What is contracting?
Contracting involves entering into an agreement with a company that provides your firm with a service. In the case of the market-entry options we have been discussing, this service would involve the contract to manufacture and/or market your goods in an overseas target market.
A management contract is an agreement whereby
a company (the management company) manages some or all
of the operations of another company in return for management
fees and, sometimes, a share of the profits. Many hotel
groups have management contracts with hotels in other countries
and earn fees for consulting and for providing management
services. With management contracts, there is minimal risk
associated with market entry, no expropriation risk, and
no need for capital investment. These contracts capitalise
on management skills and provide a guaranteed minimum income.
Contract manufacture involves a formal, long-term contract between
parties in two different countries for the manufacture or
assembly of a product. The company that places the contract
retains full control over distribution and marketing.
There are a number of advantages to contract
- As there is no need to invest in manufacturing
plant, the company placing the contract does not need vast
capital resources, nor does it have to be concerned about
the possible political instability of a market
- There is no risk of the company experiencing financial
loss because of adverse movements in foreign exchange rates
- The company placing the contract can avoid labour
and other problems that could result from a lack of familiarity
with the country concerned; at the same time, it enjoys
the advantage of being able to advertise its product as
- Cost advantages could include savings in transport
costs and lower production costs
- If a market proves to be too small or too risky,
it is easier and less costly to terminate a manufacturing
contract than shut down a wholly-owned off-shore production
Contract manufacturing, however, also
has its drawbacks. It is often difficult to find a foreign
producer with the ability to manufacture the product to
the required standards and in satisfactory quantities;
even when a suitable manufacturer is identified, the company
placing the contract runs the risk of training a future
You may want to consider the following factors when deciding on whether to go the contracting route.