Mudassir Altaf

Interdisciplinary Studies Thesis 398-399

Professor Dana Lascu & Professor Saif Mehkari

May 21st, 2015

Role and Importance of Contract Manufacturing in Pakistan

Contract manufacturing has been increasingly gaining popularity with the constant

improvement in technology and communication mechanisms. The process has also been fuelled

by the creation of Global Value Chains (GVCs), which are supply chains formed across borders

that aim to deliver the output in the most efficient and cost effective way.1 Contract

manufacturing can be described as the process of producing a firm’s goods in another country by

a foreign producer and under contract with that producer. The producer is not responsible for the

marketing or sale of the product but is just solely responsible for the manufacturing of the

product.2 For contract manufacturing to be useful for the hiring firm it must be ensured that the

producing firm has enough capability to deliver products of the required quality, a factor which

usually becomes a hurdle in contract manufacturing. But it can also yield many benefits for the

hiring firm, which might not have to invest in plant and production costs and focus its energies

on marketing and sales activities. Besides this if a product fails to meet the demands of the

market then it would be less costly for the hiring firm to end a contract rather than shut down its

own production plant.

This paper aims to analyze the role and importance of contract manufacturing for

Pakistan, a developing nation. During the course of this essay the scope of contract

1 Elms, Deborah Kay, and Patrick Low. Global Value Chains In A Changing World, 2013.

2 Terpstra, Vern, Ravi Sarathy, and James Foley. International Marketing. [Naperville, Ill.]: Naper Publishing Group, 2012.

manufacturing in Pakistan will be examined in light of six companies, belonging to different

sectors (beverages, construction, and textiles).

Literature Review

Abundant literature is present on the topic of contract manufacturing and it would be

useful to review it while developing a case for the country under discussion. Plambeck and

Taylor assert that the role of contract manufacturing is on the rise especially in the

pharmaceutical, automotive, electronics, textiles and beverage industries. The study also presents

the view that firms are moving towards improving their marketing and sales activities while

outsourcing manufacturing activities to other firms on a contract basis. The authors have

believed that contract manufacturing increases the rate of innovation by reducing costs of

production and also has the potential to improve capacity utilization especially in industries

where the asset specificity is low. The study also presents an interesting view about the rise of

contract manufacturers and goes on to explain how rising success of contract manufacturing can

itself become a reason for its demise. According to the paper, there is also a threat to the hiring

firm that the contract manufacturers might gain enough knowledge and expertise to become

competitors of the hiring firm itself. Plambeck and Taylor emphasize that contract manufacturing

should only be undertaken in circumstances where the production cost per unit falls with the

cumulative output.3

Blakley, Doyle and Murray also shed light on the topic of contract manufacturing. In

their paper they are of the view that contract manufacturing can become an increasingly complex

3 Plambeck, Erica L, and Terry A. Taylor. 'Sell The Plant? The Impact Of Contract Manufacturing On Innovation, Capacity, And Profitability'. Management Science, Vol. 51 Iss: 1, (2005): 133-150.

2

process for both the hiring firm and the manufacturing firm, to whom the contract has been

handed over. This can result in payment delays due to cross-country transactions and increased

transportation costs for the manufacturer. But it would be fair to assume that since this study is

not the most recent literature, some of the issues highlighted have been resolved such as the ease

of making payments across borders. They also assert that firms with the lower cost of capital

should finance the working capital and that it is very rare for the manufacturing firm to bear the

majority of working capital costs.4

Another interesting recent study on Brazil helps us understand the role and importance of

contract manufacturing for developing nations. In this study Lezzi explains how the Brazilian

government was able to effectively lower its cost of healthcare and increase access to healthcare

by partnering with Contract Development and Manufacturing Organizations. Since the

manufacturing was related to the pharmaceutical industry special care that had to be taken care

was to ensure that stringent quality checks were in place and that all complexities of the

manufacturing process were taken into consideration. This is also important since many

developing countries usually do not possess the high level of information and skills that are

required to be able to manufacture and capitalize from the various opportunities and as has been

pointed out, there is great potential for contract manufacturing in the pharmaceutical and

healthcare sector. Another benefit of contract manufacturing for the developing nations such as

Brazil in this case was that it was able to acquire the technical skill set to produce and was thus

able to expand its capabilities. Besides this costs were substantially reduced and issue of supply

and importing foreign medicines was adequately addressed.5

4 Blakley, Daniel, Barry Doyle, and William Murray. 'Improving The Effectiveness Of Offshore Production Agreements In Dynamic Product Markets'. Management International Review, Vol. 27 Iss: 3, (1987): 26-37.

