The benefits of co-manufacturing can range from cutting costs to quickening innovation – but larger food companies in Europe seemingly use the practice less than peers in North America. Simon Creasey explores.
In Europe it’s an unspoken secret. Some big food groups use it, but few admit to it largely because they don’t want their competitors or customers to know. However, in North America it’s common practice. Pretty much all the big food groups use it and they’re not ashamed to admit it. What’s the ‘it’ in question? Co-manufacturing.
Co-manufacturing is when a brand owner outsources the production – and usually the packaging – of a product or range of products to a third-party manufacturer. In North America, the practice is so widespread hundreds of companies have been founded to service this market.
But what are the benefits of taking this approach – and the pitfalls? And could co-manufacturing ever take off in Europe on the same scale as it has in the North America?
Establishing the size of the market for co-manufacturing in Europe isn’t easy. What we do know is the size of the market in North America. According to the Contract Packaging Association’s annual State of the Industry report the North America contract packaging and contract manufacturing sector was worth $53.6bn at year end 2017 and is forecast to break the $75bn mark by 2020.
The figures tally with the findings of AlixPartners, which recently compared the growth rates of US food contract manufacturers to the general growth of US consumer product companies.
“What we found is that contract manufacturers in the food sector have grown at five to six times the pace of the consumer product sector that they serve and it’s our belief that it [growth] will strengthen further and accelerate over the next couple of years,” explains Andrew Csicsila, managing director at AlixPartners.
Why is co-manufacturing growing?
Csicsila says a number of factors are driving growth in the co-manufacturing sector, with the pursuit of margins by the big food groups being a significant contributor.
“If you look at it from the lens of the CPG companies, what we’re seeing is a large number of businesses, like PepsiCo, Nestlé, Mondelez International and Kraft Heinz, are actually closing a lot of facilities and they’re reducing that capex spend. A lot of CPG companies are looking to free up operating cash to fund growth and one way to do that is to really take out the overhead and the responsibility of running manufacturing facilities.” Csicila asserts that by taking this approach and outsourcing manufacturing to co-manufacturers brand owners are able to free up “anywhere from 17-23% operating cash”.
Although Csicsila doesn’t have any hard and fast figures about the scale of co-manufacturing undertaken by food companies in Europe, he thinks many of the global groups that use co-manufacturing in North America will also be taking advantage of it in Europe.
“I would imagine that the global CPG groups have a global strategy in their supply chain and if they’re consistent with their supply chain strategy globally and if they’re doing it [co-manufacturing] in North America, the odds are they’re also doing it in other parts of the world,” he says.
However, Csicsila suspects for the time being at least the use of co-manufacturing in Europe by the big food groups is not on the same scale as in the North America. The reason it’s not as widely embraced could be due to a number of different factors.
“I think it may have to do with the fact that own-label penetration is much lower in the US, so therefore there is less inclination to make own label, which is the default choice for small manufacturers in Europe,” says Martin Deboo, consumer goods analyst at Jefferies International. “My instinct is it’s still seen by branded players as a very peripheral activity to be considered only on lines which are very fringe to their production. So when it is done [by European food groups] it is short-run length, relatively low-margin stuff.”
Another reason it’s hard to quantify how large the co-manufacturing market is in Europe is reputational risk, which is why food brands are reluctant to reveal if they use co-manufacturers.
“You don’t want the public to know some of your leading brands are being produced by third-party manufacturers because of the risks in terms of quality and the risk of your competitors using that information against you,” says Csicsila.
Although the food groups may not want to openly talk about this issue, Csicsila adds there is a fairly easy way of establishing which companies are taking advantage of co-manufacturing.
“When you read about a company undergoing a transformation so that it can push a lot of speed to market and innovation, that’s usually a flag to tell me that ‘a third-party manufacturer will be more responsive than our own facility’,” Csicsila asserts. “The other question I always ask is ‘how is someone able to close plants, yet still meet production?'”
Only some food companies openly talk
just-food tried to put questions like this to a number of leading global food companies, in addition to co-manufacturing operators in North America and the UK. Unfortunately the vast majority of them either failed to reply or declined to comment.
One that did respond was Nestlé. In a statement, a spokesperson for the company said: “Our operations already use third parties to support accelerated product launch, provide additional capacity needs and to better service our customers. However, we do not communicate on the extent to which we use third-party manufacturing, its evolution or the names of suppliers.”
PepsiCo was more forthcoming. Paul Campbell, supply chain senior vice president for PepsiCo’s business in Europe and sub-Saharan Africa, was happy to spell out the benefits of using co-manufacturing.
“The need for faster speed to market for our innovations, additional capability to harness the latest consumer trends and solutions to meet the more complex requirements of channel partners means co-manufacturing provides us with an alternative way to expand into new categories, channels and markets,” Campbell says. “Co-manufacturing provides us with many benefits including being able to leverage knowledge and technology we may not already have in-house, which in turn allows us to focus investment on areas of our own supply chain where we have proprietary technology or ingredients.”
He adds that through co-manufacturing PepsiCo has also been able to further explore ways of enhancing its packaging and product sustainability.
There are a number of additional benefits food companies can enjoy when they use co-manufacturers, according to a spokesperson for Hearthside Food Solutions, a US-based food contract manufacturer operating 38 production locations, including four in Europe.
