw materials especially from local sources.
• Supply of packaging materials.
• Product manufacturing.
• Control of process and product quality.
• Order fulfillment and delivery.

Contracting should fit into strategic business sourcing considerations, as well as be in line with company’s quality, environmental, and safety policies. Moreover contracting arrangements must respect the relevant guidelines and policies of the particular business unit (culinary, frozen foods, margarines etc).

A proactive approach has been adopted by the company to maintain the highest product value for customers. This approach involves a thorough and sophisticated procedure to approve a new contractor and frequent improvement reviews with existing contractors. By setting appropriate quality standards and by helping the contractor to attain these standards, the company ensures that the contractor delivers products of the highest value with the minimum supervision. For example, contractors have full purchasing authority; except for few critical supplies (e.g. food additives) which are jointly approved by the company buying group and by contractor supply units. In theory, every company product line can be contracted to a contractor. However, there are some considerations taken into account (more effective utilization of Elais production capacity, loss of core competencies, profitability of outsourced product line) in the make or buy decision.

The contracting procedure is dynamic in nature consisting of a number of stages and possible iterations as shown in figure 1. The boxes with bold text show the main stages of the contracting procedure.

Screening the market

Initial shortlist

Making initial contact

Final shortlist

Auditing & selecting

Status C: Rejected

Status B1: Corrective actions

Status B2: Re-audit

Status A: Making the contract

Relationship Management

 

 

Figure 1: Flowchart of the contracting procedure

Stage 1 – Company Buying Group Searches Supply Market 

The usual sourcing methods (trade exhibitions, catalogues, other group companies, web search, etc) are applied. Preliminary information (production capacity, quality policies, material specifications, supplier performance measurement, financial information, ownership status  etc.) is collected on the contractor using a “pre-audit questionnaire”, which is usually sent for completion to potential companies.

Stage 2 - Company Buying Group evaluates potential contractors

A cross-functional team (members from Commercial, Development and Technical functions) led by the "contractor manager" evaluate potential contractors as to their capability to fulfill company requirements, and their willingness for co-operation. The contractor manager is normally a senior buyer. A secrecy agreement may be signed at this stage. Moreover, product specifications, production trials or transport tests (secondary packaging, pallet loads etc.) may be agreed upon. The team produces a final shortlist of potential contractors.

Stage 3 – Team audits potential contractors

The purpose of the audit is to assess the compliance of contractors to company standards, and to help them improve various aspects of their operations.

Audit duration and audit team makeup depends on risk assessment considerations, based on:

o   Product safety risk (e.g. microbiological hazards).

o   Product quality risk (e.g. spoilage, organoleptic).

o   Contractor risk (reliability record on quality and delivery, financial stability).

o   Company financial risk undertaking.

Audit criteria include three categories: technical (organizational roles and responsibilities, systems and procedures for product development, commissioning of raw products etc.), commercial (prices, partial cost breakdowns, raw materials costs, production cost etc.) and strategic (capacity, market position etc.).

The outcome of the audit is a ranking of potential contractor according to the following scheme:

A: approved/fully satisfactory

B1: Conditionally approved/satisfactory

B2: Not approved/unsatisfactory

C: Rejected/ High risk

Depending on the final rating, a corrective action plan is agreed upon, which is aimed to eliminate deviations from approved company standards. Company assists contractors to improve either by training or by capital equipment exchange.

Stage 4 - Company Buying Group draws the contract

When the potential contractor is selected for cooperation, a formal contract is drawn. The contract is split in a legal/commercial contract and a technical document, which specifies the following: responsibilities and authority, formulas for performance metrics, raw materials, ingredients and packaging, estimates of orders etc.

Stage 5 – Company Buying Group manages the relationship 

Contractor performance is monitored through periodic reviews. In these reviews, continuous improvement plans are devised.

As relation develops and function-to-function communications expand between the two companies, a “relationship coordinator” keeps track and coordinates all co-operation activities. This function is assigned to the Company Buying Group. The role of the “relationship coordinator” is to compromise and resolve misunderstandings and cope with changes in delivery schedules and quality specifications, material shortages, order volume variations, etc.

Recorded Benefits

The application of the contracting procedure has been found beneficial for both the company and contractors.

For the Company	For the Contractor
·         Product quality improves ·         Product recalls reduce ·         Product price reduces ·         Product portfolio expands with minimum capital ·         Number of contractors reduce ·         Technical skills and competencies grow.	·         Workload is guaranteed for long periods ·         Growth opportunities appear ·         Managerial/organizational competencies grow ·         Improvements are gained in technical areas