5 Lezzi, Dina. 'Contract Development And Manufacturing Organizations (CDMO): Are They Needed In Brazil'. BMC Proceedings, Vol. 8 Suppl: 4, (2014): O3.

3

Hsiao and Chen, try emphasizing the importance of assessing the organizational

capabilities and firm performance when deciding the mode of entry. They strongly believe that

organizational capabilities of the firm being handed over the contract must be properly assessed

and only then should an informed decision be made. According to them firms would prefer

contract manufacturing if the hiring firms do not possess sufficient and superior manufacturing

and processing facilities, while the parent firms would prefer branding strategy if they have

access to better research and development capabilities. Thus according Hsiao and Chen the

ability of a contract manufacturing firm to succeed depends upon the conditions that it

encounters while the joint benefit for both the hiring and contracting firm lies in that they should

sync their strategic choices.6

Overview of Pakistan

As it has been previously mentioned contract manufacturing is a method that is fast

becoming a global phenomenon, since it is not only advantageous for the manufacturers but also

accrues many benefits that encourage this practice. Reports suggest that the global

pharmaceutical contract manufacturing market is expected to reach approximately 150 billion

dollars by 2015. Since many other leading developing nations such as India and Bangladesh are

employing and making use of contract manufacturing practices, Pakistan must and should also

step into this field.

One of the areas that Pakistan can focus on is the manufacture of common products of the

pharmaceutical industry. Pakistan boasts a large pharmaceutical industry and it must make the

6 Hsiao, Yung-Chang, and Chen, Chung-Jen. 'Branding Vs. Contract Manufacturing: Capability, Strategy, And Performance'. Journal of Business & Industrial Marketing, Vol. 28 Iss: 4, (2013): 317-334.

4

most of this opportunity. According to the Pakistan Bureau of Statistics it is worth almost 2

billion dollars and is also the fourth largest industry in the country.7 The benefits for this can not

only be viewed in economic terms for the firm or the country but will also significantly improve

the healthcare facilities for the general populace with the availability of cheap and widely

available medicines, especially in remote areas of the country. Though there is great market,

many international pharmaceutical firms have reduced their investment in the country due to

falling returns for their parent country. Such measures have been prompted by the decline in the

value of the Pakistani rupee, which has subsequently reduced profits for the parent companies.

Similarly there is also a great potential for activities to go out of control such as either the

production of banned drugs (psychotropic and narcotics) or the production of substandard drugs.

Thus strict policy measures must be put in place to ensure that any such unexpected incident is

avoided.8

Pakistan also has potential for growth in the engineering and electronics manufacturing

sector. Sincere efforts are being made on the public and private front to ensure that this sector not

only develops but also prospers in Pakistan. Through this Pakistan can aim to expand its export

base from the usual textile and agricultural products to more value added products, such as

electrical and engineering products. The potential for this also lies in the fact that America alone

contracts out more than 600 billion dollar worth of products to developing countries for

manufacture. Since Pakistan is a major ally of America, it should use its diplomatic goodwill to

ensure such contracts to benefit the economy and expand its export base. Besides this, this mode

of market entry will also equip the Pakistani firms with the technical skills and knowledge

7 RA Consultants, CONTRACT MANUFACTURING: Background And Draft Policy. Islamabad: RA CONSULTANTS, 2013.

8 Ibis

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required to develop such products on their own in the future. The aeronautical industry which

also makes use of the process of contract manufacturing has contracted Pakistan for the

production of various electrical and engineering in the past, as Boeing tasked Pakistani firm to

prepare parts used in their 777 aircrafts. Besides this the government has also planned to set up a

dedicated area for such industries to which contracts will be handed over, known as the

Electronics and Electrical Contract Manufacturing City.9

Though Pakistan can take advantage of its position as a developing nation and attract

investors to procure contract-manufacturing services for its industries, as there are still many

obstacles that it faces. Low labor costs are an advantage for Pakistan but on the other hand labor

also becomes an issue for Pakistan. This is because these low labor costs are usually achieved by

sacrificing upon the internationally recognized and required labor health and safety conditions.

