Definition Toll Manufacturing

An arrangement in which a company (which has specialized equipment, knowledge, know-how)

processes raw materials or semifinished goods for another company.
In todays corporate environment, many companies consider toll manufacturing arrangements in
emerging market countries to reduce costs while maintaining access to a highly educated and
technologically advanced work force. Toll manufacturing can allow a company to realize cost savings
by outsourcing functions to highly specialized service providers in lower cost jurisdictions.
While toll manufacturing can provide companies with valuable bottom-line drivers in their production
pipelines, it presents unique risks for the potential loss of trade secrets and the enablement of a new
competitor.
The general benefits and risks of a toll manufacturing arrangement -

Due diligence measures to carry out before entering into any toll manufacturing transaction.
How a company can strategically structure a toll manufacturing arrangement?
Practical and contractual protective measures and controls to secure trade secrets and
technological assets.
An overview of other key contractual provisions to include in a toll manufacturing
agreement.

In a toll manufacturing arrangement, a company provides its raw materials or semifinished goods to a third-party service provider. The service provider, who often has specialized
equipment or infrastructure, provides a subset of manufacturing processes on behalf of the company
using those materials or goods for a fee.
Some toll manufacturing related important terms Plant: A manufacturing site.
Bonded Warehouse: A warehouse where goods are physically stored in country, but have not yet
been imported. (the custom charges or duties have not been paid) Once the goods are released for
sale, the customs duties will be paid.
Affiliate: Company commercial legal entity within a country that distributes goods to third party
distributors and end customers within its country borders.
Third Party: An entity external to your company. This term may reference both third party suppliers
and third party customers.
Toll manufacturer: A company manufacturing site that processes raw materials or semi-finished
goods. Company maintains ownership of some or all of the raw material or semi-finished inputs, as
well as the finished goods inventory. The toll manufacturer will charge a fee for processing (toll) to
the company.
Contract manufacturer: A companys manufacturing site that processes raw materials or semifinished goods, and sells the finished goods output to another companys legal entity. The contract

manufacturer regularly procures the components which are required for producing the final product.

Subcontract manufacturer: A third party manufacturing site that processes raw materials or semifinished goods for the company. The company maintains ownership of some or all of the raw material
or semi-finished inputs, as well as the finished goods inventory. The subcontract manufacturer will
charge to the company a fee for processing (subcontracting charge).
Direct Ship: Refers to the inter-company delivery scenario where the manufacturing site physically
ships the goods directly to the final inter-company recipient, while the logical delivery (funds flow) is
routed via the trading company.
Inter-company contract manufacturing: Refers to scenarios where material is procured from
another legal entity of your company. The process will trigger inter-company invoicing in the
background.
Inter-company toll manufacturing: Refers to scenarios where a service is performed on a
customer's process, for a fee. In these scenarios, the Customer and Supplier are two different
company legal entities. After the service is completed, the process will trigger inter-company
invoicing in the background.
Third Party contract manufacturing: Refers to scenarios where material is procured from an
external Supplier.
Third Party subcontract manufacturing: Refers to scenarios where a service is performed on a
customer's process, for a fee. In these scenarios, the Customer is a legal entity, and the Supplier is
an external entity.
Supply from another division: Refers to scenarios where material is procured from another
companys division.
Supply from another affiliate: Refers to scenarios where material is procured from another
companys affiliate. Today this process is referred to as re-positioning.
Trading Terms / INCOTERMS: INCOTERMS refer to globally recognized standard agreements for
the purchase and shipping of goods internationally. There are 11 different official terms, governed by
the International Chamber of Commerce, and provide internationally accepted definitions and rules
of interpretation for common commercial terms. INCOTERMS regulate responsibility for the costs,
transition of the risks, and delivery place in international shipping transactions.
HOME

5: Toll Manufacturing Basic Concepts (SAP way)

Here are some of the crucial steps that one should carry out to have basic Toll Manufacturing setup
done in SAP ERP.
Planning Phase
End customer should plan the net requirement for Finished Product based on the forecast

The net requirements generate Component Requirements at inter-company packager based

on the Bill of Material

The Components net requirement is sent to another packager or Vendor when Component is
sourced from an outside vendor

Execution Phase: Supply Free of Charge Component

Depending on components minimum lot size / order quantity and lead time, Toll Manufacturer
places a free of charge purchase order to vendor

Then vendor purchases the component from another inter-company vendor or 3rd party
vendor

Upon shipment (mostly direct delivery from the vendor), vendor posts the total quantity to the
vendor stock and does not bill Toll Manufacturer for the shipped goods

Execution Phase: Supply Finished Product to End Customer

Depending on the Finished Products minimum lot size / order quantity and lead time, End
Customer places a purchase order to company

Company purchases the Finished Product from Toll Manufacturer

Company runs PO Adjustment Report to clear the difference between the planned and actual
consumption per batch / order.

Toll Manufacturer produces the Finished Product

Upon statistical Goods Receipt, customer reduces the vendor stock based on the planned
Component consumption according to BOM for the Finished Product. Toll Manufacturer bills
company only the Toll Fee.

