Innovation and the quest for a competitive industrial policy
By Sergio Ornelas, MEXICONOW’s Editor
De-globalization, de-industrialization, innovation, re-shoring, regionalization, nanotechnology and additive production are the new buzz words in manufacturing.
The world is undergoing a new manufacturing order driven by economic, technological, market and geopolitical forces. During the past few years and into the near future, the changes in global manufacturing make its outlook for 2020 unimaginable back as recently as 2000.
Mexico is positioned to take advantage of the profound and structural transformations taking place in the global manufacturing landscape. But the journey is not rosy if Mexico continues to be its own worst enemy.
In this article, we will review the macro trends in global manufacturing and how they affect Mexico’s performance in the value chains of the auto, electronics and aerospace sectors. De-industrialization
The battered economies of the European Union (EU), where manufacturing accounts for approximately 16% of Gross Domestic Product (GDP), suffered a decline of 11% in manufacturing employment since the beginning of the financial and economic crisis.
Other than high-technology manufacturing such as the pharmaceuticals and scientific instruments sectors, the modest recovery in the EU has kept employment levels in manufacturing low. The prospects for recovery in medium-to-high, medium-to-low and low technology manufacturing remain rather weak.
In Japan, the ministry’s labor force recent survey showed that the number of people working in the manufacturing industry in December 2012 dipped below 10 million for the first time since June 1961. This represents a reduction of some 40 percent from the peak of 16.03 million in October 1992, and 15% since the start of the economic crisis in 2007.
A combination of factors is contributing to a greater burden on manufacturing companies in the land of the rising sun, including a stronger yen that inhibits exports, power shortages because of the suspension of nuclear power plant operations, tax measures to combat global warming and more strict labor laws.
The significant reductions in manufacturing in the EU and Japan represent a huge challenge for the affected countries’ domestic economies. Efforts to recover the pre-crisis levels of production, such as the Horizons 2020 in the EU and the attempt to stop deflation in Japan are underway, but they will unlikely make up the lost ground in the short or medium terms.
The decrease in manufacturing in these two important regions is not temporary, it is rather structural in nature and it opens up opportunities elsewhere for both developing and developed countries.
De-globalization and Regionalization
The strongest positive force currently favoring Mexico’s growth is the economic phenomenon of “Regionalization”.
Conceptually, regionalization is globalization taking a step backwards. Indeed, the world is “de-globalizing” and Mexico stands to be one of the largest beneficiaries of this process.
Let’s recall that globalization refers to the reduction and removal of barriers between national borders in order to facilitate the flow of goods, capital, services, labor and technology.
The process of globalization has many positive aspects, such as the emergence of worldwide production and financial markets; and broader, less expensive access to a range of foreign products and services for consumers and companies.
But the development of globalization had a major setback with 9/11, which triggered significant restrictions in the international flow of goods and individuals. And recently, the great recession helped to further reverse the process of globalization as developed nations activated domestic job protection and import restriction initiatives.
Since the price of crude oil started to spike, it became clear that globalization was receding and that world production value chains engaged in a process of restructuring their global footprints, leading the way to a new wave or order that we have labeled as “Regionalization”.
Regionalization is simply the trend of reordering production value chains to better serve regional markets. In this fashion, regional production and logistics supply chains are reshaping and restructuring in Asia, Europe and the American continents. So what we will have in the long-term is manufacturing and logistics platforms to serve the different regional markets.
This is not to say that the U.S. imports from China will stop altogether anytime soon, but rather that we are going to see, for example, more Toyota, Hyundai and BM W plants opening in the U.S. and Mexico to serve the North American regional markets.
Total cost of product ownership is evidently a big driver behind regionalization. Please see Exhibit #1 by Alexis Partners where they project that China’s total landed cost for goods will generally be about equal to the U.S. index by 2015. The graph shows that comparatively, Mexico and India will remain competitive.
China knows well that its booming years of attracting manufacturing and export capacity will soon be over. So, China has already started a “going-out” industrial policy by establishing value chain platforms outside of its mainland in other Asian regions and farther abroad.
Not surprisingly, China’s new global industrial strategy contemplates Mexico as an ideal logistics passage and manufacturing hub for reaching the North American regional market.
The savvy Taiwanese electronic goods contractors learned of the benefits of regionalization earlier. They started to significantly regionalize their operations in the NAFTA region ten years ago, by taking literally millions of square feet of light manufacturing space in Tijuana, Ciudad Juarez, Guadalajara and Reynosa primarily to serve the U.S. market.
“Time-to-market” has been a strong driver in regionalization. Consumers not only demand custom built products but also prompt deliveries. Taiwan’s Foxconn, Asus and other international electronics manufacturing contractors such as Flextronics and Sanmina learned some time ago that competitive manufacturing costs and adequate time-to-market logistics for the U.S. market were impossible to be attained from Asia, but were quite efficient from locations in Mexico, avoiding long lead times and immense investments in inventory.
The supply chains from Mexico to the U.S. and Canada are evidently shorter, less risky and have a lower “Landed Cost” than those from Asia and Eastern Europe. The cost of inventory alone has played an extremely important role in the regionalization of the countries of NAFTA as well as those of the European Union.
