Page 103 - DMGT545_INTERNATIONAL_BUSINESS

International Business

notes 6.2.4 contract manufacturing

To attempt to have the best of both worlds, more and more companies are adopting an import
strategy which uses contract manufacturing abroad. Instead of simply ordering products as
needed, the company enters into a contract with the foreign supplier, which fixes production
amounts and delivery times and allows the supplier to maintain hands-on management of the
production process. This gives the importer a greater assurance of supply and quality control
while capitalizing on lower wage rates and still limiting the company’s commitment to the
manufacturer and the country of manufacture. This program can be used either to acquire a
lower-cost source of components or for a production base for final assembly of products.

Benefits of Contract Manufacturing

In contractual agreements between a principal and a foreign market-based manufacturer who
produces branded products, both the principal and sub-contractor expect to benefit.
1. For the principal, contract manufacturing offers access to raw materials and cheap labour
supply, flexible production planning, and the opportunity to circumvent restrictive
employment legislation in the host country.
2. For the sub-contractor, there are a number of benefits; the opportunity to create and sustain
additional employment, and manufacture to international standards.
3. In cases where manufactured products are re-exported to third markets, contract
manufacturing is encouraged by the host government as it contributes to improved balance
of trade.

limitations of contract manufacturing

It may be very difficult to find suitable sub-contractors in the host market whose facilities,
equipment and know-how are compatible with the requirements of the principal.

1. The principal may not have direct supervisory control over the manufacturing process.
This can lead to serious problems of quality control.
2. Contract execution and supply of merchandise may be disrupted either by local political
upheavals or industrial relations difficulties in the host market.
3. For a sub-contractor largely dependent on the principal, termination of contract by the
principal could cause short-term difficulties and might lead to bankruptcy in the long
run.

Example: Nike has contracted with a number of factories in south-east Asia to produce
its athletic footwear and it concentrates on marketing.
Bata also contracted with a number of cobblers in India to produce its footwear and concentrate
on marketing.
Mega Toys- a Los Angels based company contracts with Chinese plants to produce toys and
Mega toys concentrates on marketing.

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