Contract manufacturers, or co-mans, do business in one of two ways: tolling or turnkey. Tolling is what it sounds like. Customers pay a per-unit fee (or “toll”) for the manufacturer to produce their product. The customer supplies all ingredients and packaging components to the manufacturer, who then turns them into the finished goods. Turnkey is also what it sounds like. Customers pay the manufacturer to produce a completed unit for them, all-inclusive (or “turnkey”) — the manufacturer supplies all the materials needed.
A company can find success with either model depending on their goals. I’ve seen success with both models, and have also seen companies find an even better fit with a hybrid model — one that lies somewhere in the middle.
The benefits of a turnkey approach
For a company, choosing between a tolling and turnkey agreement comes down to resourcing as much as strategy. Tolling is largely do-it-yourself outside of the manufacturing piece, requiring the company to source and supply all the materials, and demands more internal resources. Turnkey is more flexible. It can range from a fully hands-off model, where the manufacturer handles everything, to hybrid approaches where the company still owns pieces of sourcing or specification.
Other factors can also influence why a company may opt for a turnkey agreement over a tolling agreement.
Turnkey shortens the cash conversion cycle. Turnkey puts more of the working capital burden on the co-man. Companies will see a shorter cash conversion cycle since they do not have to front cash for ingredients or packaging.
Turnkey can get products to market faster. Tapping into a co-man’s network can greatly reduce the time it takes to bring a product to market. The need to build and qualify new supplier relationships is reduced or eliminated.
Turnkey fills the gap where a procurement function may not yet exist. Early-stage or mid-size brands may not have a fully built out procurement function. They rely on the co-man instead to perform this function. Buyer beware, though, as oftentimes this comes in the form of a fixed fee or markup on ingredients as a service charge. I learned this the hard way several years ago when a product line I converted from tolling to turnkey all of a sudden cost me more, even though I’d turned all my suppliers and contracts over to the co-man. The capital relief was worth it, but I paid for that convenience in ways I hadn’t fully priced in going in.
Turnkey shifts supply risk onto the co-man. Companies are not on the hook for ingredients or materials that don’t arrive. Co-mans manage their own purchasing and deliveries to ensure uptime on their lines. Ingredient and shipping delays are a frequent source of anxiety for any procurement professional. In pure tolling relationships, I’ve lost track of how many times one put us on the verge of downtime and the hoops we had to jump through to convince the co-man to rearrange their schedule to help out. Sometimes that peace of mind is worth it.
Turnkey can mean better pricing through the co-man’s scale. Co-mans may have a larger book of business on the ingredients they’re sourcing than the individual company and can leverage their spend across multiple customers to negotiate better pricing.
A hybrid approach
With full turnkey, the co-man sometimes has little incentive to check market prices, since any cost increases just pass straight through to the customer. For many companies, the optimal approach to a contract manufacturing agreement is hybrid, with the relationship being somewhere on the spectrum between full tolling and full turnkey.
Companies should evaluate their network and do what is ultimately right for them, but could benefit from a hybrid approach in the following ways.
Companies can still combine their own scale where it counts. If a company uses the same ingredient across multiple different co-mans, the company may see cost benefits from combining their full portfolio demand of that ingredient. The company could still rely on the co-man for other ingredients that, due to its scale, it sees better pricing on, getting the best of both worlds.
Owning part of the portfolio is its own risk mitigation. While turnkey allows some of the risk for ingredients to be transferred to the co-man as called out above, there is also beneficial risk mitigation for a company maintaining control over a portion of the portfolio ingredients. They can form and nurture partnerships with suppliers as well as control dual sourcing options for key ingredients.
Key ingredients are worth keeping in-house. For key ingredients (think flavors or a differentiating ingredient) the company can maintain control over the quality as well as keep any proprietary formulations proprietary. I’ve seen this done well through preblends: sending the co-man a proprietary mix already combined (either directly from the supplier or a secondary co-man), instead of handing over the individual ingredients that make it up. It adds a step to the process, but it also means no one outside your walls ever sees the full formula.
Choosing the right model
There’s no universal right answer between tolling, turnkey, and everything in between. The right agreement is the one that matches how much internal resourcing a company actually has today, and how much risk it’s willing to hand off in exchange for speed and capital relief. (For the other half of this decision — who sees your input costs under each model, and who has a reason to fight them — see Tolling vs. Turnkey: Who Sees Your Costs, and Who Fights Them?.) Full turnkey isn’t a shortcut companies grow out of, and full tolling isn’t a badge of control they should aspire to. Most companies land somewhere in the middle, and the smart ones keep re-checking whether that middle is still in the right place as they scale.
