What is Contract Manufacturing?
Contract manufacturing is also called outsourcing. Contract manufacturing is when a firm enters into a contract with local manufacturers in foreign countries to get goods produced as per its specifications. It can be classified into three major forms-
Production of certain components like automobile components to be used for producing cars.
Assembling components into final products such as modem chips into computers.
Complete manufacture of the products for, e.g. garments.
Advantages of Contract Manufacturing
Contract manufacturing offers several advantages to both the international company and local producers in foreign countries. Some of them are discussed below-
Contract manufacturing permits international firms to get the goods produced on a large scale without requiring investment in setting up production facilities. These firms make use of the production facilities already existing in foreign countries. The company does not have to arrange for sources for the process of production.
Firms can get products manufactured at lower cost by approaching countries which have lower material and labour costs.
The company gets rid of the risk of investment in a foreign country
If the business does not prove to be successful, it can be easily closed.
Local manufacturers also get the opportunity to participate in international business and take advantage of incentives.
Disadvantages of Contract Manufacturing
The disadvantages of contract manufacturing are discussed below-
Lack of control over the production activity.
The risk from prospective competitors.
Local firms that produce under contract manufacturing are not free to sell the produce at their own discretion. They have to follow the prices predetermined by international firms.
What is Licensing in International Business?
Licensing refers to the agreement to produce and market the product of the company of another country in exchange for a royalty or fee. Under the licensing system, Pepsi and Coca-Cola are produced and sold worldwide by local bottlers overseas. Licensing and franchising are examples of internalisation.
What Do You Mean by Franchising?
Franchising refers to that special right which is given by a producer to a trader to start the same business at a particular place being done by the producer.
McDonald's, for instance, operates fast food restaurants all over the world through its franchising system.
Franchising is similar to licensing, but it is a term used in connection with the provision of services.
Advantages of Licensing and Franchising
Inexpensive entry into international business.
Double income of franchiser.
Increases the goodwill of the franchiser.
Business can be run with comparatively less investment.
Limitations
The limitations of licensing and franchising are discussed below-
The reputation of a producer can be at risk if a franchiser does not fulfil the definite business standards.
Huge expense is made on research and specialists.
A franchisee gradually starts understanding the secrets of the success of the producer, and a time comes when he ends the contract with the producer, and himself becomes an independent competitor.
If the business does not run smoothly, the fees paid by the franchisee become a burden.
Case Study
In March 2011, Tesco, the world's third largest British grocery and general merchandise retailer, signed a deal to build three more shopping centres in China. 50% of the project will be owned by a consortium of Asian investors, including Singapore-based Metro Holdings. The total value of the project to build shopping centres in Shenyang, Xiamen and Fuzhou is approximately £170 million, with Tesco and the consortium each investing approximately £30 million in equity.
1. Identify the mode through which Tesco is entering further into China.
2. State other modes of entry with respect to international business.
Ans.
1. The mode through which Tesco is entering China is a 'Joint Venture'. A Joint Venture refers to establishing a firm which is jointly owned by 2 or more independent firms for a defined period.
2. Other modes by which a business enterprise can enter into an international business are as follows:
Exporting and Importing: Export means producing goods in one’s own country and selling them to another country, whereas import involves bringing goods into the home country from abroad.
Contract Manufacturing or Outsourcing: In this mode, a company may enter into a contract with another company in a foreign country to manufacture goods or components as per the former’s specifications. It is also called outsourcing.
Summary
International businesses are run by licensees/franchisees who are locals, so there is less risk of business takeovers and government interference. The manufacturing franchise model examples include Coca-Cola, Hyundai, Nestle, etc. All the major international companies such as Nike, Reebok, Levis and Wrangler today get their products or components produced in developing countries under contract manufacturing.
FAQs on International Business: Licensing and Franchising Explained
1. What are licensing and franchising as modes of entering international business?
In international business, licensing is a contractual agreement where one firm (the licensor) grants another firm (the licensee) in a foreign country the right to use its intellectual property—such as patents, trademarks, or technology—in exchange for a fee, known as a royalty. Franchising is a specific form of licensing where a firm (the franchisor) grants another firm (the franchisee) the right to operate a business using its brand name, products, and operational systems, also in return for a fee.
2. What is the main difference between licensing and franchising for a Commerce student?
The primary difference lies in the scope and application. Licensing is typically used for manufacturing and marketing goods. For example, a local bottler producing Coca-Cola. In contrast, franchising is predominantly used for service-based businesses and involves replicating an entire business model, including branding, operations, and customer service standards, such as with McDonald's or Subway restaurants.
3. What are the key advantages of using licensing or franchising to expand globally?
Expanding through licensing or franchising offers several key advantages as per the CBSE syllabus for 2025-26:
- Low Capital Investment: The licensor or franchisor does not have to invest their own capital in setting up operations in a foreign country.
- Reduced Risk: Since the licensee or franchisee makes the investment, the parent company has minimal political and business risk.
- Local Market Knowledge: It leverages the local partner's knowledge of the market, culture, and legal system.
- Rapid Expansion: It allows for faster global expansion than setting up wholly-owned subsidiaries.
4. What is contract manufacturing and how does it differ from licensing?
Contract manufacturing, or outsourcing, is when a firm hires a local manufacturer in a foreign country to produce its goods according to its specifications. The key difference from licensing is in the control over marketing and sales. In contract manufacturing, the international firm retains full responsibility for marketing and selling the products. In a licensing agreement, the licensee typically produces and also markets the product in its territory.
5. What are some well-known examples of companies using licensing and franchising?
For franchising, famous examples include service-based businesses like McDonald's, Subway, and hotel chains like Marriott. For licensing, common examples are found in manufacturing, such as Coca-Cola granting licences to local bottlers worldwide, or Disney licensing its characters for use on merchandise like toys and clothing.
6. How can a franchisor protect their brand's reputation and business secrets from a franchisee in a foreign country?
A franchisor protects their brand and trade secrets through a combination of legal and operational strategies. The most critical tool is the franchise agreement, which legally binds the franchisee to strict standards. Other methods include:
- Providing comprehensive training on operational procedures.
- Conducting regular quality control inspections and audits.
- Controlling the supply chain for critical raw materials.
- Including strong non-disclosure and non-compete clauses in the contract to prevent them from becoming a competitor after the agreement ends.
7. Why might a business choose licensing even though it offers less control compared to other entry modes like a joint venture?
A business might strategically choose licensing despite the lower control primarily to achieve rapid market entry with minimal financial risk. Licensing is an ideal mode when a company lacks the substantial capital required for a joint venture or wholly-owned subsidiary. It allows the firm to generate revenue from a foreign market without bearing the costs and risks of foreign investment, especially in politically or economically volatile regions.
8. From a strategic perspective, when is franchising a better choice for a service-based company than licensing for a manufacturing company?
Franchising is strategically better for a service company because it ensures consistency and replication of an entire business system, which is vital for service quality and brand identity (e.g., the customer experience at a fast-food chain). Licensing, however, is more suitable for a manufacturing company because its focus is on the transfer of product technology or a brand name, allowing the licensee to leverage its existing production and distribution infrastructure without needing to adopt the licensor's entire operational model.
