Contract Manufacturing - Foreign Market Entry via Contract Manufacturing - Conceptualization and Implementation in Industrial Goods Markets

Diploma Thesis, 2000
28 Pages, Grade: good (2,0)



1. Introduction
1.1 Internationalization as a Surviving Strategy
1.2 Problems with Internationalization

2. Conceptualization of Contract Manufacturing
2.1 Contract Manufacturing as a Foreign Production Strategy
2.2 Types of Contract Manufacturing
2.3 Benefits and Advantages against other Strategies
2.3.1 Evading Financial, Political and Legal Barriers
2.3.2 Gaining Advantages in Sourcing and Customer Orientation
2.4 Risks and Disadvantages against other Strategies
2.5 Recommendations of Strategy Choice

3. Implementation in Industrial Goods Markets
3.1 Finding and Selecting the Right Manufacturers
3.2 Structuring a Contract
3.3 Realizing a Supply Chain Management
3.4 Controlling of Contract Manufacturing

Index of Abbreviations

Index of Illustrations


Index of Abbreviations

illustration not visible in this excerpt

Index of Illustrations

Illustration 1: Contract Manufacturing in its Context

Illustration 2: Checklist of Strategy Choice

Illustration 3: Possible Supply Chain with Contract Manufacturing

1. Introduction

1.1 Internationalization as a Surviving Strategy

There is almost no day passing without any news about mergers, acquisitions or cooperations between two or more companies. In most cases, one of the major motivations is the recognition of cost reduction potentials to stabilize profits. Daimler-Benz and Chrysler, since early 1999 known as DaimlerChrysler, merged their R & D and sourcing activities to achieve economies of scale. But for what reason do they have to stabilize profits? Because they live in a world of decreasing margins and stagnating sales. It is evident that despite their high volumes the markets of the industrialized countries are almost satisfied and lack appreciable growth rates. Product life cycles (PLCs) become gradually shorter, reducing the profit periods of products.[1] Moreover, these markets are mostly dominated by a destructive price competition so that often companies are forced to offer at almost dumping prices in order to survive. The big German mineral oil enterprises recently claimed that the introduction of Dea’s payback card to bind their customers via a one-pfennig (!) patronage refund per consumed liter had been, in their opinion, responsible for a follow-up ruinous price “battle”. At the same time, they were all fighting together against the private brands. Shortly afterwards, it was the food trade battling, which had been instigated by Wal Mart’s dumping-price policy with basic foodstuff. And this development will continue.

Therefore, companies more and more initiate activities to conquer foreign markets, with many of them evading to less developed countries. This apparent contradiction turns out to be a logical step of enlarging upon business activities because many of these countries are on the threshold of becoming industrialized and consequently, they reveal huge potentials of unsatisfied demands, which, up to that point, remained unattended. Hence, even small and medium-sized enterprises turn “international”, seeking advantages in distribution and sourcing as well.

1.2 Problems with Internationalization

A company that has realized the necessity of internationalization and decides to tap foreign markets has to consider that on the one hand there is no foreign market that is similar to the domestic one. Kotler says that a common mistake about internationalization is to think ethnocentrically.[2] Markets and therefore the demands on and for products (quality and quantity) differ due to economic, geographic and socio-cultural factors (market volume, import and export activities, average income and spending power, education, mentality, traditions and habits, climate and topographical factors, etc.)[3]. Apart from that, there are two different tendencies concerning the country of origin of a product: In many countries consumer patriotism is a major market entry barrier (= country-of-origin effect), whereas “made-in” images may influence buying decisions positively, e.g. products “made in Germany” are subliminally combined with a high quality standard).[4] These aspects do not primarily concern industrial goods marketing, but regarding the fact that demand for industrial goods is derived from the demand of consumer goods, it is necessary to take them into consideration as well.[5]

On the other hand, the company has to consider potential barriers against entering a market. These can be subdivided into legal and political barriers (market form, protectionism by tariff and non-tariff barriers, risk of political stability), financial barriers (risks of investment and markets, lack of capacity, risk of exchange and payment and expensive handling of goods to be exported), competition (market coverage and growth, number of competitors, price level) and the language barrier. Besides, an international company supplying durable goods (either for industrial or consumption purposes) will also be confronted with the demand for quick, efficient and competent after-sales service on site to build up a good reputation and confidence[6].

These efforts and investments companies make in order to enter foreign markets meet with a high degree of uncertainty regarding the development of their foreign businesses. Therefore, companies have to select their new markets carefully, to examine them precisely by using the instruments of market research and to gather all knowledge available before finally starting to internationalize.

illustration not visible in this excerpt

Illustration 1: Contract Manufacturing in its Context

2. Conceptualization of Contract Manufacturing

2.1 Contract Manufacturing as a Foreign Production Strategy

After the selection and examination of the new market, a company being about to go international has to opt for a market entry strategy considering capital investment, risks, outsourcing of production, distribution and / or after-sales service and therefore proximity to its customers, market coverage, possible profits and control over the strategy.

