EuroAsia Industry Magazine July 2012: Shifting Sands

Eurasia

Based on an Interview with Entrada Group’s Doug Donahue

With the loss of China’s low-cost manufacturing crown to Mexico, the eyes of the world are now firmly fixed upon Latin America’s leading recipient of foreign investment as companies rethink their global sourcing strategies. Marius Goubert investigates how Mexico is seeing investment across the board, from aerospace to automotive manufacturing, as it retakes its position as the best cost country for goods destined for the North American market.

It was off the back of the so-called maquiladoras-boom that the city of Ciudad Juarez, the second largest bi-national metropolitan area on the Mexico-US border, emerged as a shining beacon of economic prosperity at the turn of the 21st century. A report published by the Federal Reserve Bank of Dallas highlighted how this thriving Mexican border city had managed to outstrip the national growth average – achieving a consistent growth rate of around 5.2 per cent year on year between 1990 and 2000. Home to an ever-expanding manufacturing base as well as strip malls, pristine roads and American fast-food restaurants, Ciudad Juarez had become the lure of rural workers eager to grab a slice of this glittering Eldorado, where foreign direct investment in maquiladoras (foreign manufacturing operations) offered the prospect of plentiful jobs that paid double a farmhand’s wage.

But as American consumer demand began to sag around 2001, export manufacturing operations concentrated in border towns such as Juarez began to lose their shine as the Mexican economy slowed like a trailer hitched to a broken down truck. Juarez suddenly found itself with 40,000 newly unemployed workers and, as the streets continued to swell with new arrivals seeking employment, it was not long before the fallout was providing fertile ground for violence (particularly on account of competing drug cartels whose bloody turf wars soon turned this one-time manufacturing Mecca into “the most dangerous place in the world outside of declared war zones”). But while Juarez went from boom town to ghost town in little under a decade, visible signs of recovery have since begun to emerge.

Juarez was recently described by the New York Times as ‘absorbing more industrial real estate space than any other North American city’ and, with it continuing to represent a critical link in the North American supply chain, 15 companies announced plans to expand into the city between July 2009 and August 2010. A total of 26,000 new jobs were added by the maquiladoras during the same period. Murder rates fell by 45 per cent and, in January 2012, the Asociacion de Maquiladoras Asociacion Civil (AMAC) recorded the largest increase in the number of workers employed in maquiladoras since January 2000. Indeed, there might be significant ground still to make up, but the turnaround of Mexico’s deadliest city reflects a broader shift in which the country is steadily whittling away the cost advantages of China, and reassuming its position as the ‘best cost country’ for products destined for the US market.

Down Mexico way

Perhaps one of the most telling signs of the growing economic activity can be gleaned from airport traffic statistics released by Aeroporuario del Sureste (operator of nine Mexican regional airports). Recently, it described how passenger numbers for January 2012 were up some 10 per cent compared with the same month last year, and many observers have put the spike down to an increase in the number of business executives scouting the country for potential manufacturing opportunities. It is a trend that Doug Donahue, Vice President of Entrada Group, is keenly aware of. His company specialises in supporting overseas firms looking to establish a footprint in Mexico, and Entrada Group has the capability to offer ‘shelter operations’ – in which firms can set up shop without establishing a direct, in-country presence – in just 90 days.

Using models like the one offered by Entrada, companies send in raw materials and supervisory personnel and outsource all associated non-core activities of doing business in Mexico to shelter service providers. “The reasons for the shift from contract manufacturing in China to Mexico are diverse and cannot be attributed to just one single factor,” explains Mr Donahue. “On the one hand, we are seeing a decrease in the value of Mexican currency while, at the same time, we are seeing an increase (or an anticipated increase) in Chinese currency. It is important to consider the fact that companies make investments for the long term (three, five or perhaps seven years), and many are anticipating that the Chinese currency is going to appreciate greatly in the coming years. Similarly, Mexico has traditionally always been about the border, and the border got very crowded and expensive in 2001.

“Meanwhile, China ascended to the WTO (World Trade Organisation) and garnered a lot of attention from manufacturers based in Mexico. Interestingly, however, there were a lot of companies in Mexico who could not move to China, and they began to look more and more at the interior. Examples include General Motors and Bombardier Aerospace, which both started to build up skills bases in the interior. Indeed, they soon discovered it was far cheaper than the border – for example, in Zacatecas – an interior area where Entrada Group operates – a labour person costs $1.50 per hour, while at the border it can be as high as $5.00.”

Everything under one roof

When considering the narrowing gap between Mexican and Chinese labour costs, it can also be observed that Mexico has already absorbed the rapid increase in manufacturing wages that are just starting to kick in across China and other developing economies. As pointed out by Mr Donahue, Mexico’s labour cost advantage is poised to continue to grow as the appreciation of the yen erodes the profits of Chinese-based producers, and its competitiveness is reinforced by the stability – even slight devaluation – of the Mexican peso. Equally important, however, Mexico’s proximity to one of the world’s largest consumer markets, which means that manufacturers stand to gain huge savings in a world where energy and transportation costs are continuing to climb.

The logistical advantages of shipping product from Mexico to the US are being further boosted by the establishment of so-called economies of scale. For example, a number of world-leading producers of industrial, commercial and home refrigeration, heating and air-conditioning equipment moved to form an industry ‘cluster’ to attract a supply base in Monterrey, northern Mexico. Leveraging economies of scale is also a key part of the Entrada Group business model, and the company is able to achieve substantial cost savings by seeking to accommodate all of its clients under one roof within a single industrial park.

