Mexico gains market share in U.S. imports By Sergio L. Ornelas, MEXICONOW Editor
Mexico’s remarkable recovery in its share of U.S. imports of goods in the last five years or so is a story that begins in China.
Most of the early movers to China in the late 70’s and early 80’s such as the auto OEMs, went there to pursue the growing and promising consumer market of a nation that was heralded to become a leading economy in 50 more years or so.
They were later followed in the 90’s by many firms that were primarily interested in low cost manufacturing for the goods they ultimately intended to sell in the U.S. and European markets.
The economic recession at the turn of the century accelerated the trend of going to China. Companies flocked to China for no other reason than that it “was the thing to do to be competitive and survive.”
Prior to the “dot-com” 2000 recession, China’s ability to attract international firms went very much unnoticed in Mexico. Suddenly, as the recession hit, in just a few months thousands of jobs were drained from Mexico’s manufacturing plants.
Back in late 2002 when MEXICONOW magazine was launched there was nothing but bad news to report about the maquiladora industry in Mexico. Literally hundreds of international companies were quitting their operations in Mexico. Some of the companies closed down because they went broke but the majority relocated to China.
Many of the cost-cutting-hunting firms that went to China in the “irrational exodus” made their move based on poor cost analysis. They concentrated on the low cost of labor and marginal transportation increases but badly failed to identify myriad logistics, management, inventory, training and other countless hidden cost items.
After many years of production successes and failures, many firms that belong in China will remain there, and some of those that don’t have brought manufacturing back home to the U.S. and Mexico.
Largely remaining in China are companies that supply the huge domestic market of China and other eastern countries.
Other firms that have stayed in China and other Asian countries produce goods for sale in the U.S. market that are generally very high-volume in nature, with little variations in design and that can afford to travel for weeks across the ocean.
In this article, we will review the variables that have led many firms to choose manufacturing near-shore in Mexico versus going off-shore. We will also explore the dark side of near-shoring and the missing links in Mexico’s logistics corridors.
The source of all evils
Inventory build-up is the result of the fundamental waste: Overproduction.
Excess inventory of raw materials, parts, work in process and finished products is not only a financial burden for a company, but the perfect disguise for other supply chain related problems.
Extra inventory hides late deliveries from suppliers, product defects, parts obsolescence and other deficiencies in the supply chain.
Inventory performance should be the single most audited variable in a supply chain. In the ideal supply chain, there would be zero inventories; everything would just flow through from suppliers, to the production line and out the door to the customer.
Inventories consume cash and credit, have a high carrying cost and represent a large jeopardy to the bottom line. Imagine the investment in parts and finished product inventory to keep the pipe line flowing in transit for months of a supply chain from China to markets in the NAFTA region.
Evidently, supply chains within the NAFTA territory required a lot less inventory and are by far less expensive and less risky than supply chains from Asia.
The double challenge of innovation
As a result of intense competition and highly sophisticated product development and marketing processes, consumers have grown spoiled. They expect innovative products of the highest quality at an affordable price, and they expect them fast.
U.S. firms are under increased pressure to develop new products: Back in 2000, on average, it took about 18 months for companies to design, prototype, test, produce and launch a new product into the marketplace. By 2008, the product development cycle was shortened to only about twelve months and currently it is about 10 months.
Interestingly enough, in 2000 new products accounted for 20% to 25% on average for total revenues of U.S. corporations. But today, firms get close to 40% of their current revenues from new products.
The double challenge of innovation is simply that in order to stay financially viable, a company must develop more products at a faster pace. And the pressure will keep growing from both ends in the future.
The logistics for developing a new product are extremely demanding, particularly if manufacturing is going to be conducted outside the U.S. Not only do the management and technical staffs need to be on top of the process, but they need to be present to handle design and engineering changes. In addition, production processes need to be frequently adapted to attain desired efficiencies. Launching the product into the market is evidently easier done closer to home than farther away.
The double challenge of innovation is another very forceful trend that favors near-shoring over off-shoring. This of course is of significant advantage to Mexico over its Asian counterparts. In fact, Mexico, with its easier access and logistics is quickly becoming “the place” from where new products that need a low cost manufacturing platform can be launched effectively.
Usual and unusual suspects
For the past 15 years we have all witnessed the escalating cost of oil rising from US$17 per barrel in 1999 to about US$100 per barrel currently. This huge spike in oil prices started to de-globalize international trade.
