Choosing Between Licensing and Contract Manufacturing: What You Need to Know 

Choosing Between Licensing and Contract Manufacturing: What You Need to Know 

Written By
Joy Cunanan
Updated on
May 6, 2024
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If you’re a business owner looking to expand your product line or bring a new product to a market, you may be considering licensing or contract manufacturing as two potential avenues for production. While both options can be effective ways to scale your business and increase revenue, they differ in key ways that are important to understand before making a decision - as choosing the wrong option can have serious implications for your business, both from a legal and financial standpoint.

In this article, we'll explore the differences between licensing and contract manufacturing, the benefits and drawbacks of each, and how to determine which option is right for your business. 

Whether you're a startup or an established company, this information can help you make an informed decision and help you avoid costly mistakes, such as entering into an unfavourable licensing agreement or choosing a contract manufacturer that doesn't meet your quality standards.

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What Is Licensing?

Licensing is a legal agreement between two parties that grants permission to use certain intellectual property, such as patents, trademarks, copyrights, or trade secrets, in exchange for a fee or royalty. In this arrangement, the owner of the intellectual property (licensor) grants permission to another party (licensee) to use their property in a certain way or for a certain period of time, usually with specific terms and conditions outlined in a contract.

Here are some real-world examples of licensing:

  • A technology company licences its software to another business for distribution or use.
  • A well-known celebrity licences their name or image to a fashion company to create a clothing line.
  • A toy manufacturer licences a popular children's cartoon character to create a line of toys.
  • A publishing company licences a popular book series to a movie studio for adaptation into a film franchise.
  • An artist licences their artwork to a company to use on products such as calendars, greeting cards, or posters.

These are just a few examples of how licensing can be used to create new revenue streams and expand product offerings without investing in production or distribution. 

However, licensing also means giving up some control over your intellectual property, as the licensee is given permission to use and potentially modify it in certain ways. 

It is crucial for both parties to carefully negotiate and outline the terms of the licence agreement to ensure that their rights and responsibilities are clearly defined and protected. Check out how you can avoid contract irregularities with a reliable contract management software, or choose the right CMS software here

What Is Contract Manufacturing?

On the other hand, contract manufacturing involves hiring a third party to produce your product according to your specifications. This can give you more control over the production process, but it also requires more upfront investment and carries more risk.

Contract manufacturing is in essence a business arrangement where a company hires another company, known as the contract manufacturer, to produce a specific product according to the hiring company's specifications. In this arrangement, the hiring company retains ownership of the product and is responsible for marketing, sales, and distribution.

Contract manufacturing is a common practice in many industries, and there are numerous examples of companies that use this production strategy. Here are some real-world examples:

  • Apple - Apple relies on contract manufacturers, such as Foxconn, Pegatron, and Wistron, to produce its iPhones, iPads, and other products. These manufacturers build the products according to Apple's specifications and design, and Apple handles the marketing, sales, and distribution.
  • Nike - Nike uses contract manufacturers to produce its shoes and apparel, outsourcing the manufacturing process to companies in countries like China, Vietnam, and Indonesia. Nike provides the design and specifications, and the manufacturers handle the production and shipping.
  • Nestle - Nestle outsources the production of its products, such as coffee, chocolate, and infant formula, to contract manufacturers. These manufacturers produce the products according to Nestle's specifications and quality standards, and Nestle handles branding, marketing, and distribution.
  • Coca-Cola - Coca-Cola has contract manufacturers in various parts of the world to produce its beverages. The manufacturers are responsible for sourcing the raw materials, producing the beverages according to Coca-Cola's formula and quality standards, and packaging the products. Coca-Cola then handles the branding, marketing, and distribution.

It is often used by companies that do not have the resources, equipment, or expertise to produce a product themselves, but still want to bring it to market. The contract manufacturer is responsible for sourcing materials, manufacturing the product according to the hiring company's specifications, and ensuring quality control standards are met. 

However, the hiring company may also play a role in the production process by providing guidance and oversight.