This becomes a major conflict between the hiring firms and the firms being handed over the

contracts. Pakistan has the major sporting goods industry, mainly the soccer producing industry

but it has faced severe setbacks when contracts handed to them have been cancelled due to poor

labor conditions.10 Pakistan must ensure to strengthen its labor laws and improve labor-working

conditions to make full use of this opportunity.

Another major industry that has great potential in the contract-manufacturing arena is the

textile industry. Not only are the conditions favorable for a foreign firm to adopt the

aforementioned mode of entry but also the industry itself is a major part of the Pakistani

economy. The textile industry in Pakistan is one of the best established and textile exports make

9 Pabe.org, 'Contract Manufacturing In Pakistan: The Next Industrial Revolution, Pervaiz Lodhie - PABE'. N.p, 2015.

10 Lund-Thomsen, Peter et al. 'Labour In Global Value Chains: Work Conditions In Football Manufacturing In China, India And Pakistan'. Development and Change, Vol. 43 Iss: 6, (2012): 1211-1237.

6

up a huge proportion of the overall export base of the country. But the industry is facing threats

and reduced importance with the rising costs of production, which have been attributed to the

escalating energy crisis. Besides this other factors that are negatively affecting the industry and

restricting its potential for growth is the quota system for apparels and textiles in place by the

World Trade Organization. But the granting of a GSP-plus status to the Pakistan by European

Union has been a ray of hope and this presents a major opportunity for the Pakistani textile

industry, which should aim to secure contracts from European firms now.11

Data Collection Procedures

For the purpose of this study a research design comprising of primary and secondary

research was compiled. Secondary research was obtained from relevant published material which

included peer reviewed articles and books related to the topic under discussion.

The collection of primary research was an important task since it provided an insight into

the actual workings and approaches that are being adopted. Primary research was collected

through a series of interviews conducted of managerial staff in various organizations belonging

to different industries. The interviews were structured and consisted of the same set of questions

being asked to all the respondents. This was done to ensure that there was conformity in the

answers and that the interviewees did not drift away from the main topic. It was also ensured that

those being interviewed had a significant role in the company and held senior positions, this was

important to make sure that the results obtained presented a fair and accurate picture of what the

real issue was. Though the interviews were structured in a manner to obtain as much data as

11 Gereffi, G, and Stacey Frederick. The Global Apparel Value Chain, Trade And The Crisis: Challenges And Opportunities For Developing Countries. World Bank, 2010. World Bank Policy Research Working Paper No. 5281.

7

possible, there were some gaps since some of the companies did not want to disclose their

operational details due to confidentiality reasons. This was one of the setbacks that were faced

during the course of this research. All of the respondents were interviewed individually, either in

person or on Skype. This was done so as to encourage some open ended discussion at the end of

the interview which would help better grasp the topic, besides this another advantage of such an

approach was it gave the ability to be able to judge the respondents views through his way of

responding. Personally interviewing also brought forth the concerns that the interviewees had

and at times they even elaborated on certain crucial aspects, which were mentioned in the

interview questionnaire.

The interview questionnaire was prepared keeping in mind the requirements of the study

to ensure that all relevant information was acquired. Besides this the companies that were

interviewed also belonged to different industries, beverages, steel/construction, textiles and

plastic/polythene production. This was important so that a holistic overview of the Pakistani

market could be obtained rather than focusing specifically on just one sector or industry. Due to

logistical difficulties it was not possible to visit the factories and workplaces of the interviewed

firms but in the future when advancing this study such a visit could prove to be vital. Some of the

issues that were faced while collecting data were that there was no foolproof mechanism to

ensure that the respondents were completely objective and unbiased, thus the data collected and

answers received could be expected to be skewed. Besides this many respondents were unwilling

to share financial records and other documentation of the company, which could have been

extremely helpful, such as some respondents, did not wish to explain the production process in

detail or the state their source of raw materials. Of the companies interviewed only one is a

multinational organization while the rest are locally owned and operated.