Many of the international efforts to reduce import tariffs and reduce costs have been scratched by the rise in oil prices. Some estimates place the increase of oil as the equivalent of a 10% global tariff on goods. But after a few years we have grown accustomed to the high cost of oil.
What we did not see conspicuously coming was the recent rise in cost of another world valuable commodity: Labor in China.
Total cost of product ownership is evidently a big driver behind near-shoring. 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 while Brazil topped the graph some years ago.
The sample of firms surveyed in the study indicated that the most attractive advantages for near-shoring were, not surprisingly, lower freight costs and improved speed-to-market as illustrated in Exhibit #2
Other important advantages mentioned included fewer supply disruptions in a clear reference to the Tsunami supply chain interruptions from Japan. And after millions of miles traveled and countless red-eye phone calls, management prefers to work within reasonable time- zones.
Industry analysts estimate that reverse logistics accounts for approximately 5% of total logistics costs. If we consider that in the U.S. and Mexico total logistics costs are 10% and 15% of their respective Gross National Product figures, then the cost of reverse logistics represents about US$65 Billion for the U.S. and about US$8 Billion for Mexico!
Dealing with a flow of goods from the consumer back to the producer brings significant challenges for logistics managers. Returned merchandise, warranty repair and maintenance work are better handled from a location nearer to the source.
Mexico provides ideal conditions for the handling of reverse logistics needs at low-cost labor rates. This is particularly true for the electronics industry. Even Chinese and Taiwanese manufacturers such as Lenovo, Foxconn and Wistron have found that the expediency that Mexico offers for reverse logistics in the North American market is paramount to any other location.
Logistics partnerships save costs
Mexico’s third party logistics (3PL) market is still in a developing stage. In the U.S., about 30% of logistics services are outsourced to third parties while in Mexico it is less than 10%.
Yet during the past few years, large and mid-size global logistics suppliers have flocked to Mexico. In addition, many small domestic firms have also been created by Mexican entrepreneurs, and others have partnered with foreign providers.
A form of 3PL function that is extensively available in Mexico is the “Shelter” service. Under this arrangement, the service provider takes care of all the logistics, legal, personnel and administrative cores while the customer is responsible for manufacturing and supplying the equipment and materials.
About 15% of all manufacturing foreign direct investment projects in Mexico start under a Shelter form of service. The Shelter option is more than a mere 3PL service because a stronger partnership of shared responsibilities is developed between the parties. Colloquially, the Shelter may be regarded as a 4PL service, meaning a 3PL plus one additional dimension: Trustful management.
Unlike Brazil, China and Russia, Mexico has a large and competitive “Shelter” suppliers industry, which facilitates the establishment of foreign operations by reducing their start-up periods and exposure to risk.
Whether starting an operation or already having one in Mexico, foreign investors should consider outsourcing their logistics operations to 3PL or Shelter providers, there’s really proven value and savings in doing so. Exhibit #3 includes some of the main 3PL and shelter providers operating in Mexico.
Follow the money
Currency exchange rates also play a very important role in the choice of near-shore over off-shore. 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 2014 with close to 40,000 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 gained 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.
The dark side of near-shoring
Near-shoring is not a rose garden. Being close to a market is not necessarily 100% favorable, especially in the case of Mexico and the U.S. Following are some of the disadvantages.
One of Mexico’s most criticized failures is the lack of development of a domestic supplier base. Local suppliers are scarce and most of those active are concentrated in packaging materials and non-critical production components. The most optimistic statistic credits only about 5% of the total value of exports by international firms as sourced from Mexican capital funded companies.
There are domestic reasons for this condition such as the lack of credit, production capacity and know-how among other short-comings of Mexican companies. And there is also the fact that, unlike China that forced foreign investors to joint-venture with local enterprises, Mexico’s policy in this regard has been traditionally non-restrictive and open, except for protected sectors such as petroleum and electricity.
But the overwhelming reason for not having Mexican suppliers is precisely because Mexico is very close to the U.S. In a typical “Catch-22” situation, it so happens that there is no need for the Mexican suppliers because the U.S. suppliers (taking advantage of the proximity, the similar business practices and the open-door policy) can establish the facilities themselves in Mexico.
In addition, the buyers and supply chain managers at the headquarters of U.S. firms have a much easier work day encouraging U.S. suppliers to open shop in Mexico than trying to develop a new provider originally from Mexico.
In a near-shore situation, another area that discourages further development of Mexico’s industry has to do with the far end of the supply chain: Scrap and recycling.
Unfortunately, in many sectors, scrap is more profitable than recycling.
