Industry Week 2014: Low-Cost Manufacturing Locales — It’s All About Growth in Mexico

By Doug Donahue, as published in Industry Week.

Wholesale relocation to other parts of the world with lower labor costs is clearly a prominent and irreversible economic condition that changes how we manufacture and trade goods. At the same time, an equally important trend, that of expansion of production, deserves consideration as well, with a focus on growing the overall pie, rather than moving slices from one country to another in an effort to cut costs.

Both relocation and expansion of manufacturing offshore have evolved greatly over the past 20 years or so. Because Mexico is our company’s area of specialization, we can use that country to illustrate effects of this shift.

Over Two Decades of Growth

As long ago as the late 1960s, foreign manufacturers have had a presence in Mexico under the maquiladora concept, with a sole focus on lowering labor costs. Assembly and similar labor-intensive processes were the bulk of the activity.

In the 1990s, interest in Mexican manufacturing exploded due to the weakening of the Mexican peso and the ratification of NAFTA, the latter of which helped reduced both the real and perceived risk of investing in Mexico. This growth attracted investment from numerous industries but the profile, for the most part, was similar – companies engaging in labor-intensive processes that were difficult or impossible to automate.

Furthermore, at this time, the products they built were typically easily transportable and didn’t incur high freight costs. Components such as wire harnesses, for example, were ideal for Mexican manufacturing because they required a lot of direct labor to build a relatively light product that could be cost-effectively exported outside of Mexico – primarily to the U.S. and Canada. Such products were low-margin goods too, and outsourcing production to Mexico made a lot of sense.

Fast forward to today, still sticking with the Mexico example, and the profile of foreign manufacturers has changed dramatically. For one thing, cost is no longer the only driver. Nowadays, manufacturers from all industries are expanding to Mexico to realize topline growth, not just cut costs.

Mexico’s free trade agreements with 44 countries make it an ideal manufacturing hub for the western hemisphere, suitable for export production not just to North and South America but to Europe as well. The VW Beetle that is produced in Puebla, for example, is shipped to both the U.S./Canada and Europe. This means that Mexico is increasingly about corporate expansion leading to opportunities to reach new markets, rather than a cost-cutting move from the U.S. or Canada to a lower-cost location.

Additionally, mirroring the global shift in manufacturing to enhanced automation, Mexican plants have become far more sophisticated, offering more technical processes and lean manufacturing techniques on a par with the global manufacturing powerhouses worldwide. So the types of products manufactured in Mexico has matured too, moving away from a sole focus on labor-intensive production and assembly.

So what kind of growth is possible as a result of offshore expansion? We will again use Mexico as the case study, focusing on two industries that have a strong presence there– automotive and aerospace.
Between 2000 and 2014, foreign OEMs have invested (or in the case of recent companies like BMW and Kia, announced investments of) more than $31 billion in Mexico.

With Kia’s recent announcement of a plant opening in Monterrey in 2019, Korea becomes the latest nation to join the fold in Mexico, and now practically all global automakers are represented there. (See our Auto OEM Landscape map for details and locations in Mexico.)

In aviation/aerospace, the figures in Mexico are also impressive. Over the past three years alone, foreign manufacturers have invested more than $3 billion in Mexico operations. More than $5 billion worth of aircraft and parts are exported from Mexico annually and the industry employs some 31,000 people.

First Step in Industrial Expansion – Cost Model Analysis

For manufacturers serious about offshore expansion, the first step should be a thorough exploration of costs in the target country and, equally important, regions in that country. In Mexico, for example, total operating costs in the state of Zacatecas (in the central part of the country, where Entrada’s industrial facility is located) can be as much as 40% less than in a similar site near the US border. So it’s crucial to become familiar with costs, labor market access, logistics and infrastructure in different regions.

We advise manufacturers contemplating expansion to start their journey with a cost model analysis. This helps uncover costs and potential issues early in the expansion process, rather than discovering them when it’s too late.

A thorough cost model analysis should encompass all operating costs associated with doing business in a particular place, except for raw materials. From there, it should take account of various local costs as well. Examples of these expenses include rent, taxes, utilities, maintenance, waste, security and shipping costs (among others).

Once manufacturers have an accurate sense of the full range of costs, they can confidently engage in a region and enjoy the benefits of cost-competitive production, as well as the future growth prospects that accompany the area.

Doug Donahue is vice president of Business Development with Entrada Group, a U.S.-based company that helps manufacturers transition to Mexico swiftly and cost-effectively.

Source: Industry Week

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