Under contract manufacturing, a company doing international marketing contracts with firms in foreign countries to manufacture or assemble the products while retaining the responsibility of marketing the product. This is a common practice in international business. There are a number of multinationals and affiliates of multinationals which employ this strategy in India in respect of some of the products they market, like Park Davis, Hindustan Lever etc.,
Contract manufacturing has the following advantages:
1. The company does not have to commit resources for setting up production facilities
2. It frees the company from the risks of investing in foreign countries.
3. If idle production capacity is readily available in the foreign country, it enables the marketer to get started immediately.
4. In many cases, the cost of the product obtained by contract manufacturing is lower than if it were manufactured by the international firm. For example, the product cost in the small scale sector is much lower than in the large scale sector for many products because of the lower wages, lower overheads, and tax concessions. Moreover, if excess capacities are available with existing units, it may even be possible to get the product supplied on the marginal cost basis.
5. Contract manufacturing also has the advantage that it is a less risky way to start with. If the business does not pick up sufficiently, dropping it is easy; but if the country had established its own production facilities, the exit would be difficult. It may be interesting to note that the availability of excess capacity with some soap manufacturers enabled several foreign companies to experiment with new brands of toilet soap in the Indian market. For example, Godrej soap manufactured Dettol for Reckitt and Coleman; Clearton for Nichlas Laboratories; Johnsonâ€™s Baby Soap for Johnson and Johnson; and Ponds Dreamflower, Cold Cream and Sandalwood for Ponds. It may be noted that some of these brands have not succeeded in the market. The cost to the company of the product failure is relatively low when it did not invest in production facilities.
6. Moreover, contract manufacturing may enable the international firm to enlist national support.
Contract manufacturing, however, has the following disadvantages:
1. In some cases, there will be the loss of potential profits from manufacturing.
2. Less control over the manufacturing process.
3. Contract manufacturing also has the risk of developing potential competitors.
4. It would not be suitable in cases of high- tech products and cases which involve technical secrets etc.
Under the management contract, the firm providing the management know-how many not has any equity stake in the enterprise being managed. In short, â€œin a management contract the supplier brings together a package of skills that will provide an integrated service to the client without incurring the risk and benefit of ownership. Thus, management contracting is a low-risk method of getting into a foreign market and it starts yielding income right from the beginning. The arrangement is especially attractive if the contracting firm is given an option to purchase some shares in the managed company within a stated period.
Management contract could, sometime, bring in additional benefits for managing a company. It may obtain the business of exporting or selling otherwise of the product of the managed company or supply the inputs required by the managed company.
Management contract enables a firm to commercialize existing know-how that has been built up with significant investments and frequently the impact of fluctuation in business volumes can be reduced by making use of experience personnel who other wise would have to be laid off.
Management contracts have clear benefits for the clients. They can provide organizational skills not available locally, expertise that is immediately available rather than built up, and management assistance in the form of support services that would be difficult and costly to replicate locally.
Management contracts have disadvantages under certain conditions. The arrangement is not sensible if the company can put its scarce management talent to better use, or if there are greater profits to be made by undertaking the whole venture. Management contract may prevent a company from setting up its own operations for a particular period.
One possible risk from the point of view of the client is over dependence and loss of control. The client should enable itself to steadily develop its own capabilities.
Some Indian companies Tata Tea, Harrisons Malayalam and AVT have contracts to manage a number of plantations in Sri Lanka. Tata Tea also has a joint venture in Sri Lanka, namely, Estate Management Services Pvt Ltd.
Turnkey contracts are common in international business in the supply, erection and commissioning of plants, as in the case of oil refineries, steel mills, cement and fertilizer plants etc., construction projects and franchising agreements.
A turnkey operation is an agreement by the seller to supply a buyer with a facility fully equipped and ready to be operated by the buyerâ€™s personnel, who will be trained by the seller. The terms is sometimes used in fast food franchising when a franchiser agrees to select a store site, build the store, equip it, train the franchisee and employees and sometimes arrange for the financing.
Many turnkey contracts involve governments / public sector as buyer or seller in some cases. A turnkey contractor may subcontract different phases/parts of the project.