Analysis of Mexico vs China Logistics Uncovers Hidden Differences
Dr. Barry Lawrence, professor of Industrial Distribution at Texas A&M University and Director of the Texas Mexico Trade Corridor a research consortium studying best business practices for our region, reported that after a decade or so many businesses which jumped on the China bandwagon learned a tough lesson about attention to details and what really affects the bottom line.
Many of the costs, he said, are driven by items not found on any ledger line. More of them should.
The message becomes, “What you need to know, not what you want to hear!” Sometimes the dollars don’t get greener on the other side of the Pacific:
MEXICONOW: Earlier in this decade many companies operating in Mexico felt they just had to get to China. It was nearly a “China Mania.” For many, it was a bad move. What were the faults of their analyses?
Dr. Barry Lawrence: That situation also affected Monterrey and Guadalajara. The situation was very much amplified in Guadalajara because they were dealing with electronics companies. The electronics companies were the first ones to take off and run. Because that city had so focused itself on electronics firms, they were devastated.
What went wrong? The companies were basically looking at the location equation but either not calculating accurately or leaving things out altogether. China as an emerging country had the chance to put the land in place. They were able to match facility costs with North America without too much dif- ficulty. The second thing that came up was transportation – this would become their “Achilles’ Heel.” They had to overcome transportation with labor, and they did not properly calculate transportation. The third component was labor. On labor, China looked good on the books. It looked good, but people didn’t calculate it correctly.
MEXICONOW: What other cost elements do you see as not having been calculated correctly?
Dr. Lawrence: Other factors that got left off the table included inventories, finance, taxes, security and bureaucracy.
China would make sure they were competitive on taxes. So what it came down to was taking taxes and facilities out of the way. Then they let labor take on transportation. Labor won for all the wrong reasons.
MEXICONOW: What were the “wrong reasons” concerning labor?
Dr. Lawrence: The first thing concerning labor was it is one thing to say Chinese labor is going to be one-tenth of U.S. or one-fourth of Mexico. What that reasoning does not get into is you have to train them. Keep in mind that training in Mexico is going to be more expensive than training in the U.S. because you may have language barriers and differences in education levels.
But it was not a major leap because the two countries culturally understand each other extremely well. There could be people coming from the southwestern United States. There is an ample supply of bilingual people from the U.S. and Mexico. It was not that hard.
In China, it was a totally different situation. You get over there and right away, how many ex-pats are you going to findwho speak excellent Chinese? If you find that ex-pat is going to cost you a lot of money. The ex-pat is going to be paid a much higher amount.
MEXICONOW: What about additional operational considerations?
Dr. Lawrence: If you open up in Mexico, there’s a good chance multiple executives from the company have been there and know something about it, and may understand the area well. If they don’t, it is not expensive to get them there.
With China, you got to fly them business class. They haven’t been there before.
They don’t know much about it. They have to make multiple trips and must stay – they can’t fly back to the U.S. within a day. If you got to go over the China, you got to be there at least a week. During that week, one has to go to many places. Getting people the institutional knowledge to be able to hire and lead people effectively became a huge issue with China.
What happened? Typically the ex-pat would land over there, all the corporate execs would come over – and you’re forking out money for that – you got all these things going on in addition to buying your facility and get up and start running.
MEXICONOW: You also point to another problem, one of the contract to do business in China.
Dr. Lawrence: The Chinese operate on a three-year contract. You don’t have any middle management in China. The middle management you can find is not usually bilingual. Your ex-pat winds up with an army of translators and consultants. Those are all additional costs piled on. As you are going through the training process, one of the first things that happen because they work on a three-year contract, you get the middle manager trained, and then everyone else moving over there wants them.
So what happens is you have tremendous turnover of your middle management which is the most difficult team to train, and are the ones you are counting on to train the rest of your employees.
By the time you get over all this and you are still saving money over the U.S., you’re lucky. It is very doubtful you are saving money over Mexico on labor. But labor was supposed to take care of the transportation costs.
MEXICONOW: What other cost problems – accounting or opportunity – come into play?
Dr. Lawrence: People missed the boat on transportation costs. When it comes to transportation costs, what they did not factor in was the volatility of fuel. If everyone starts shipping all over the place and fuel costs rise with the economy, would your cost equation still be good? No one did a probability analysis and when oil went to $150 a barrel, it did not make sense to ship out of China under any circumstances.
If fuel was not enough of a problem, what about shipping capacity? If everybody’s moving over to China, how much shipping capacity is there in the world to handle this? The fact of the matter is there wasn’t sufficient shipping capacity to handle this situation. So shipping prices start rising due to the demand. On top of that, shipments back to China are primarily empty back haul.
You run into capacity constraints; you run into logistics carriers violating their contracts because they can make more money doing something else when they want to. There was not much respect for the U.S. legal system and so forth.
MEXICONOW: Would it be safe to say you are advising entrepreneurs to really do a deep dive into the details concerning the location equation?
Dr. Lawrence: That is right, and with the logistics equation, we work to capture all the cost factors that had not been previously captured. We’ve all learned the lessons concerning quality and the need to spend the money to fully vet the supplier in China. The one organization that has responsibility for quality is the parent company. If they don’t want to spend the money it takes to fully vet and set a quality process all through their supply chain in China, they get exactly what they deserve.
Take for example the many high profile quality failures of major international firms in China, do you think they would have hired non-ISO 9000 companies anywhere in their supply chain had they not been following this China hysteria? I don’t think so.
That hysteria is much a, “We can find a way to get cheaper. The board and the shareholders are pushing us to go to China.”
