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Contract Manufacturing – Advantages and Disadvantages | International Business Management

Contract Manufacturing

The term ‘contract manufacturing’ refers to an international business model in which a company contracts with a local manufacturer in another country to get certain components or goods produced according to its specifications. Contract manufacturing comes in three major forms: 
  • Production of certain components, such as automobile components and shoe uppers. These components can be used to manufacture cars and shoes; 
  • Assembly of components into final products, such as hard drives, motherboards, floppy disk drives, and modem chips in computers;
  •  Complete manufacturing of products, such as garments. 
Local manufacturers produce or assemble the goods according to the technology and management guidelines provided by the foreign company. Local producers make or assemble the goods, which are then delivered to international firms for use in their final products or are sold as finished goods by the international firms under their brand names in other countries, such as the home country and the host country. Today, all major international companies such as Nike, Reebok, Levis and Wrangler have their products or components manufactured in developing countries via contract manufacturing. 

Advantages of Contract Manufacturing

There are several advantages to contract manufacturing for both international companies and local producers in foreign countries. 
  •  International firms can get goods produced on a large scale using contract manufacturing without investing in setting up production facilities. Companies take advantage of the existing production facilities in foreign countries. 
  • There is little to no investment in the foreign countries, so there is little risk associated with foreign investments. 
  • Contract manufacturing also provides the international company with the advantage of getting its products manufactured or assembled at a lower cost, especially if the local manufacturing companies are located in countries with lower labor and material costs.
  •  Contract manufacturing also benefits local producers in foreign countries. Contract manufacturing jobs provide them with a ready market for their products as well as ensuring a greater utilization of their idle production capacity. The Godrej group benefits from contract manufacturing in India in this way. Many multinationals, including Reckitt and Colman, use its soaps including Dettol soap. This has allowed it to utilize excess soap production capacity. 
  • The local firm has the opportunity to participate in international business and to take advantage of any incentives available to export companies if an international company wants to export the goods to its home country or another foreign nation. 

Disdvantages of Contract Manufacturing

Contract manufacturing has the following major disadvantages for international firms and local producers in foreign countries:
  • International firms might suffer serious product quality problems as local firms do not adhere to production design and quality standards. 
  • Because the goods are manufactured strictly in accordance with the contract terms, the local manufacturer in the foreign country loses control over the manufacturing process.
  • Under contract manufacturing, a local firm is not free to sell its output as it sees fit. Predetermined prices are set for the products it has to sell. As a consequence, the local firm is likely to earn lower profits if the open market price for such goods is higher than the price stipulated by contract.

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