The factory system is a method of manufacturing whereby workers and manufacturing equipment are centralized in a factory, the work is supervised and structured through a division of labor, and the manufacturing process is mechanized. Because of the high capital cost of machinery and factory buildings, factories are typically privately owned by wealthy individuals or corporations who employ the operative labor. Use of machinery with the division of labor reduced the required skill-level of workers and also increased the output per worker.

The factory system was first adopted by successive entrepreneurs in Britain at the beginning of the Industrial Revolution in the late-eighteenth century and later spread around the world. It replaced the putting-out system (domestic system). The main characteristic of the factory system is the use of machinery, originally powered by water or steam and later by electricity. Other characteristics of the system mostly derive from the use of machinery or economies of scale, the centralization of factories, and standardization of interchangeable parts.

The defining characteristics of the factory system are:

Workers were paid either daily wages or for piece work, either in the form of money or some combination of money, housing, meals and goods from a company store (the truck system). Piece work presented accounting difficulties, especially as volumes increased and workers did a narrower scope of work on each piece. Piece work went out of favor with the advent of the production line, which was designed by factory staff on standard times for each operation in the sequence, and workers had to keep up with the work flow.

Critics of the factory system have associated it with the other example of bulk human-labor organisation of its era—slavery.

In Ancient Sumer around 3000 BC, the Ancient Mesopotamian economy began to develop a version of the factory system that also featured the division of labor.

One of the earliest factories was John Lombe's water-powered silk mill at Derby, operational by 1721. By 1746, an integrated brass mill was working at Warmley near Bristol. Raw material went in at one end, was smelted into brass and was turned into pans, pins, wire, and other goods. Housing was provided for workers on site. Other prominent early industrialists who adopted the factory system included Josiah Wedgwood (1730–1795) in Staffordshire and Matthew Boulton (1728–1809) at his Soho Manufactory (1766–1848).

The factory system began widespread use somewhat later when cotton-spinning was mechanized by a series of inventors.