MEXICONOW: A few years ago customers of Tier 1 and Tier 2 suppliers out of Mexico reportedly all but told these suppliers they had to get to China. What went wrong?
Dr. Lawrence: Automotive is a different industry for there is a growing automotive market in China. In the location equation it was a matter of anyone wanting to serve North America from China who was usually making a mistake. If you are thinking about serving China you got a different story.
MEXICONOW: What was a cost factor that seems to have been most overlooked for those who went to China to try to serve North America?
Dr. Lawrence: Inventory! For the past 20 years I have done inventory observation.
Nobody wants to admit how much it costs to hold inventory. Nobody wants to do the hard math to calculate how longer lead times and higher variability associated with those lead times affect inventory. So starting with the first one — holding costs of inventory – there are four categories: cost of capital; cost of storage space; cost of obsolescence and cost of insurance and taxes.
It’s really easy to ignore obsolescence and assume it is going to be the same to ship it across the Pacific Ocean; think again! Insurance and taxes may be a wash, but those are small numbers. Big numbers include storage costs and, especially, the cost of capital. More often storage costs are underestimated, especially if one carries a larger inventory. Instead of the often predicted 10 percent, it is closer to 18 to 24 percent for the costs of storage of inventory.
When you move over to the cost of capital, no one wants to admit that cost into the calculation of inventory holding costs. The reason is that cost of capital for many of these firms in a non-risky environment is at least 15 to 20 percent.
In a high-risk environment, like going overseas, it’s got to be 25 to 40 percent! Add up the storage and capital costs with the longer lead time and then you have to explain why you are holding so much inventory. Nobody wants to do that.
They’ll never admit how high holding costs are.
MEXICONOW: What about the costs of additional lead time?
Dr. Lawrence: It’s a big number and you add that to the cost of holding inventory.
All too often, no one questions the variability of that lead time. Because if we can’t get the shipment to take place on time, we are probably looking at an additional three weeks to six weeks or months to get the product in there. The variability of that is going to explode your forecasting issues. It is going to explode your issues regarding virtually everything you’re engaged in for inventory planning – and explode your inventory even further. Inventory holding costs alone tell us that serving North America from Asia is not viable.
But they didn’t calculate that. They didn’t want to; they did not want to admit to themselves how much shipment was going to cost. They stay there three or four years and still try to figure out why they are losing money.
MEXICONOW: Another problem would be expedited shipments – usually resulted from poor planning or sudden shifts in demand.
Dr. Lawrence: About 10 percent of all international shipments get expedited.
From Mexico, you can expedite UPS with a one- or two-day delivery. You expedite out of China, you have to go air. That can be prohibitively expensive. That, all too often, is not factored in at the level it should have been.
MEXICONOW: How costly is security in this equation?
Dr. Lawrence: In this one, Mexico loses. China has pretty good security. The United States has excellent security. That is an issue we in this region have to deal with. The way to deal with it is calculate the private security costs and add that into consideration.
MEXICONOW: Many transnational enterprises complain about “red tape” and bureaucracy. Where do they fit in the total cost analyses?
Dr. Lawrence: Chinese bureaucracy? You have to hire specialist lawyers in China to get you set up doing business there.
You have to do the same to some extent in Mexico, but it is not nearly as difficult a process as doing that in China.
When you add all these costs together, it was astronomically higher than they thought it would be.
MEXICONOW: Many areas in Mexico have over the past four decades become heavily dependent on the auto industry. During more recent years, there has been an automotive “boom” in China. What must this area understand about that development?
Dr. Lawrence: The automobile industry knows China will be the world’s largest marketplace. If China is going to be the world’s largest marketplace, you have to be in China if you plan to sell in that marketplace. Because for the same reason you don’t ship products across the Pacific Ocean to serve North America, you don’t ship across the ocean to serve China.
So, under those circumstances, North American corporations that have an opportunity for a major Chinese market are going to need to have locations in both places. That requires two investments, not one. This means the ROI equation becomes much more intense. It means having operations in China to serve China and operations in the North America to serve North America.
MEXICONOW: Much has been made about the growing market in China.
To what extent is that growing market a sure-fire winner for investment on that side of the Pacific?
Dr. Lawrence: There has been a tendency to overestimate what “Serve in China” would look like. There is the belief that the Chinese market as the world’s largest market would be an irresistible market. For example, if you are making automobiles and going into a country where you are going to have a rising middle class and nobody owns automobiles, it’s not bad. It makes sense, and we have seen that. But if you’re talking about selling other types of products, you have better have a really good marketing plan.
The percentage of the population that can buy and will buy foreign goods is really small. Keep in mind that right now, the Chinese economy is less than one-third the size of the U.S. economy.
MEXICONOW: You stated the case concerning competitiveness. What would you urge Mexico to do at this point?
Dr. Lawrence: Mexico needs to not just ask, but demand that their U.S.
partner help them do something about security. Despite what some might say to the contrary as in “numbers holding up,” trade is being affected. It needs to be a joint effort between our countries to do something about it.
There are a lot of great thinkers in Mexico and they emphasize innovation.
You are talking about new products which give higher margins and fewer barriers of entry into market. New products are a solid win, and that’s the reason Mexico should continue its very positive and aggressive movement on innovation. You get that through education and engineering.
There is also a point that the United States should consider: automation of processes. If corporations in the United States could convince the various interested parties in investing in automation instead of looking for low-cost labor around the world, the United States would have factories here in the U.S. that have left. They would be here instead of in other countries because automation is cheaper than cheap labor!