Contract manufacturing refers to type of international business where a firm enters into contract with some local manufactures in foreign countries to get certain components of goods produced as per their specifications. It is also called outsourcing. It can take three forms: Getting produced certain parts of final products which will be used for the production of final products later; assembly of components into final products; and complete manufacture of the products like garments.
Merits of Contract manufacturing
1. Less investment: It helps international firms in production of goods at massive scale without making any investment in setting up production facilities. Therefore, it is more suitable for small and medium size manufacturers who can’t undertake 100% or even 50% investment.
2. Less risky: It is less risky as there is little investment involved. Moreover, local manufacturers who have been given specific product design and quality standards do not deviate from them.
3. Low cost: If goods are contracted in low labour and material cost country, then it also gives benefit of low cost. For example, in India labour is very cheap and therefore it has become a favorite destination for contract manufacturing.
4. Better capacity utilization: Local producers benefit get from contract manufacturing because it allows them to make better use of their idle production capacity.
5. An opportunity for local producers to become international: Local producer also gets an opportunity to get involved in international business.
Disadvantages of Contract Manufacturing
1. Deviations from Product design and quality Specifications: Local firms might not follow product design and quality standards causing serious product quality problems for international firm.
2. Loses control over Manufacturing Process: Local manufacturer in the foreign country loses control over manufacturing process.
3. No authority to sell output: The local firm cannot sell the output according to his will. It has to sell the goods to international firm at pre-determined prices.