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Findings

Interviews were conducted with management staff of the following companies, Al

Mehboob Industries (Pvt) Ltd, Rauf Textile & Printing Mills (PVT) Ltd, M/S Liberty Mills

Limited, Amreli Steels Ltd, Coca Cola Beverages Pakistan Limited (CCBPL), Millennium

industries (PVT) Ltd. Findings of the interviews with comments are listed company wise in this

section of the paper.

Al Mehboob Industries (Pvt) Ltd

The Director of Al Mehboob Industries was interviewed for the purpose of this study. It

was informed that Al Mehboob is operating in the textile sector and is involved in providing

processing to yarn for weaving. The company does not make a final product but provides a

service, the process known as ‘sizing’ in technical jargon. The company imports its raw material

Polyvinyl Alcohol (PVA) from Singapore and China, while other raw materials ‘starch’ and

‘softener’ are purchased locally. The Director also explained the production process of Al

Mehboob in detail explaining how the yarn is starched and given strength for the next stage

weaving. The production process of Al Mehboob is only restricted to the ‘sizing’ phase and does

not extend to the weaving phase. Thus they only provide a service for the preparation of the final

product which is fabric used to make garments, bed linen and other textile products. The

company is usually working for local companies, which have their own weaving facilities. These

weaving companies many of which are clients of Al Mehboob either locally sell their products or

export abroad. Al Mehboob prides itself in the fact that it has been working with the same

customers for years and says that it has been able to achieve this through prompt service and

competitive prices. Competitive prices are an important factor considering that for Al Mehboob

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the cost of production accounts for almost 90% of their revenue. This cost does not include the

transportation costs, which are borne by the client itself.

Al Mehboob would be a great beneficiary if it can avail the opportunities of contract

manufacturing. Since it has been operating in the market for a long time it has adequate

knowledge of the product. Besides this many of its clients export the final product thus it can be

assumed that the quality is also closely taken care of. The company is not involved in any

marketing activities since it just provides one service in the whole process and says that usually

customers approach them through references and thus it does not have to engage in marketing

activities. If the textile sector is being boosted in Pakistan firms such as Al Mehboob could prove

to be an asset, they can attract foreign companies for manufacturing their products as they

already have the plant and necessary facilities. A setback for Al Mehboob could be that it is

involved in only one part of the whole process and the hiring firm might want a company which

can deal with all aspects, reducing the need to go to many suppliers. Besides this the textile

industry in Pakistan is highly competitive and Al Mehboob will have many similar competitors.

Rauf Textile & Printing Mills (PVT) Ltd

The Director of Rauf Textile & Printing was also interviewed and he presented an

interesting picture of his company. The company is also associated with the textile industry but

unlike the previous company, Rauf Textiles prepares the final product, fabric, which is purchased

by both local companies and is exported to foreign buyers in Europe and USA. The company has

easy availability of raw materials since its main raw material yarn is widely available at the

several spinning mills in Pakistan. The production process for Rauf Textiles spans over many

steps that include: weaving, processing, dyeing/printing and finishing to create the final fabric,

10

which is then used to make garments (trousers, shorts, shirts). The main competitive edge that

Rauf Textiles possess is the low cost of production and vast experience in the field. Since costs

of production is around 85% of the revenue, low costs serve as an important differentiating

factor. Rauf Textiles states that its main competition comes from neighboring countries India and

Bangladesh and also from Turkey, which have a huge textile industry but still Rauf Textiles

manages to retain almost all of its customers. Rauf Textiles employs some marketing staff, which

visits different brands while other customers are attracted through various brokers and

middlemen.

