Contract manufacturing in India – regulatory aspects

published on 8 Dezember 2023 | reading time approx. 3 minutes

Contract manufacturing, also known as outsourcing or third-party manufacturing, involves companies engaging a specialised manufacturing firms to produce goods on their behalf. It’s a business agreement where one company pays another to provide the necessary components to assemble finished goods, or even manufacture the product in its entirety.

Suitability of contract manufacturing

In these competitive times, investors are demanding continued high financial and operational performance, under all circumstances. Thus, contract manufacturing should be opted for companies who often don’t have the resources, budget, or staff to manufacture products on their own, especially during expansion into a new geographical territory. Companies could improve their bottom lines, by conversion of their fixed costs into variable costs. They accomplish this by eliminating in-house production capabilities and replacing them with contract manufacturers.

Contract manufacturing may not suit complex or unique products, sensitive Intellectual Property, or strict quality standards. It is unsuitable for products with unpredictable demand cycles, prototyping, and when long-term cost efficiency or strategic control is needed. In-house manufacturing is favoured for greater brand control, effective communication, or due to regulatory compliances.

Benefits of contract manufacturing

Contract manufacturing presents a cost-efficient avenue for businesses, minimising production expenses through economies of scale and access to affordable labour. Leveraging the expertise of specialised manufacturers allows companies to focus on their core competencies, such as marketing and innovation, while benefiting from advanced manufacturing technologies. The flexibility and scalability of contract manufacturing enable quick adjustments to market demands, reducing excess inventory and optimizing resources.

Additionally, it mitigates operational risks and accelerates time-to-market, aiding in global market expansion. Overall, contract manufacturing offers an efficient and strategic approach to production, driving competitiveness and ensuring high-quality products for businesses.

Contract manufacturing in India

There are many market participants in India's contract manufacturing sector, and they provide full manufacturing services for a range of industries. The market for contract manufacturing in India stands at USD 19.63 billion in 2023, and it is estimated to be worth USD 38.92 billion by 2028.

Summary of the advantages of contract manufacturing in India:

Cost-Effectiveness: Lower production costs due to affordable labour and operational expenses.
Favourable demographic profile: Maximum population in the working age group
Skilled Workforce: Abundance of skilled workers across various industries.
Diverse Industry Expertise: Specialised manufacturing across a range of industries.
Government Incentives: Indian government provides various incentives for the manufacturing sector, providing stable growth for manufacturing sector.
Market Access: Ease of access to India’s growing domestic market as well as the Asian and Western markets.

Legal framework in India

The term contract manufacturing has not been defined under laws in India, even though you might find references of contract manufacturing in the certain laws. In simple words, contract manufacturing means outsourcing your manufacturing function to a third party through a legally tenable contract. Certain Indian laws which shall affect contract manufacturing activity in India are:

Indian Contract Act, 1872: Governs basic contract principles.
Income Tax Act, 1961: Regulates income taxation and transfer pricing.
Goods and Services Tax (GST) Act: Governs in-direct taxation and compliance for goods and services.
Intellectual Property Laws such as Patents Act of 1970, Copyright Act of 1957, Trademarks Act of 1999, and Designs Act of 2000 protect intellectual property rights of the owner.
Customs Act, 1962: Regulates import and export of goods.
Foreign Exchange Management Act (FEMA), 1999: Governs foreign exchange transactions.
Environmental Laws such as the Environmental Protection Act of 1986, Water Act of 1974 and Air Act of 1981 shall govern the environmental impact of manufacturing, if any.

Crucial considerations

It is essential for companies looking to engage contract manufacturers to strategically protect their intellectual property and proprietary information which contract manufacturers become privy to. This mitigates the risk of infringement and allows principal companies to retain their competitive edge. Poorly managed intellectual property can lead to serious competition, in some cases from the contract manufacturer itself who may become a competitor, resulting in a diminished market and serious losses for the principal company.

Another critical point is control over the quality. It may be challenging to replicate the in-house quality of your products when you contract manufacture. Hence, it is very important to do the due diligence of the capabilities and capacities of the contract manufacturer before entering into a definitive agreement.

Summary

Contract manufacturing in India offers an attractive proposition for businesses seeking to optimize production processes and leverage cost advantages. Understanding the legal framework, intellectual property considerations, compliance with regulations, and taxation aspects is crucial for a successful contract manufacturing relationship. With careful planning and adherence to legal guidelines, contract manufacturing can be a mutually beneficial arrangement for both parties involved.