Manufacturing Digital May 2013: Establishing low-cost operations without giving up control

This article by Entrada Group’s Doug Donahue looks at options for manufacturers to set up in Mexico: standalone, contract manufacturing or the shelter model

Manufacturing in Mexico can help companies realise substantial cost savings; but if you aren’t accustomed to operating in the country, savings can be eaten up by inefficiencies, grave mis-steps and a host of other frustrations.

The list of companies that have transitioned all or some of their manufacturing operations to Mexico is a long one, including OEMs and suppliers from across many industries – electronics, automotive, aerospace, consumer goods, medical devices and more.

What all of these manufacturers have discovered is that there are numerous advantages to manufacturing in Mexico, with tremendous cost savings being the greatest attraction.

Wages for directs and indirects in Mexico represent a fraction of similar costs in America and Canada. And if you investigate further inland, wages for directs can approach $1.50 per hour in a state like Zacatecas.

Of course Mexico isn’t the world’s only low-cost destination, but its proximity to the US and its NAFTA-member status (North American Free Trade Agreement)has put it head and shoulders above other alternatives, for many manufacturers.

Three ways to establish a presence
Any manufacturer wishing to set up in Mexico for the first time will likely be considering three options: contract manufacturing, establishing an independent operation, or starting an operation with the support of a shelter provider.

Contract Manufacturing

Outsourcing production to a Mexican contract manufacturer at first glance may seem an ideal way to benefit quickly from Mexico’s cost advantages.

With this option, a company shares their design and/or prototype with the contractor and the contractor quotes a price. Once a deal has been agreed, the contract manufacturer serves as the company’s Mexico factory, producing on their behalf.

This outsourcing approach, however, does not come without risks. Lack of control is primary among them.

The company will have no input into the production staff, working environment, facility design/layout and operations of their contract manufacturer. In fact, compromises may have to be reached in order to fit the contractor’s capabilities.

More worrying, ultimately the contract manufacturer sets the quality level – not the company that must market the resulting goods. That’s a problem when the company only learns about quality problems after the complaints start flooding in from their final customer.

Couple the issue of quality with loss of intellectual property, capacity constraints and the need to maintain a positive relationship with the outsourced partner, and many companies discover that giving up complete control in order to gain speedy entry to Mexico just may not be worth it.

Independent Operation

At the other end of the spectrum, under the standalone model, control over production and quality is the greatest. But it comes at significant investment.

Manufacturers establishing their own facilities in Mexico have to select the site, set up as a legal entity in the country, secure permits and leases, etc. – all of which requires huge amounts of know-how, management attention, time and capital.

And that’s just the startup phase. Once a company has established operations, they still have to run the facility. This entails hiring staff, learning about and complying with Mexican employment law, dealing with unions, managing payroll and taxes, ensuring compliance with environmental health and safety legislation, maintenance, security, accounting, gaining customs permits, logistics and warehousing. And I’m only getting started…

The risks associated with establishing an operation in Mexico independently can be too much for all but the biggest companies, which leaves many midsize and smaller manufactures pondering “Is there yet another way?”

Shelter Model

The shelter model, by contrast, gives manufacturers – no matter their size – a balance of quick startup, minimal risk and complete control over their operation. The concept of shelter services – so named because they “shelter” clients fromsome of the inherent risks of offshore production– has a long, established tradition in Mexico.

Shelter programs can come in a variety of flavors, but the most comprehensive offer turnkey solutions to companies including start-up activities through to ongoing back-office functions delivered within the confines of the provider’s industrial park.

When manufacturers operate under the legal entity of the shelter, they are not subject to income tax as long as the finished goods or components are made for export. Their time-limited contract covers everything from the leasing of manufacturing and office space to other overhead functions and staff, which are also provided by the shelter.

The shelter provider can also supervise areas such as building management and IT, recruitment, payroll and administration, obtaining permits, regulating the local purchase of materials, and helping with the import and export of raw materials and finished goods. The manufacturer basically only has to provide the machinery, equipment and production know-how to get started.

In essence, a shelter provider provides the structure, facilities and services that enable manufacturers to concentrate on their core competency – producing goods and servicing their customers.

Conclusion

There are many attractive reasons to manufacture in Mexico, and there are perceived tradeoffs for every approach that gets you there. Don’t hesitate therefore to ask many, many questions. And above all, find a trusted partner who will give you clear and honest answers.

Edited by Jonny Williamson
Source: Manufacturing Digital

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