Rauf Textiles is involved in contract manufacturing since it prepares products for both

local customers and exporters. It can further seek to gain if it can focus all energies on

streamlining and further making its production process cost effective. To do this it must shift its

resources away from marketing activities. It must employ an effective and targeted marketing

strategy to gain large foreign clients and then focus on delivering the best product at the lowest

price. Rauf Textile faces severe competition from Turkish producers since they have a much

better access to the European market, thus it should explore other options.

Liberty Mills Limited

The Manager of Liberty Mills was interviewed who revealed to us the operations and

working of the company. Like the previous two companies, Liberty Mills is also a part of the

textile industry, but is involved in a different stage of production and operating on a much larger

scale than the previously discussed two companies. Liberty Mills’ production process involves

processing and dyeing the yarn after which the fabric is prepared into garments, home textile and

institutional products. The final products would include printed bed sheets, blankets, lab coats,

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gowns and shorts. These final products are usually exported to different countries but mainly to

USA, though this might seem like a good opportunity it must not be forgotten that there is severe

competition in this sector. Liberty Mills accepts the high level of competition that it faces in

order to remain at the top, according to its manager the company faces competition from

international competitors, which include China, India and USA. The basis for this competition is

said to be quality and price. Since price is an important part, to remain a major player Liberty

Mills must work to minimize its cost of production. Cost of production accounts for almost 70%

and price fluctuations can affect profits as much as 20% as stated by our respondent. The cost of

production for Liberty Mills does not include the transportation costs since they are borne by the

contractor, this is a positive sign for the company since it has to bear less costs. The company has

abundant raw materials (yarn) present locally which is a major plus point, but Liberty Mills also

imports many dyes and chemicals from China, Korea, Japan and UK.

Liberty Mills has been running successfully and its client retention rate is very high

which also helps the company save up on marketing costs, since it does partake in any formal

marketing activities but claims that clients approach it because of position in the market. The fact

that Liberty Mills exports 80% of its products shows the potential that is not only present for

Liberty Mills but for the whole of the textile sector of Pakistan. Liberty Mills, produces high

quality textile products and must try to avail more contract manufacturing deals to expand its

base. It is one of the largest textile companies of Pakistan and produces fabric for many

international brands. Since it has the knowledge and expertise it may at a later stage also decide

to enter the market on its own, which means it will also be handling the marketing activities.

This is a challenging task and proper strategies must be developed to ensure that the production

side does not face any losses or shortage of resources. Examples of such expansion are present in

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the Pakistani market, the most common one being IDEAS by Gul Ahmed. The company was

also involved in producing fabric and textiles for a long time becoming a market leader, it then

entered the market with its own brand name.

Amreli Steels Ltd

This company is in the construction and steel industry producing steel construction bars

and both raw materials and finished goods in the form of extreme and deformed bars.

Information regarding the production process, marketing activities and source of raw materials

was not revealed during the interview on the basis of maintaining confidentiality. Amreli Steels

does not trade internationally and all its products are sold to local clients thus this shows a major

gap that exists. Lloyd’s Register Quality Assurance has certified Amreli Steel’s manufacturing

facility for the ISO 9001 Quality Management System. They provide a 100% quality guarantee

on their products, this also strengthens the case for Amreli Steels to move towards securing

contracts for production for foreign firms. Since the product is used in every construction project,

the product will remain relevant in the foreseeable future. Besides this due to the high costs of

setting up and since it is a heavily capital intensive industry, Amreli Steel faces much lower

competition than of the previous operating in the textile sector. Amreli Steels claims to have a

customer retention rate of over 90%, which could be used to encourage foreign clients to grant

projects to the company. The problem lies with transportation since the product is bulky and

transportation costs raise significantly, thus many foreign firms might not want to outsource

production.

Millennium industries (PVT) Ltd

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When interviewed the Marketing Director of Millennium industries informed that the

company is involved in producing polypropylene and polythene bags. Its raw materials are

imported from Saudi Arabia and UAE. The company produces final and finished products,

polythene bags, which pass through a 4-stage process during their production. The production

process and business model are low cost and the product is also low quality polythene bags. The

product is sold to various companies by Millennium Industries itself and no formal marketing

procedure is in place, its main clients are usually sugar mills, rice mills, textile mills, fertilizer

companies. Since Millennium Industries is the one of the pioneers in Pakistan for this specific

product it has an advantage that it can use and if the company was to trade internationally it

would face stiff competition from China. The cost of production amounts to approximately 85%

of which the main cost is that of raw materials. Millennium Industries should try to secure

contracts for its products from neighboring countries but China is a major competitor in the

region. Though the company has been established for a long time and well acquainted with the

field it is operating in, due to the nature of the product and its quality it might be difficult to

secure international contracts.