Pre-requisites for Provision of FoC Component to Toll Manufacturer

Toll Manufacturer creates the Purchase Order with a special PO Document Type (example
ZTOLL)

PO Document type is converted to a special Sales Document Type (example ZSTL).

Company Sales Order should have partner function VN that points to the Toll Manufacturer.
Goods Receipts at Toll Manufacturer must be done via VL32N.
No MIGO bookings are allowed!

Provision of FoC (free-of-charge) Component to Toll Manufacturer

After Goods Issue is posted at SAP, the delivered quantity is added to the component stock at
SAP:

Pre-requisites for Toll Manufacturing of FDF / Bulk from FoC Component

Material Master

o Free of Charge Component MRP view set up

o Finished Product Sales Organization View 2
o Finished Product and Free of Charge Component are defined in the correct plant(s) and
storage location level

Purchase Info Record

o Finished Product Sub Contracting

Source List

o Finished Product is linked to the correct vendor

BOM

o BOM must be maintained at SAP

Toll Fee (depends on End Customer)

o Toll Fee must be maintained at Toll Manufacturer

1. When company places the order to Toll Manufacturer, PO calculates the quantity of
Component to be used based on BOM:

BOM information maintained in Companys PO: If BOM is not available in Company profile, PO
will not be created!

2. Toll Manufacturer produces Finished Product and ships it to the customer.

3. As soon as Goods Issue is posted at Toll Manufacturer, the following bookings are done
automatically:
3.1 Inbound from the vendor is created and GR is posted.
3.2 After Goods Receipt is posted, Component stock is decreased accordingly (as per BOM).

HOME
6: SAP Toll Reconciliation
Here are some of the crucial steps that one should carry out to have Toll Reconciliation verification
in SAP ERP.
At least monthly reconciliation of logical component stock vs. physical component stock is required.

Toll Reconciliation includes:

1. Component consumption for shipped Finished Products
2. Component consumption for Other Usage (samples, scrapings, write-offs)
1. Component consumption for shipped Finished Products
Actual consumption at production plant and planned consumption at company level should be
compared and adjusted. Adjustment is done on PO basis.

All process orders related to the shipped orders must have Final Delivery Flag on.
After PO adjustment is done, Component stock at company level is recalculated.

2. Component consumption for Other Usage WIPx (samples, scrapings, write-off)

Other Usage Consumption is indicated in Toll Reconciliation Report as WIPx. It captures component
consumption related to samples (both FDF and components), scrapings, write-offs*

*Write-offs include all cases related to physical destruction of the goods at Toll Manufacturer. All
such cases must be approved by Owner of the FoC Components as per defined Write-Off Approval
Process. Destruction can be done only after it is approved by the Owner of the Components.
As soon as PO Adjustments and Other Usage Consumption are booked, Toll Reconciliation is
complete.

HOME
7: External Subcontracting Bird View
Heres pictorial view of high level events for an external subcontracting scenario.
Events
1. Warehouse clerk does stock transfer for respective subcontractor. (subcontracting material is
procured and posted)
2. Buyer creates subcontracting purchase order.
3. Subcontracting PO gets approval and same PO information is transmitted to Vendor.
4. Warehouse clerk created delivery request with respect to subcontracting purchase order
created on step 2.
5. Warehouse clerk picks up the delivery list and confirms the same.
6. Delivery confirmation initiates PGI (post goods issue) and hence a delivery note is sent by a
vendor.
7. Once material is received at docking location, good receipt is done and then it goes for a
quality inspection.
8. Quality inspection is done and result records updated with a digital signature.
9. Same time during goods receipt respective inventory GR/IR subcontracting is done.
10. Once invoice receipt is done in finance it will be sent to a respective vendor.

HOME
8: Internal Subcontracting Bird View
Heres pictorial view of high level events for an internal subcontracting scenario.
Events
1. Production order created.
2. MRP (material requirement planning) is done and MRP list is generated and saved in SAP.
3. Sales order entry is maintained by sales administration when product is bought. Customer can
confirm or reject order that has been placed by sales administration team.
4. This information goes back and updates MRP planning data.
5. Planned orders converted to process orders.
6. ATP (available to promise) check is carried out and ATP quantities are updated.
7. After process order the confirmation is sent to sales administration team, who follow the
delivery creation request.
8. Warehouse updates picking and inventory consumption cost along with stock quantities.
9. PGI (post goods issue) triggers delivery note to customer and same time updates inventory
COGS (cost of goods sold).
10. Sales team carries out finance posting and hence a final billing statement is sent to a
respective customer.

HOME
9: Summary
In this article, we understood the various aspects of Toll Manufacturing covering basic concepts, explanation of
common toll manufacturing terms, benefits, risks, due diligence, roles and responsibilities at different
organizational levels. Also we have covered the most critical pieces of Toll Manufacturing i.e. Toll reconciliation,
allied SAP checkpoints and configurations, internal and external toll manufacturing important events and related
interaction with different business stakeholders.
Hope you found this document relevant and useful!!!

HOME