Outlining how Entrada Group uses this model to pass on additional cost savings to its clients, Mr Donahue explains: “Every action undertaken by various clients adds to the scale of the park, and we use that to enable everyone to share in the cost benefits. For example, if our clients operated independently, they would probably run one or two trucks a week, but in the park, we can combine all of those logistical needs together. By running 40 trucks a week, we can negotiate significantly lower prices. Indeed, this does not necessarily just relate to logistics, but also applies across the board on everything from transactional costs to border costs. What’s more, Mexico’s Maquila system has built up a 45 year history which, over that time, has become very transparent. A lot of companies that went into China faced issues they were not anticipating, and were exposed to a range of hidden costs that had not been factored in to their business models.”

Challenging China

For large multinationals – particularly major players such as Flextronics and Foxconn whose global footprints encompass both Mexico and China – this increased competitiveness has not so much led to a relocation to the Mexican market, but a reassessment of which market is more cost effective when a new product is due to be launched. And while these multinationals are increasingly finding that it is becoming cheaper to utilise their facilities in Mexico rather than China, Mr Donahue also outlines how many firms are recognising that, in addition to equal or lower costs, Mexican shelter operations allow firms to exert greater control over the production process.

“What we are also seeing is that companies that used to go to China to subcontract their product – so they were not controlling production – are setting up their own operations in Mexico. This means they are taking control of the production, the supply chain and the quality. Through these shelter operations, it has become easier to establish your manufacturing operation than it is to outsource to Chinese subcontractors. So, the cost is no different and we are seeing a real influx of firms which previously used Chinese subcontractors into the Mexican market.”

Car wars

Evidence of the growing influx has been particularly stark in the aerospace and automotive sectors. Mexico has always been a global leader in the automotive market – turning out more than 2 million units a year – as well as a location of choice for automakers like Honda, Nissan, Mazda, and Toyota. Indeed, as they look to build upon their extensive presence, Japanese automakers are now transforming Mexico into a manufacturing hub for the entire Western Hemisphere. Honda, for example, plans to expand total production at its three Mexican facilities from 60,000 to 460,000 by around 2015. Nissan is building a new plant that will expand capacity to 780,000 cars by 2013, with Mazda even halting production in the US to relocate to Mexico. When these expansions are complete, combined annual production for these Japanese producers alone will reach two million by the end of the decade.

“Japanese automakers have also applied incentives for their suppliers to come to Mexico,” informs Mr Donahue. “The same can be said of German OEMs, which are also moving to capitalise upon these cost savings. Indeed, the automotive and aerospace industries are two growing areas that are really visible to anyone who travels to Mexico. That said, however, all industries are really expanding. We are seeing growth in sectors like electronics, consumer goods, financial, tourism and medical devices – Mexico sees investment in all areas.”

Going south

As demonstrated by the meteoric rise of cities like Ciudad Juarez, the Mexican border has always been a hotspot for foreign investment. Yet, as illustrated by Honda’s establishment of a US$800 million assembly plant in Guanajuato (also the site of Mazda’s new facility), companies are increasingly being drawn into the Mexican interior. Toyota has also confirmed that it has plans to build a new plant in Guanajuato while Europcopter, the world’s largest producer of civil helicopters, is now opening a US$550 million plant in the nearby state of Queretaro. Indeed, Central Mexico not only benefits from lower labour costs, lower living costs and a better climate, but is traditionally less exposed to the security issues that have so blighted businesses around the border.

“Central Mexico also puts you at the heart of the golden triangle,” points out Mr Donahue. “You are between the largest population centres of Mexico City, Monterrey and Guadalajara, which are the three consumer and manufacturing hubs in Mexico. So, from a consumer perspective, you are at the heart of 90 million consumers. From a first or second tier supplier perspective, you are ideally situated to supply all of the major OEMs in the country.”

A land of contrasts

Indeed, with its cost growing competitiveness and location within a stone’s throw of the world’s largest consumer market, Mexico has achieved distinction as a low-cost manufacturing destination. As energy and transportation expenses account for an increasingly large chunk of company margins, it is becoming less viable for companies to service all global markets from just one low cost manufacturing destination. “The reality is that they are going to need footprints everywhere,” concludes Mr Donahue. “It is no longer a choice between China and Mexico, companies have to be in both, and Mexico will be an integral part of a more localised manufacturing landscape in which producers adopt so-called ‘multi-country strategies’.” Clearly, the days when companies could see cost savings of 30 per cent or more by making a ‘no-brainer’ outsourcing decision to China are gone. With a large consumer population, skilled workforce and open trade regimes with North America, Mexico is now the number one location for foreign investment across Latin America. That said, it remains a country of contrasts, where affluence, poverty, violence and natural splendour all rub shoulders, and where security and high-bureaucracy remain visible challenges. But, as reflected by the rise of Ciudad Juarez, foreign investment and the sheer endeavour of the Mexican population have proven to be a potent combination. As foreign investment picks up from the border to the interior, industry is staking its claim in the burgeoning potential Mexico’s future. And as the commitment grows from businesses worldwide, Mexico looks poised to commit another major economic rebound.

Source: EuroAsia Industry Magazine


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