Coca Cola Beverages Pakistan Limited (CCBPL)

Unlike all the other companies that were interviewed, this one is a multinational firm

operating all over the globe. CCBPL is a company producing beverages of different kinds; fizzy

drinks, mineral water and juices. Due to the nature of the business, information regarding the

production process, business model and financials were not shared to maintain confidentiality.

Though Coca Cola has operations all across the globe and its products are sold internationally,

for Pakistan specifically all production and distribution is handled by CCBPL. This is a prime

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example of a wholly owned subsidiary, which has transferred knowledge and set up plants in the

host country. The management consists of locals but the CEO is a foreigner.

CCBPL engages in a multitude of marketing activities and invests heavily in advertising.

Its main competitor is Pepsi Co. both internationally and locally in Pakistan. CCBPL boasts an

impressive customer satisfaction rate of 100%. CCBPL is a prime example of how contract

manufacturing can and should work in Pakistan. Through CCBPL several jobs have been created

in the Pakistani economy, this along with knowledge transfer and the setting up of production

plants has benefited the country and beverages industry.

Conclusion

As discussed contract manufacturing can yield many benefits for the contracted company

and country. Pakistan must make the most of this opportunity through helping the developed

industries secure contracts in the international market. Some of the industries that it can focus on

are the textile and beverages industry. Besides this Pakistan also needs to go a step further and

help establish industries that gain through contract manufacturing while also helping nurture

industries that are present but not fully utilized. For the former, Pakistan must work to establish

its automotive, electrical and engineering industry, some are already functioning such as LG

Electronics and Samsung. While for the latter it must work to save and strengthen industries such

as the pharmaceutical industries, which possess great potential, such as GlaxoSmithKline.

References

Blakley, Daniel, Barry Doyle, and William Murray. 'Improving The Effectiveness Of Offshore

Production Agreements In Dynamic Product Markets'. Management International Review,

15

Vol. 27 Iss: 3, (1987): 26-37.

Elms, Deborah Kay, and Patrick Low. Global Value Chains In A Changing World, 2013.

Gereffi, G, and Stacey Frederick. The Global Apparel Value Chain, Trade And The Crisis:

Challenges And Opportunities For Developing Countries. World Bank, 2010. World Bank

Policy Research Working Paper No. 5281.

Hsiao, Yung-Chang, and Chen, Chung-Jen. 'Branding Vs. Contract Manufacturing: Capability,

Strategy, And Performance'. Journal of Business & Industrial Marketing, Vol. 28 Iss: 4,

(2013): 317-334.

Lezzi, Dina. 'Contract Development And Manufacturing Organizations (CDMO): Are They

Needed In Brazil'. BMC Proceedings, Vol. 8 Suppl: 4, (2014): O3.

Lund-Thomsen, Peter et al. 'Labour In Global Value Chains: Work Conditions In Football

Manufacturing In China, India And Pakistan'. Development and Change, Vol. 43 Iss: 6,

(2012): 1211-1237.

Pabe.org, 'Contract Manufacturing In Pakistan: The Next Industrial Revolution, Pervaiz Lodhie -

PABE'. N.p, 2015.

Plambeck, Erica L, and Terry A. Taylor. 'Sell The Plant? The Impact Of Contract Manufacturing

On Innovation, Capacity, And Profitability'. Management Science, Vol. 51 Iss: 1, (2005):

133-150.

RA Consultants, CONTRACT MANUFACTURING: Background And Draft Policy. Islamabad:

RA CONSULTANTS, 2013.

16

Terpstra, Vern, Ravi Sarathy, and James Foley. International Marketing. [Naperville, Ill.]: Naper

Publishing Group, 2012.

17