This article has been cross-posted at Artful Sourcing.

So, you are an entrepreneur with a great idea, a great design, a surefire business plan, but a limited budget. Surely contract manufacturers will be beating a path to your door to line up to manufacture your product, right?

The cruel reality is that seldom is this the case. Contract manufacturers draw on past experiences with entrepreneurs that were just as excited about their products as you are about yours. Some of those projects turned into winners and the entrepreneur and the CM made good money. Many (most?) of them, however, fell short of expectations. In fact, in some cases, the CM lost a lot of money when the glowing forecasts for 1 million units the first year fizzled. More than one CM has ceased to exist by not exercising caution regarding a customer.

In addition to past experiences, CMs have CFOs and controllers on staff whose job it is to ensure that their firms are not taking inordinate risks. This means that if you hope to secure a quality manufacturer to build your product, you are going to have to be willing to “open the kimono” and reveal the details about your credit and financial situation. The cardinal rule for strong CMs is that they will not assume their customers’ market risk, especially as it relates to inventory. If your business fails, they have to make sure it doesn’t cause theirs to fail.

Example

Your new firm (owned by you and your buddy Fred), Intergalactic Widgets, has just invented a new widget that your market research has indicated every gamer with a game console will just have to buy. You have paid $15,000 to have an engineer complete the drawings and deliver a manufacturing data package from which CMs can quote. A patent attorney has prepared and filed your patent application. You have written a business plan that describes the product, the market, and the non-existent competition. It is a slam dunk, and it is going to make you and the CM a lot of money. You are an evangelist for your widget.

The Bill of Materials (BOM) for the product includes plastic components, electronic components, a cable, and a keypad. The average cost of the BOM, according to the three CMs that quoted the package, is $7.50 at your conservative forecast of 1,000 units a month for the first six months. You figure you can sell your widget, that has no competition, to your distribution network for $20 per unit. They will mark it up and wholesale it to retail outlets.

To prime the pump of the distribution chain, you need your CM to produce 10,000 units right out of the gate. Not considering the upfront costs of tooling and fixturing, the initial inventory alone is going to cost the CM $75,000 ($7.50 X 10,000). Even though Intergalactic Widgets is going to issue a purchase order to the CM for the production of 10,000 units, the CM has no assurance you are going to pay your bill. What happens if you go broke? What happens to the $75,000 worth of inventory? The CM gets stuck with it and usually ends up scrapping the custom parts and selling the standard parts for pennies on the dollar. For these reasons, CMs are very cautious about who they engage with. If the customer is a multi-billion dollar public company that everyone knows, the CM is not going to be that concerned – their PO is going to be fine. This explains why CMs are hardly ever as enthusiastic about your project as you are. They can’t afford to buy the hype. They have to ensure that safeguards are in place.

How can you convince CMs that you are a worthy customer?

The first step to success with a CM is to understand the concerns they are bringing to the potential relationship, as described above. Your interaction with them at every level should indicate an understanding that their financial concerns are legitimate. With that in mind, here are some suggestions to increase your odds of finding a true manufacturing partner:

1. Maintain your optimistic tone about your product, but temper your “irrational exuberance” when interacting with the CM. Be sure they know that you are level-headed and realistic about the challenges of moving into manufacturing. Wild-eyed optimism will be interpreted by many CMs as inexperience and lack of preparation. If your exuberance is ultimately proven by the results to have been justified, everyone will be happy.
2. Similar to the first suggestion, be realistic with your forecasts. If you tell the CM that you are going to sell a million widgets the first month, they are not going to take you seriously. Do a little homework and talk to some entrepreneurs that have taken a product from idea stage to launch. Ask them how their initial forecasts panned out. Were they too optimistic, too pessimistic, or did they get it “just right”? You might prepare your forecasts with three potential outcomes: Conservative, Moderate, and Aggressive. The CM will like to see that you understand the complexities of product launches and that you are level-headed. They can probably offer their experience with other product launches and help you sharpen your forecast.
3. Be flexible with regard to credit terms and inventory risk issues. Again, the CM’s biggest concern is that your business may fail and they may be hurt with inventory that cannot be used and whose value can never be recovered. How can their concerns be addressed? Well, you could always pay cash in advance with your order. That will satisfy most any CM because it eliminates their inventory risk. That is clearly not an arrangement you would want to maintain very long. Your wholesale customers are not going to pay you cash in advance when they order your product, so if you are paying cash for the production and granting 30 or 45 day terms to your customers, you are going to feel the pain. However, it may be possible to negotiate a plan that over some period of time can get you to terms with your CM. This may involve paying cash for a set period of time or for a certain number of units. This should prime the pump of revenues and allow you to start demonstrating a track record for the product. Like a credit card company that slowly raises your credit limit as you pay our bill on time, the CM will have a better idea of where your product and company is headed after a while. When the conversation with your CM turns to credit, tell them you want to work out a plan to grow into credit terms.
4. Be sure you are talking to the right CM. Contract manufacturers come in many different sizes and have many different capabilities. Small entrepreneurs will find it very difficult to get the attention of a large, Tier One CM. These CMs have huge facilities and concentrate on the largest OEM customers. Most of them do have New Product Introduction (NPI) centers, but this is not the best place for entrepreneurs to start. Do a little research on the industry and focus your efforts on CMs whose business model includes a genuine interest in new products and small businesses. See post Finding CMs with the proper capabilities for more on this topic.