By Sergio L. Ornelas, Editor MEXICONOW
This is an article about the electronics industry of Mexico that begins in China’s ancient Silk Road.
The Silk Road (or Silk Routes) was a network of trade and cultural transmission land and sea routes connecting China, India and other Asian and Middle-East countries to Europe and the Mediterranean Sea.
The 6,500 kilometer long routes were used for 1,500 years since around year 114 Before Christ, and although silk was certainly the main trade item from China, many other goods were traded and traveled along with religions, philosophies and diseases.
Trade on the Silk Road was a significant factor in the development of the civilizations of Asia, Arabia and Europe.
Since the marvelous tales of Marco Polo’s travels, the Silk Road has not ceased to amaze the world. Today, China is firing global imagination once again by building the greatest economic development and construction project ever undertaken.
The ambitious attempt is to resurrect the ancient Silk Road as a modern transit, trade and economic corridor that runs 13,000 kilometers from Shanghai to the Iberian Peninsula, traversing China, Mongolia, Russia, Belarus, Poland, Germany and France.
On the heels of an initial US$50 billion funding by China, a train track was completed connecting the Eastern city of China Yiwu and Madrid in Spain. A container cargo train recently completed its first journeys along the world’s longest railway line which spans along 1/3 of the earth.
The plan envisions building high-speed railroads, highways, energy transmission lines, fiber optics and financial support to foster economic development in regions along the way. Over five dozen nations have chartered the Asian International Infrastructure Bank to fund the projects.
Unlike China, Mexico doesn’t need to construct huge infrastructure projects to reach its main markets. Mexico, though, has the opportunity to significantly improve its trade by building new and better value chains that do require some investments in infrastructure but also need imagination, planning and execution.
Consider the electronics industry of Mexico which has lagged the auto industry in growth over the last decade or so. In this piece we will review some issues that may revive and propel Mexico’s electronics industry exports.
Metaphorically, we will refer to our analysis as the need for Mexico to build its own Silicon Road.
According to INDEX, The National Council of the Maquiladora and Manufacturing Export Industry, in 2014, Mexico’s electronics export sector employs about 256,000 workers and exported approximately US$80 billion worth of computers, communication devices and equipment, and other electronic goods such as televisions and recording products.
Please see Exhibit#1
showing that the electronics goods sector employs 11.7% of the total manufacturing export firms’ jobs, only behind the automotive or transportation industry.
Interestingly enough, the electronics industry in Mexico is divided in two distinct segments: The Original equipment Manufacturers (OEMs) and the electronic contractors, commonly referred to as Electronic Manufacturing Services companies (EMS).
EMS firms manufacture finish goods, components and make repair work on behalf of OEMs. They are generally very competitive in price because they fill their plants to near full capacity with production from various OEMs.
Among the main EMS firms in Mexico we find Sanmina-SCI (U.S.), Foxconn (Taiwan), Wistron (Taiwan), Flextronics (U.S.), Celestica (Canada), Jabil (U.S.) and Venture (Singapore).
Data from New Venture Research Corp. indicate that EMS companies established in Mexico had revenues of almost US$33 billion in 2014 and that they lease or own production capacity in industrial facilities totaling 20.4 million square feet.
Many OEMs in Mexico such as Philips, Nokia, Samsung, HP, Toshiba, IBM, Sony and many others, use their own facilities as well as those of EMS firms under specific work orders, and many times opportunistically for overflow production.
Many OEMs and EMS companies are located along Mexico’s northern border mainly for logistics reasons. From that location, they are able to supply quickly and efficiently custom orders that are generally placed on-line.
Welcome to the era of “postponement manufacturing”, where products are assembled after they have actually been ordered. By so doing, producers of electronic goods are able to fulfill custom orders while minimizing inventory.
In postponement manufacturing, producers delay adding value to their goods in time and geography.
For example, in “time postponement”, manufacturers defer the final product assembly until the order is received. In “geographical postponement” they try to get the parts and subassemblies as close to the customer as possible before final assembly.