Extensive traveling and mid-night business phone calls have slowly broken the resilience of many managers and engineers of international firms. Staying closer to home and operating during normal business hours is a growing preference in the minds of many executive and technical U.S. and Canadian workers, and another reason in favor of regionalization.
Even the masters of round-the-clock work shifts are recognizing this fact: Indian outsourcers Tata Consulting Services Ltd. and Infosys Technologies Ltd. have established Information Technology services operations in Mexico, in line with the strategy of many Indian outsourcers to deliver services to customers from locales in nearby time zones to better serve their regional markets.
Currency exchange rates have also played a very important role in the wave of regionalization. This is one of the main reasons behind the remarkable growth of the aerospace industry in Mexico in the past few years, which has gone from about 50 companies in 2004 to over 300 in 2013 with over 35,000 workers.
France’s Safran and Zodiac and U.K.’s Triumph along with Spain’s Aernova and more recently, Brazil’s Embraer have substantial investments in Mexico.
As the Euro gains strength over the dollar, many European aeronautical supply firms that have dollar denominated contracts are ailing with higher manufacturing costs in Euros. These corporations know that relocating to Mexico, gives them the advantage of a low-cost manufacturing platform as well as the benefit of shifting their costs to a “dollarized” region.
Regionalization will continue to gradually shift manufacturing from off-shore to near-shore regions and new windows of opportunity will open for Mexico.
As manufacturing costs rise in China and elsewhere in the world, countries such as Mexico will continue to benefit. But as of recent, an unlikely player is poised to join the likes of the so called low-cost countries for manufacturing: The United States of America.
Indeed, U.S. exports have been increasing seven times faster than GDP since 2005 on the heels of significant world competitive electricity and natural gas costs. Even labor in the U.S., adjusted for productivity, is competing with China’s and it is well less expensive than its counterparts in Europe and Japan. Please see Exhibit #2showing the average 2015 projected manufacturing cost structures of the major exporting nations relative to the U.S.
In a recent study by the Boston Consulting Group (“Behind the American Export Surge”), the think-tank organization says: “We project that the U.S., as a result of its increasing competitiveness in manufacturing, will capture US$70 billion to US$115 billion in annual exports from other nations by the end of the decade.”
The study explains: “About two thirds of these exports gains could come from production shifts to the U.S. from leading European nations and Japan. By 2020, higher U.S. exports, combined with production work that will likely be “re-shored” from China, could create 2.5 million to 5 million American factory and service jobs.”
The U.S. boasted 17 million manufacturing jobs in 2000 and is currently creeping back at a snail pace to 12 million. Because of automation, innovation and productivity, it is hard to imagine that the manufacturing jobs in the U.S. will be over 15 million by 2020, even at a decade high production capacity. But the boost from exports and re-shoring will be substantial.
The good news for Mexico is that any manufacturing jobs gains in the U.S. translate into new jobs in Mexico as well. Since the supply chains of both countries are highly interlinked, Mexico is poised to gain at least one manufacturing job for every 10 to 12 jobs created in the U.S. (The current level of manufacturing jobs in Mexico is 3.3 million).
As a result of these trends, the new geographical manufacturing order is already being reflected in the U.S. imports market share by country, as illustrated in Exhibit #3 which shows that the gap between China and Mexico is narrowing since 2009.
Additive Manufacturing and Nanotechnology
Two relatively new technologies are making their way into the Research & Development department and the manufacturing floor of companies. Additive manufacturing and nanotechnology represent a realm of opportunities for global engineering and manufacturing and Mexico should be in the hunt for these technologies.
Although three-dimensional (3D) printing technology has been available for a few years, it has not been until lately that manufacturers have intensified its use.
In a nutshell, 3D printing uses Computer Aided Design (CAD) files as a blueprint to build physical objects or parts by repeatedly applying thin layers of materials in a “build-up” or additive process. This is regarded as Additive Manufacturing (AM).
Thus, Subtractive Manufacturing (SM) represents the traditional production processes such as milling, drilling and grinding by which material is taken away from a larger piece to shape objects or parts.
Evidently, the advantages of AM are many, including: Elimination of material waste, fast development of prototypes, quick production cycle turnarounds, ability to create geometrically complicated parts, capability to change the density of the object’s body and others.
To date, the industries taking advantage of this technology include those in need of small, light parts, with low volume production levels such as the aerospace, electronics, auto and medical sectors. The most popular materials include plastics, ceramics, aluminum, steel and other alloys.
But still, the technology is in its early development stages. General Electric, for example, is the world’s largest user of additive technologies in metals with over three hundred 3D printers in use across the company. Additive fabrication helps GE file approximately 2,000 patents in the U.S. alone per year.
Christine Furstoss, Director for the GE Global Research Center explained: “3D printing is changing business models and represents the first paradigm transformation in the last 30 years in fabrication. AM brings democratization to the production process and it truly allows the industrial internet to meet manufacturing.”
“Currently, we are still in development with AM, we want to make sure that we have a complete understanding of the technology’s possibilities and limitations. We still need to invest to develop new types of materials such as ceramic matrix composites and silicon carbide.”