“In an era of SKU proliferation, it enables food companies to meet expanding omni-channel requirements,” says Melville. “It allows brands to meet increasing shelf competition, drives and enables greater R&D and innovation, and can be cost-saving as well.”
He adds co-manufacturing is far from a new trend. “Examples of contract packaging and manufacturing go back well over 50 years. In the recent years, it has expanded to meet the evolving needs of food companies. Once a tactical necessity, it is now a strategic function integrated into the value chains of food and CPG companies of all sizes.”
Co-manufacturing varies by category
As well as being more of a mature sector in North America, co-manufacturing is more established and more prevalent in some food categories than in others, according to Hamish Renton, managing director of UK food and drink consultancy HRA Global, who uses the term ‘co-packing’ to describe the process of contract manufacturing and packing.
“The presence or absence of co-packing can give you a clue as to the amount of innovation in a category because what co-pack does is it lowers the barriers to entry in a certain category and makes the overall market more competitive, which has the effect of hammering down on own label and therefore there are more brands, more innovation and the category tends to grow,” says Renton. “So, co-packers have a benevolent effect on a) innovation and b) the growth of a category because they stimulate competition and competition brings in new shoppers because it unleashes all sorts of forces.”
It’s a view shared by AlixPartners’ Csicsila, who says many food groups use co-manufacturing to bring innovation to market more quickly and cheaply.
“You may not have the necessary capacity or the infrastructure to support this innovation, so you can outsource to a third-party manufacturer and work with them to get this to market quickly,” says Csicsila. “The other times CPGs might want to work with third-party manufacturers is when you just want to focus on high-running, less-complex products and you want to outsource your low-volume, high-complexity products and really put that burden on them. High change-overs and low runs are the things third-party manufacturers do for a living and are really good at.”
Csicsila says many relationships between CPG companies and co-manufacturers are long-standing and are based on trust. It’s an ingredient PepsiCo’s Campbell thinks is vital for a co-manufacturing partnership to thrive. “Critical to the success of all co-manufacturing relationships are of course fundamentals, such as ensuring our partners can match the high quality and food safety standards we set, but in addition trust, transparency and shared planning is essential to ensure the partnership develops around future shared goals and with mutual benefit.
The risks of outsourcing
Even with these ingredients in place there are still risks associated with big food companies outsourcing production to co-manufacturers. Quality control is one of the key things to consider.
“‘Do I want to put my brand’s reputation at risk by getting someone else to manufacture it?’,” Csicsila says, putting forward a question food company executives may ask themselves. “That’s naturally the first question and it’s the one thing that is always going to be top of mind for companies. ‘Am I going to lose control of the quality of my product, is my contract manufacturer going to be able to produce to the same standards as my production?’ There are always risks, but I think that contract manufacturers have evolved to the point that they are on a par with or even better than some of the existing facilities of CPG companies. That’s evidenced in the growth rates they’re [co-manufacturers] enjoying.”
But no matter how good the third-party manufacturer is “you’re not living their moments and they don’t necessarily have the same sense of customer and the importance of the customer as the brand does,” argues Julian Mosquera, a director at Netherlands-based management consultants BearingPoint. As a result, brand owners need to mitigate these risks by putting robust quality assurance protocols in place.
“Ultimately it is the principal manufacturers’ responsibility to do the due diligence and ensure the quality standards [provided by the co-manufacturer] reflect the consumer expectations and the brand needs of their business. What I find shocking is the degree to which that actually is not in place,” says Mosquera. “When they enter into this sort of relationship the principle manufacturer needs to ensure their audit standards are well practised and well understood by the co-manufacturer and if not they shouldn’t be a partner because this is where it all goes wrong.”
One significant hurdle some food companies struggle with is the possibility some co-manufacturers that specialise in certain product categories may well be producing goods for rival companies. To assuage these concerns, Csicsila says contract manufacturers do a good job of partitioning out facilities and sometimes even use different teams for the production of different brands. A further mental obstacle associated with outsourcing to a third-party manufacturer is the potential loss of intellectual property.
“The risk you have to consider is ‘will my IP get leaked to another company who will use it to create a private label or store brand knockoff?'” says Csicsila. “You’re usually able to decipher most ingredients in products, but there is always 5-10% of the ingredients that you just don’t know. That could be a binding agent in a candy bar or a nutritional bar, for instance. There’s a heavy emphasis on ‘if I give you my product, you will not for a period of three to four years, produce a similar product’. There are a lot of guardrails put in place [by the food groups] to protect IP.”
Such considerations help to allay any lingering fears and give the big food companies reassurance they can safely use the services of co-manufacturers. The benefits many North American food groups are enjoying from utilising co-manufacturers is something Deboo thinks more and more European food companies will find increasingly compelling in the future.
“European food companies are under big pressures to liberate cost and cash and co-manufacturing does both,” says Deboo. “Also I think as the food market becomes more fragmented there is going to be more short-run-length manufacture and therefore more room for co-manufacturers to come in.”
Mosquera agrees. “Co-manufacturing is a way of getting to scale, it’s a way of flexing and a way of getting investment in areas you are unable to invest in, so I think it can only grow in Europe.”