On the one hand, the company may select an exporting strategy, i.e. the goods will be produced in the domestic factory and afterwards forwarded to the foreign country. On the other hand, it has the possibility of choosing a foreign production strategy, either with or without direct investment (cf. illustration 1 on p. 3).

Contract manufacturing – as one possible strategy – can be defined as follows: ‘a cooperation on a contractual basis between a company (called original equipment manufacturer = OEM) and an independent manufacturer (contract manufacturer) who is transferred the know-how to take over certain steps or the entire production of goods’.

It is now evident that contract manufacturing is about outsourcing manufacturing processes, where the OEM acts as a demander to the manufacturer. But this general description is still far from being a strategy, especially one of foreign market entry. Indeed, the initial idea behind contract manufacturing has been to achieve production cost advantages[7] by shifting to specialists all those manufacturing processes that do not belong to the key capabilities.

Nevertheless, the contract manufacturer may be located in a foreign country so that there are three possible approaches to contract manufacturing, which are distinguished by the further utilization of the goods produced:[8]

(1) The goods are destined for the domestic market. The intention is reducing costs via outsourcing to factories in countries having lower factor costs.
(2) The goods are destined for another foreign market. This is to facilitate conquering new markets with a lower price level or a high price competition via outsourcing to third-country factories where production costs are lower.
(3) The goods are destined for the same foreign market in which they have been produced. This is to circumvent the above-mentioned barriers to internationalization, whereas the cost reduction aspect might perhaps – but not necessarily – be a minor objective.

Despite the fact that alternative (2) is also a strategy of foreign production and of foreign market entry as well, the following statements primarily concern the approach to contract manufacturing like in alternative (3). However, the implementation process of contract manufacturing as well as the close interrelation and the high interdependence of the two partners involved, which result from each approach are comparable to one another.

The initial definition can now be completed as follows, covering only the aspects of alternative (3):

Contract Manufacturing is a strategy of foreign market entry via a cooperation on a contractual basis between a domestic company (OEM) and an independent contract manufacturer in the country to enter, without capital engagement. The manufacturer is only transferred the know-how to take over certain steps or even the entire production of goods and, possibly, logistics (stocking and dispatch) exclusively for the OEM, while research & design, marketing and distribution activities remain with the latter.

As indicated in illustration 1 on p. 3, licensing and franchising are closely related to contract manufacturing. For a detailed comparison see chapter 2.5.

2.2 Types of Contract Manufacturing

Contract manufacturing cooperations may be differentiated according to what extent production is transferred to the manufacturer, ranging from parts manufacture up to the complete production of a product[9].

With contract manufacturing as a strategy of foreign market entry, it is likely that the manufacturer will take over the entire process of producing the goods, especially if it is rather easy and coherent, as for example the German skin-care products company Beiersdorf, which transfers production of its Nivea cream for the Philippinean market to a local factory over there.[10]

In contrast, OEMs may on the one hand shift complex procedures like printed circuits to contract manufacturers (which then are mostly small specialized companies) whereas they continue producing the casings and take over assembly. (This is, indeed, very common among computer suppliers like IBM and Apple.) On the other hand, the foreign manufacturer can be handed over only the assembly of the goods while the OEM keeps core competencies.


[1] cf. Backhaus (1999), p. 16 – 19

[2] cf. Kotler / Bliemel (1999), p. 635 f.

[3] cf. Berndt et al. (1999), p. 15

[4] cf. Berndt et al. (1997), p. 33

[5] cf. Kotler / Bliemel (1999), p. 359

[6] cf. Backhaus (1999), p. 649 – 653

[7] cf. Carbone (1999),

[8] cf. Weiss (1996), p. 11

[9] cf. Piontek (1997) p. 77 f.

[10] cf. Quack (1995), p. 111

Excerpt out of 28 pages


Contract Manufacturing - Foreign Market Entry via Contract Manufacturing - Conceptualization and Implementation in Industrial Goods Markets
Ruhr-University of Bochum  (VWA Lippstadt)
good (2,0)
Catalog Number
ISBN (eBook)
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452 KB
Beschaffung, Purchasing, Supply Chain, Markterschließung, Market Development, OEM
Quote paper
Reinhard Nickel (Author), 2000, Contract Manufacturing - Foreign Market Entry via Contract Manufacturing - Conceptualization and Implementation in Industrial Goods Markets, Munich, GRIN Verlag,


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