Classic Subcontracting – Outsourcing Production
Introduction: This article helps SAP Procurement consultants to understand the difference between classic subcontracting and production outsourcing. It explains associated benefits from business context. Consultants who work on traditional subcontracting process gets more insight in to modern processes.
- External vendor
- External vendor with chargeable components
- External processing
- Inter company
- Toll manufacturing
- Contract manufacturing
The following section explains each of the above scenario in detail
i. Subcontracting with external vendor: It is the allocation by one enterprise, assigning their one portion of a production process under agreement to another enterprise that is having some specialized skills in this process.
Subcontracting is often resorted to by manufacturing companies due to limited in house production
capacities of a part of their Production Processes.
In this scenario, the manufacturer sends Material (Inputs-Raw Material Semi Finished Goods like Spares components etc) from his Stock to the Subcontractor for Job-Work / Processing.
After the Processing the manufacturer receives back the Material in changed form or in other words a different Material or assembled condition.
SAP MM subcontracting process involves sending raw components to a vendor for specific manufacturing processes and receiving the value-added finished material back into inventory.The subcontractor sends the invoice for the job work performed. It is a traditional process of outsourcing. All the transactions with external vendor will happen in ECC itself and no separate instance is required. A Bill of material set up is required for this process and stock tracking will be available in ECC. There is not much financial benefit out of this process but still manufacturer can leverage subcontractor’s specialized skills
ii. Subcontracting with Chargeable components: The Subcontracting with chargeable components solution allows manufacturer to record all transactions with subcontractors under certain requirement act.
In this process, manufacturer provides components to subcontractor on chargeable basis. Subsequently, manufacturer invoices the subcontractor for the chargeable components. On the other end, subcontractor sends invoice for the FG along with chargeable components, after the subcontractor completes the process and sends FG to the manufacturer. Invoice based on component consumption. The components known as “chargeable components.” In the traditional Subcontracting, neither party makes any charge for any components and all the goods issue components at free of cost. SAP offers two ways of handling the invoices for the chargeable components. In one of these methods, the invoices only serve as documentary evidence of the sale of the components and are not actually paid. This document helps to track of components issued to the subcontractor.
Other method called percentage-based offsetting, manufacturer deduct the invoices from the subcontractor from a certain percentage of the invoices that you have sent it, and the subcontractor pays the difference. Stock movement is visible in this process
iii. External processing: In case, certain components subjects to external processing, manufacturer sends particular component to the external vendor/subcontractor to perform the particular operation, thus manufacturer can focus on other important activity and optimize the capacity of the plant. It is a simple form of subcontracting process.The source for this process is the creation of production order and certain operation of the production order which is subject to external processing will be assigned to the purchase requisition and the purchase order will be created based on the purchase requisition.Stock movement is not visible in this processing.
iv. Inter company Subcontracting: In this process, company B acts as a Subcontractor and process components to make a finished product and sends back to company A. vendor plant assignment is required for this process and the components needs to be maintained as valuated in company A and Non-valuated in company B. Finally company B sends invoice to company A for the subcontracting charge.
All the above scenarios applicable to discrete manufacturing industries. It is a standard SAP functionality with minor configuration. component stock is easily traceable and system posts consumption of components immediately upon receipt of FG without further manual interaction. A proper set up of BOM is required for the smooth transaction.
1.) Toll manufacturing
In this process, Company A or Product owner procures raw materials widely known as API (Active Pharmaceutical Ingredients) from its affiliated companies or one of its approved third party suppliers. Some time, company procures from both affiliate and third party. Supplier delivers RAW/API directly to the Company B or Toll manufacturer. The toll manufacturer completes its manufacturing and sends the finished goods to the product owner facility or its distribution warehouse. Finally, the toll manufacturer submits invoice for the toll fee to the product owner. In this, product owner owns complete stock and financial accounting and toll manufacturer Toll manufacturer sends component consumption details to the product owner enables to post RAW/API consumption against FG receipt.
Toll manufacturing is extensively used by pharma industries, where the availability and sourcing of key raw materials and APIs are scattered across different geographical location. It is a not a standard SAP functionality. It is a complex process. Toll manufacturing functionality requires customized code change. It reduces effort of transferring API stock to Toll manufacturer. It gives more cost benefit through toll agreement and tax savings from finance perspective. API stock is difficult to trace and it needs custom development in case of third party toll manufacturer as well consumption of API/RAW against FG receipt.
2.) Contract manufacturing
Contract manufacturing looks similar to toll manufacturing, but it involves complete delegation of manufacturing process including RAW/API sourcing to the third party vendor who specialize in the particular product. Company A or Product owner procures Finished product from one of its approved third party contract manufacturer. Contract manufacturer procures RAW/API from its own source and manufacture complete product and delivers to Product owner company. It also sends finished product to the product owner designated warehouse. Finally, the contract manufacturer submits invoice to the product owner. In this, product owner owns final finished product and pays to contract manufacturer.
Contract manufacturing is extensively used by pharma and Consumer industries. Unlike toll manufacturing, it is not a complex process. It gives cost benefit and product owner focus on product marketing. SAP SCM solution suits for this type of contract manufacturing where product owner and contract manufacturer finds real time collaboration. It gives visibility of inventory at contract manufacturer’s end
Conclusion: This article explained the process overview related to various outsourcing in SAP procurement. I believe, it will provide sufficient information to the readers. Please contact in case of any queries and clarifications.
Mohamed Hasan Rifaie M, a Lead consultant at Larsen & Toubro Infotech Ltd (LTI) with overall 18 years experience, out of which around 12 years in SAP P2P, WM, SCM, SRM, Ariba Integration and exposure in to Utilities, Media, Food/Chemical, Pharma industries. He has business experience in Manufacturing, Electro-mechanical and Process industries as a Procurement Executive.