Furstoss added: “AM integrates design and manufacturing. With AM, hardware meets software, the capacity to innovate is much greater. Manufacturing is no longer after the design, manufacturing is now part of the design, and it’s a new ecosystem.”
There are many applications already in place for AM. The medical, fashion, auto and aerospace industries have myriad of products and uses.
There are many techniques in AM, for example, the sphere on our cover of this edition is a Freedom of Creation lamp design using Selective Laser Sintering (SLS), an AM process that uses a laser to sinter (heat and fuse) the material in powder.
Another modern technology, Nanotechnology or “molecular manufacturing” (MM), as it is sometimes called, is an engineering specialty that deals with the design and manufacture of extremely small objects, devises or surfaces at the molecular level of matter.
The name nanotechnology comes from the measure “nanometer” which equals one billionth of a meter. The subject is often discussed together with microelectromechanical systems or “MEMS”, such as the sensor devises used inside aircraft turbines to measure performance and prevent engine malfunctions.
Nanotechnology is already present in many daily used materials such as waterproof clothing, heavy duty resistant materials, and “Teflon” type coverings for any surface and others. But nanotechnology still worries environmentalists and its development is generally regarded to be longer term when compared to AM in production processes.
Although enough in never enough in cost-cutting in manufacturing, plenty of cost saving techniques are already applied through most industries and their effect on productivity is becoming less effective. Cost-cutting is a “diminishing returns” tool to increase productivity and profitability.
Now days, innovation in the manufacturing world is the key for higher productivity levels and their impact on the financial bottom line of corporations.
In Mexico, over 80% of manufacturers rely on Lean/ Six Sigma methodologies to improve their production processes. But many still have manual assembly and packaging as part of their critical processes resulting in idle time and loss of efficiency and productivity.
Mexico engineering teams are very good to innovate manufacturing processes and they continually strive to incorporate semi-automated and automated operations in their production and packaging lines.
With the new technologies, Mexican plants should gradually be able to move up the technology ladder and be involved in product innovation as well.
Mexico 2020 Manufacturing Outlook
The recent tax reform passed by Congress and which will be effective on January 1, 2014 certainly had an impact on most analysts’ forecasts.
There is no question that the increase in income tax rate for maquiladoras and other qualitative (redtape) restrictions will make a dent in Mexico’s total cost of product ownership competitiveness. The effect will vary depending on the capital, labor and other factors’ mix of each operation. But as a general rule of thumb, the effect will be an increase of about 5% to the fully loaded average semiskilled worker hourly cost.
Nevertheless, the maquiladoras and other foreign direct investors in manufacturing in Mexico will survive this bump, but not after experiencing a period of analysis and revision. The market should expect a slow-down of new projects and expansions in the pipeline in the first half of 2014.
The tax reform event is another call for Mexico to continue to move up the innovation food chain. Tin many instances, firms in the country have gone from a labor intensive focus to a capital intensive mode. They now need to move to an intense process and product innovation strategy, and embrace the new technologies.
AM and MM are extraordinary opportunities for Mexico’s type of competitive manufacturing. Please remember that highvolume, low-product mix and very labor intensive production belongs in China, Vietnam and Central America. Mexico is most competitive in lower-volume, custom made, high-product mix, high engineering changes types of goods, which is precisely the manufacturing ecosystem that AM and MM technologies offer.
Our brief 2020 volume forecast for three of the main manufacturing industries in Mexico follows.
The aerospace industry is the new and most exciting sector in Mexico. Still in its early stages of development, it is set to reach at least 70,000 manufacturing and engineering jobs by 2020 as shown in Exhibit #4.
Mexico’s aerospace industry started in the safe niche of wire harnesses, but soon climbed to higher technologies such as turbine parts machining and composite fuselages. It also quickly embraced complex parts and subassemblies for small and mid size aircraft and has made important progress in design and engineering cores.
The electronics industry in Mexico is world class and it is a huge generator of technology and value added. In spite of the sector’s global product, market and technology eye blinking speed and volatility, it has managed to reach over US$72 billion in exports in 2012 and will likely reach the US$100 billion mark by 2020 or before as illustrated in Exhibit #5.
Lastly, Mexico’s biggest and most important ever industrial story is the automotive industry. The forces and trends that we have talked about in this piece are heavily reflected in the development of Mexico’s auto industry.
Light vehicle exports are projected to double from 2 million units in 2007 to an extraordinary level of 4 million units or more by 2017 as shown inExhibit #6.
The stars are well aligned for Mexico to succeed and grow in manufacturing, but this will only be possible if Mexico ceases to be its own worst enemy.
The country needs a sound industrial policy in a hurry. An industrial policy that facilitates business for both foreign and domestic manufacturers. An industrial policy with clear and permanent rules. An industrial policy that is globally competitive and friendly. An industrial policy with reasonable taxes but free of foolish red tape and bureaucracy. An industrial policy that is intelligent in nature and values the real impact manufacturing has on employment and the economic well being of Mexicans.
If Mexico does not develop a sound industrial policy congruent with innovation and global competitiveness, other countries will gladly take and eat Mexico’s lunch.