What is Subcontracting in Manufacturing? A Guide for Indian MSME Factories

Most Indian manufacturers do not build everything inside their own factory.

Some processes are sent outside. Machining, heat treatment, plating, printing, embroidery, stitching, powder coating, testing, anodizing, packaging. The list depends on the industry, but the pattern is the same.

You send material to a vendor. They perform a process. They return the processed material. You pay them for the service.

That is subcontracting.

It sounds straightforward. In practice, it is one of the hardest workflows to track in a small factory.

Why Manufacturers Subcontract

Subcontracting is not a sign of weakness. It is a practical decision based on:

• Capacity. Your machines are full, so you send overflow work outside.
• Capability. The process requires specialized equipment you do not own (CNC, plating bath, industrial oven).
• Cost. It is cheaper to pay a vendor per piece than to invest in a machine you will use only occasionally.
• Speed. Sending work to multiple vendors in parallel shortens the production cycle.
• Flexibility. You can scale up or down without adding fixed costs.

For MSMEs in clusters like Rajkot, Ludhiana, Coimbatore, and Pune, subcontracting is not an exception. It is how the cluster operates.

The Subcontracting Workflow

A typical subcontracting cycle has five steps:

1. Create the subcontracting order

The factory decides which process to send outside and to which vendor. This should include:

• what items or semi-finished goods are being sent
• what process the vendor will perform
• expected output quantity
• expected return date
• agreed rate per unit or per kg

2. Issue materials to the vendor

Raw materials or semi-finished goods are physically sent to the vendor. This triggers:

• a delivery challan (required under GST for material movement)
• inventory adjustment showing material is "with vendor" (not in your warehouse, not consumed)
• clear record of quantities sent

3. Track pending returns

This is where most factories lose visibility.

Material is at the vendor's premises. The factory needs to know:

• how much material is still pending
• whether the vendor is on schedule
• whether any material was rejected at the vendor's end
• whether additional material needs to be sent

If this tracking happens only on WhatsApp or in someone's memory, delays become invisible until they block dispatch.

4. Receive processed goods

When material comes back from the vendor:

• inspect for quality and quantity
• record the received quantity against the subcontracting order
• update inventory (semi-finished or finished goods are now back in stock)
• note any rejections, shortages, or material loss
• reconcile the difference between what was sent and what was returned

5. Process the vendor's bill

The vendor invoices for the processing work. This needs to be matched against:

• the agreed rate
• the actual quantity received (not sent)
• any deductions for rejections
• GST on the service charge

Why Subcontracting Is Hard to Track

The material is yours, but it is not in your warehouse

This creates an inventory state that Tally and most accounting software do not handle well. The stock is not consumed (you still own it), but it is not available (you cannot use it for another order).

Multiple orders may be at the same vendor simultaneously

A plating vendor may have material from five of your production orders at the same time. Tracking which batch belongs to which order, and which one is delayed, requires order-level visibility.

Rejections and material loss are common

Processes like heat treatment, plating, and machining have yield losses. If a vendor returns 95 pieces out of 100 sent, the factory needs to decide whether those 5 pieces are:

• rejected (vendor's fault, deduct from their bill)
• process loss (expected, built into costing)
• missing (need investigation)

The cost structure is layered

The total cost of a subcontracted component is:

• raw material cost (yours)
• processing charge (vendor's rate)
• transport cost (both ways)
• rejection or rework cost
• GST on the processing charge

If any of these are tracked loosely, the factory's product costing becomes unreliable.

GST and Compliance for Subcontracting

Under Indian GST, subcontracting overlaps with the concept of job work. Key rules:

Delivery challan is mandatory

When sending goods to a subcontractor, you must issue a delivery challan (not a tax invoice). This challan accompanies the goods during transit and must include:

• date and challan number
• GSTIN of sender and recipient
• description of goods
• quantity and value
• HSN code
• reason for transportation (job work)

Return timelines matter

Inputs sent for job work must be returned within 1 year. Capital goods sent for job work must be returned within 3 years. If goods are not returned within these periods, the transaction is treated as a deemed supply, and GST becomes payable.

E-way bill for movement

If the value of goods being sent exceeds Rs 50,000, an e-way bill is required even for job work movement.

ITC on job work charges

The manufacturer can claim input tax credit on the GST charged by the subcontractor for processing services, provided proper invoices and documentation are maintained.

How Factories Currently Track Subcontracting

The Excel method

Most MSMEs use a spreadsheet with columns for:

• vendor name
• material sent
• date sent
• expected return
• date received
• quantity received

This works for low volume. It breaks when:

• multiple items are sent in one lot
• partial returns happen over several days
• the same vendor handles multiple orders
• someone forgets to update the sheet

The Tally method

Tally can handle stock transfers and delivery challans, but it does not naturally support:

• pending return tracking
• order-wise material reconciliation
• vendor performance analysis
• integration with production planning

Subcontracting in Tally usually requires workarounds that become hard to maintain as volume grows.

The WhatsApp method

The purchase team sends photos of the challan to a group, the vendor responds when material is ready, and someone calls to coordinate pickup.

This handles communication but creates no structured record for planning or costing.

What Good Subcontracting Tracking Looks Like

A proper system should let the factory:

1. Create a subcontracting order linked to a production order or sales order
2. Issue materials with automatic inventory adjustment and challan generation
3. See pending quantities by vendor, by order, and by expected date
4. Receive partial or full returns with quality inspection
5. Reconcile sent vs received vs rejected
6. Calculate cost including material, processing charge, and losses
7. Track vendor reliability over time (on-time percentage, rejection rate)

This is not about complex automation. It is about having the basic operating record in one place instead of spread across Excel, WhatsApp, and memory.

Common Subcontracting Patterns by Industry

The workflow is similar across industries. What changes is the specific process and the material characteristics.

Where FactoStack Fits

FactoStack includes job work and subcontracting tracking as part of the production module. You can create subcontracting orders, issue materials with challans, track pending returns, receive processed goods, and reconcile costs in one workflow.

Related Guides

• Job work under GST for manufacturers
• How to run MRP without an SAP budget
• How to track purchase orders, GRN, and vendor payments
• Production order vs work order in manufacturing

Frequently Asked Questions

Subcontracting Is a Core Workflow, Not an Exception

For most Indian MSME manufacturers, subcontracting is not occasional. It is part of how products get made. Treating it as an informal side process, tracked in chat messages and loose spreadsheets, creates blind spots in inventory, costing, and delivery timelines.

The fix is not more spreadsheet discipline. It is a workflow that connects subcontracting to the rest of production planning.

• Production Planning and MRP
• Inventory Management
• Quality Management