Managing the electronic goods supply chain to orchestrate millions of parts to meet their appointment in the final assembly lines is a complex and challenging feat. The techniques to do so are ingenious, appealing and interesting. The terms “Kanban”, “Raw-in-process”, “Just-in-time” and “Just-in–sequence” have replaced the old “Just-in-case” of large inventories.
This model, often referred to as “Customer-to-order” or CTO, is a logistics strategy to swiftly fill orders for Dell computers, Cisco routers, Sony TVs and myriad other electronic goods and warranty repair jobs.
But, and this is a huge “But”, the large bulk orders for thousands or millions of identical units headed to the shelves of retailers in the U.S. are not made in Mexico but rather in China or Vietnam. These bulk orders are usually shipped from Asia by ocean containers directly to the customers’ distribution centers.
Indeed, Mexico is a great option for “low-volume/high-mix” type of production or customized processes, while Asia remains king in the “high-volume/low-mix” category. And even though the profit margins are smaller in the latter, the volume and revenues are significantly higher.
Mexico’s export electronics industry has been growing but it has had its ups and downs over the last 10 years as shown in Exhibit #2
which compares the electronics and the auto industries exports from Mexico.
It is granted that the auto sector has been performing very well in Mexico, particularly in the last few years, and it is a tough yardstick for comparison purposes, but nevertheless it illustrates the point that there has been plenty of opportunity loses in Mexico’s electronics sector.
Please focus on years 2008 and 2014 and notice that the electronics sector’s exports went from US$75.2 billion in 2008 to US$80 billion in 2014 which is an increase of only 6.3% in six years, whereas the automotive sector improve a bit over 100% during the same period of time.
According to INDEX, the electronics sector lost over 8,000 workers in 2014 from the previous year, a loss of 3.1% of its total workforce.
Bear in mind that the years in the graph represent a period after the exodus to China of many electronics firms in the early 2000’s, and of course note the drop in exports in the recession that hit the auto sector the hardest in 2009.
But a growth of only 6.3% for the electronics sector in six years from the pre-recession peak is flat out a sub-standard result. We have therefore an industry that has reached a plateau and has clearly missed growth opportunities.
Is there a road of recovery for the very important electronics sector in Mexico?
There certainly is, especially in current times, when it is widely known that wages in China have been creeping up and are already slightly higher than Mexico’s.
Mexico needs to move forward and up in the global electronics industry food chain by building an ample supply base to become a manufacturing hub of all trades, not only of CTO deliveries but also a supplier of bulk orders and large volume shipments.
The concept of Silicon Road in Mexico consists of a combination of public policies and infrastructure to lure more Foreign Direct Investment (FDI) and improve the supply chain to better service the NAFTA electronics market and increase Mexico’s exports.
Silicon Road starts evidently in Asia, mainly in China, it extends to Mexico and it journeys from there to the U.S.
Unlike the Silk Road which is pretty much a right of way for transportation of goods and distribution of utilities, Mexico’s Silicon Road needs three additional attributes, namely: The creation of an investment pipeline from Asia to Mexico, the building of a “really feel at home guest place” for Asians in Mexico and the improvement of business logistics with the U.S.
Following let’s explore the three main elements of Mexico’s Silicon Road.
The main global makers of electronic goods have presence in Mexico as shown in the industry’s location map in this article. But one of the principal reasons the industry has plateaued is the general absence of a supply base for the OEMs and the EMS firms.
Mexico does not have an industrial policy for the electronics industry as it does for the auto industry for example.
Mexico’s auto industry has been regulated since its inception and in modern times through a series of “Decrees” or public policies, the sector has been “encouraged” to develop a domestic (Mexico based) supply chain and comply with certain percentage minimums of domestic content in order to operate assembly operations in the country.
The national content requirements for foreign auto OEMs are paired with incentives such as the right for those OEMs that comply with the rules to import, duty-free, foreign made vehicles for sale in Mexico.