The Benefits and Drawbacks

Both licensing and contract manufacturing can be effective production strategies, but they have their own benefits and drawbacks that businesses need to consider before making a decision.

Benefits of Licensing

  • Generates revenue without investing in production equipment or facilities
  • Can help expand product offerings and enter new markets
  • Can provide ongoing revenue through royalties or licensing fees
  • Provides a way to leverage intellectual property and brand recognition

Drawbacks of Licensing

  • Loss of control over how the intellectual property is used
  • Potential risk to brand image and reputation if the licensee doesn't maintain quality standards
  • Limited revenue potential compared to manufacturing and selling products directly
  • Requires careful negotiation and drafting of licence agreements to ensure that rights are protected

Benefits of Contract Manufacturing

  • Allows businesses to leverage the expertise and resources of the contract manufacturer, such as specialised equipment or manufacturing capabilities
  • Provides flexibility in production volume and timing
  • Can reduce upfront investment in production equipment and facilities
  • Allows businesses to focus on marketing, sales, and distribution

Drawbacks of Contract Manufacturing

  • Requires investment in developing and maintaining relationships with contract manufacturers
  • Risk of quality control issues if the manufacturer doesn't meet standards or specifications
  • Potential for production delays or supply chain disruptions
  • Loss of control over production process and intellectual property

Ultimately, the choice between licensing and contract manufacturing will depend on a company's unique situation, goals, and resources. Companies must carefully weigh the pros and cons of each option before settling with one or the other.

Choosing Between Licensing and Contract Manufacturing

Choosing between licensing and contract manufacturing can be a complex decision that requires careful consideration of a company's goals, resources, and intellectual property. 

Here are some questions to ask yourself when deciding between these two production strategies:

  1. What are my goals for this product or intellectual property?

Are you looking to generate revenue without investing in production, or do you want to control the manufacturing process to ensure quality and brand consistency?

  1. What are the potential risks and benefits of each option?

What are the potential financial, legal, and reputational risks of licensing or contract manufacturing? What are the potential benefits in terms of revenue, scalability, and market expansion?

  1. Do I have the necessary resources to manage the production process?

Do you have the internal resources to manage the production process, or will you need to develop relationships with contract manufacturers or licensees?

  1. How important is control over the product or intellectual property?

How important is it to maintain control over the production process or intellectual property? Are there specific quality standards or branding requirements that need to be met?

  1. What are the financial implications of each option?

What are the upfront and ongoing costs of licensing or contract manufacturing? What are the potential revenue streams and profitability of each option?

  1. What are the legal and contractual considerations?

What are the legal and contractual requirements for licensing or contract manufacturing? Do you have the resources to negotiate and manage these contracts effectively?

By asking yourself these questions, you can begin to weigh the pros and cons of each option and make an informed decision that aligns with your business goals and resources. It's important to consult with legal and financial experts to fully understand the implications of each option and ensure that your rights and interests are protected.

Optimize Your Operations With Lexagle

A contract management system (CMS) can be a valuable tool for businesses that are choosing between licensing and contract manufacturing. Firstly, it can help in organising and managing various contract documents that are involved in licensing or contract manufacturing agreements, such as confidentiality agreements, licensing agreements, and manufacturing agreements. 

Secondly, it can help streamline contract negotiations by providing a central location for all parties to access and collaborate on contract documents, reducing the need for back-and-forth communication and version control issues, and more.

Lexagle is a contract management and collaboration tool that helps teams share, track, and manage all company documents, files, and other content in one place. Our contract management system allows teams to easily draft contracts, simultaneously collaborate in real-time, track documents, and manage projects.

If your business is ready for the next step forward in this digital age, contact us for a free demo today. 

Choosing Between Licensing and Contract Manufacturing: What You Need to Know 
Joy Cunanan
Joy is the Digital Transformation Manager at Lexagle. As a marketing professional in the Tech and B2B industry for over seven years, she is always on the lookout for the next best solution in the ever-changing online world. With a passion for helping businesses thrive and optimize operations, she shares her expertise in the power of contract lifecycle management and its capacity of easing the contracting process for busy organizations worldwide.

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