Consider Mexico’s auto industry and the light vehicles domestic market. Only about eight new vehicles per 1,000 inhabitants are sold in Mexico per year. Whereas in Brazil, a country with a similar economy to Mexico’s, there are about 17 new cars sold per 1,000 individuals.
The main reason for the low volume of new car sales in Mexico is the importation of used cars from the U.S. About 600,000 used units cross the border south-bound per year. Indeed, being “near-shore” in this case is quite a disadvantage.
And just one short paragraph to mention the darkest part of “near-shoring” which is the case of the illegal substances “industry” supply chain and the extreme damage it causes on both sides of the border.
The federal government of Mexico recently developed a long-term plan named “Mexico’s Logistics Platforms” which seeks to interconnect and stream line the flow of materials through the supply chains.
This is an extensive study that identifies the strengths and weaknesses of Mexico’s infrastructure to handle the international and domestic movement of goods through ocean ports, land, air, rail, customs’ crossings and intermodal exchanges.
Please see Exhibit #4
of a map of the main logistics corridors in Mexico. Note the main export / import routes in dark blue which link the large markets in central Mexico with the U.S. through the main entry points at Nuevo Laredo and Ciudad Juarez. The map shows in yellow the developed tier-2 logistics corridors as well.
These logistics corridors are considered mature and well developed with infrastructure, but they are still far from perfect. The main problems at the main waypoints of these corridors are bottlenecks that form when they cross or approach an urban area. There’s a notable lack of loops and relief routes for trucks in the cities and many railroads literally split many cities in half!
The light blue corridor from Mexico City to Cancun is still being developed as well as the Tier-2 corridors shown in light red. These corridors are partially built and they have incomplete sections and railways are generally inexistent.
In color gray the map shows the missing links in Mexico's logistics structure. Please note that their main purpose in central and southern Mexico is to transversally connect the ports in the Pacific Ocean (Mazatlan, Manzanillo, Lazaro Cardenas and Salina Cruz) with their counterparts in the gulf of Mexico ( Tampico, Tuxpan, Veracruz and Coatzacualcos).
In Northern Mexico highways, railways and intermodal facilities are needed to link Chihuahua and Hermosillo with the northwest metro areas of Tijuana and Mexicali.
Another important corridor that needs further development is the connection between Mazatlan and Piedras Negras via Torreon, to alleviate the intensive traffic from the heavily used corridor extending from Lazaro Cardenas to Nuevo Laredo.
Noteworthy is the fact that Nuevo Laredo in the State of Tamaulipas boasts the busiest international trade, single-land crossing point in the American Continent. Indeed the "World Trade" bridge with 2,863,499 truck crossings in 2013 surpassed the 2,351,069 truck crossings at the "Ambassador" bridge that joins Windsor, Ontario in Canada and Detroit, Michigan.
Mexico’s Achilles in logistics is the railroad. Only about 10% of the goods are hauled by locomotives, while the vast majority of land freight is trucked as shown in Exhibit #5
Evidently the Logistics Platforms plan underlines this huge deficiency in the transportation system in Mexico. All rail services in Mexico are under concession to private operators currently dominated by the American Kansas City Southern and Union Pacific railway companies. Hopefully, they will make further investments in rail infrastructure.
But Mexico seems to be its own worst enemy since as of recent the House of Representatives passed a bill that infringes the concession rights granted to these firms who are know extremely disappointed and rightly so. The bill is currently under review at the Senate.
In conclusion we can safely declare that near-shoring checkmates off-shoring, at least in a wide range of consumer and durable goods, particularly those that are custom manufactured or assembled to customer specifications including: Automobiles, appliances, lap and desk top computers, telephones, aircraft sub- assemblies and many others.
The results of the argument of near-shore versus off-shore can be seen in Exhibit #6
which shows the U.S. imports’ market share be country of origin. Note how since 2009 China’s share starts to decline in favor of gains by Mexico. The gap between the two countries will keep shrinking hopefully at the same pace or better.
For Mexico the challenge to continuously keep improving its logistics platforms and corridors is quite clear. Competition from other near-shore locations in the American continent such as countries in Central America, the Caribbean, Canada and the U.S. itself will continue to make their cases to attract manufacturing projects.
Mexico also needs to correct its ample disadvantage in energy and telecom costs. The new reforms in these subjects are on the final stages of completion, but their actual impact on the total country cost of product ownership formula are still two years away.
China knows well that its booming years of attracting manufacturing 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 markets. This is where off-shore meets near-shore: The ultimate frontier to efficiently serve the marketplace.