As a result, Mexico’s auto industry currently has a large domestic supply base (Albeit most of it belongs to multinational firms) that provides a high domestic content to vehicles made in Mexico. Likewise, the incentive is reflected in the fact that about half of the domestic automobile sales in Mexico are imported units.
There are other minimum investment and production requirements for auto OEMs to keep their privileges, but in summary, Mexico’s auto policy is very competitive and has produced most of the desired results in terms of building a supply chain.
The auto industry, as all other industries, has also the benefit of Mexico’s free-trade agreements, duty-free temporary importation of parts for re-export and other trade mechanisms available under Mexico’s customs law.
The electronics sector does not have a special industrial policy to entice the development of the supply chain. It certainly needs a policy similar to the auto sector, a policy that includes requirements and incentives alike.
Because of its smaller market, Mexico is not in a position like China where foreign investors had to establish compulsory joint-ventures with local firms or the government in order to establish operations there.
But Mexico can certainly outline public policies for reasonable mid-term and long-term programs to encourage and support electronic firms to develop a domestic base of Tier-1, Tier-2 and Tier-3 suppliers.
The Asia-Mexico leg of Mexico’s Silicon Road is actually a road well-traveled. Millions of dollars of electronic raw materials and sub-assemblies make their way across the ocean daily.
What we need under our Silicon Road concept is the transit of Yuans, Yens, Taiwanese and Singapore dollars in the form of FDI to establish manufacturing supply base operations in Mexico, and reduce the burning of oil by transoceanic ships bringing raw materials and Sub-assemblies from Asia to Mexico.
We need to build our own supply base on this side of the ocean: An appropriate public industrial policy for the electronics industry in Mexico can go a long way to accomplish that.
A wild idea
Let’s briefly talk about real estate and cultural differences to explain a potential attribute of Mexico’s Silicon road.
Mexico has great infrastructure for industry, boasting world-class industrial parks and facilities. Mexico’s industrial developments represent an important competitive advantage to attract foreign manufacturers.
Without fear of exaggerating, Mexico’s industrial real estate developers and its supply chain of utilities, contractors, capital markets and industrial services are among the most sophisticated and professional in the world.
Many electronic industry OEMs and EMS companies in Mexico are located in industrial parks and some in stand-alone sites.
From the facade to the inside of the vast majority of the plants in this industry in Mexico, other than the workers’ looks, a knowledgeable visitor would not see important differences with top quality facilities located in Europe, Asia or the U.S.
There are industry specific specialized parks in Mexico. We find the most notable examples in the auto industry including the VW plant and suppliers park in Puebla and the Ford facility and suppliers industrial development in Hermosillo, to name just a couple among a dozen or more in the auto industry.
The aerospace sector has a dedicated development in Queretaro for Bombardier and its suppliers along with an aerospace university and of course an airport.
In Mexico there are also multiple industrial developments with a large number of electronic manufacturing plants, but the most notable and specialized include the Flextronics industrial park in Guadalajara and the new Silicon Border Industrial park in Mexicali.
It’s interesting to observe the behavior of Asian management teams and engineering ex-patriates in Mexico. While they mingle and interact with locals they never leave their cultural bubble at and outside of work.
Asians tend to cling to their food, customs, language and practices and build a micro-cosmos around them to mimic the environment they have in their country of origin.
In contrast, Americans and Europeans, for the most part, eagerly experiment with Mexican food, hang around with local co-workers and more often than not embrace the Mexican culture and way of life.
It may be a wild idea, but a very desirable attribute of Mexico’s Silicon Road would be to have a large scale Asian-culture and electronics industry dedicated development.
The concept would not be just a large industrial park but a higher level project similar in composition to the Special Economic Zones (SEZ) that exist throughout China since the 1980’s which were the pillars of its very successful economic development.
Let’s imagine an ideal project: A track of land in the Pacific side of the Baja California Norte Peninsula, close to the main highway, with an ocean front suitable of a sea port or with at least ready-access to an existing port with intermodal facilities.
The total area of the SEZ in Mexico would be about 400 square kilometers in a20x20 kilometer site and not too far south from Ensenada, Tijuana and San Diego.
This area would be, of course, under Mexican sovereignty but it would be classified as a free –trade zone under the current customs regulations with all the standard tax advantages provided for by law.
The land zonings in the project’s 40,000 hectares land extension would include light industrial, innovation and incubators, housing, schools and commercial areas.
But foremost, the new development would have a hybrid culture of Asia and Mexico to accommodate the business, logistics and cultural Asian traits as well as those of the Mexican workers.
Think of a pseudo-Hong Kong concept in Mexico, where the urban planning, development and technical management would be under Asian or Chinese approach and manners.
Make the Asian entrepreneurs feel almost at home, next to the U.S. market and combine this SEZ with a public policy for the electronics industry as we explained above and there is a project for the ages.
Think of bringing a piece of China, Taiwan and the rest of Asia to Mexico, along, of course with the deep supply chain of electronics manufacturing.
Plan it and they will come and they will build infrastructure and factories, there are vast funding sources in Asia for a SEZ in Mexico dedicated to the Asian electronics industry.
The last leg of Silicon Road, from Mexico to the U.S. and Canadian markets, is relatively short and it is well developed, but important areas of opportunity still exist in physical logistics (infrastructure) and business logistics (Cost, customer service, free trade). Let’s briefly mention one of each.
Railways have the undisputed #1 place in the list in infrastructure needs in Mexico. Mexico’s rail system of 15,000 miles was built in 1910, but today only 10,000 miles of tracks are in service. Furthermore, since the privatization of Mexico’s rail system in 1995 there hasn’t been a significant investment in new tracks by the three private operators of the railways in Mexico.
Other than the rail crossing in Nuevo Laredo and the intermodal port facilities in Lazaro Cardenas, the rest of the northern rail border crossings and sea-ports rail service points are in significant need of improvement. Mexico’s logistics costs will continue to rise unless the rail infrastructure gets a century due overhaul.
We think of electronic goods as fast moving cargo, and that is true for the most part for CTO deliveries, but the large volume bulk orders rely on slower but much cheaper means of transportation. Mexico just cannot continue to rely on truck shipments alone if it wants to grow the electronics and other export industries.
In terms of business logistics, the current most important issue is the Trans-Pacific Partnership (TPP). It is a free-trade agreement under negotiation between 12 countries in the Asia-Pacific region, including: Australia, Brunei, Canada, Chile, Japan, Malaysia, Mexico, New Zealand, Peru, Singapore, the United States and Vietnam.
At this stage of the negotiations, other countries may join such as Taiwan and South Korea which have expressed interest, but China, the most notable country in the Pacific Rim, has not expressed an interest yet.
China’s main problem for joining this type of agreement is, most likely than not, the need to commit to strict Intellectual Property Rights rules. For the time being China has opted to quietly execute individual trade agreements on its own terms such as the recent ones the Chinese signed with Hungary and South Korea.
The most important countries by virtue of their economies in the TPP are, of course, the U.S. and Japan. Some of the players are in hoping to expand their export markets and lure investments, while Canada and Mexico, who have “been there, done that”, love the affair.
The U.S. has been participating in the “rounds of negotiations” since 2008 and political difficulties, particularly those of President Obama with its own Democratic party, but Republicans, who generally support free-trade, will likely move the process forward.
The North American Trade Agreement is of course at the center of the ongoing debate in the U.S. Congress. Twenty-one years since it came into effect, U.S. politicians are still arguing about the results and effects of NAFTA on jobs, foreign investment and trade.
To most of the rest of the world, it is clear that free-trade, and its related agreements for intellectual property, the environment and employment practices, is the way to go.
Mexico’s success in attracting FDI is largely due to its network of free-trade agreements. Mexico must continue to expand its free trade capabilities with TPP. It will be a big help in further developing the electronics supply chain in the country.
This article is meant as both a call to action to elevate the electronics industry to a higher level and an invitation to develop new schemes to lure FDI - unwavering in its optimism about what Silicon Road can achieve for Mexico.