Regionalization Changes Global Supply Chains

De-globalization, time-to-market and consumer preferences shape manufacturing footprint

The global landscape of the supply chain across most industries continues to change. Significant economic and political affairs are affecting the competitive strategies of international OEMs and their suppliers. As they continue to exploit new markets and look for supply chain and engineering opportunities, the option to locate in Mexico gains attention in corporate plans.

Currently, almost 90% of large manufacturers from developed countries sell their products outside their home area and about 60% of them have located facilities in a low-cost country. It is hard to forget that just 10 years ago there was an exodus of production lines from the NAFTA region to China. And 10 years from now, we will certainly remember that the pendulum somehow swung back and North American countries are recovering some of those nomads and are actually welcoming Asian investments.

Just in the past three years, and in spite of the global recessionary clouds and security concerns, Mexico has attracted an unprecedented wave of new auto assembly plants and an important number of new facilities in the aerospace, electronics and medical sectors. In this article we will review some of the main forces and trends in the manufacturing supply chain dynamics that influence the global footprint of international firms.

A NOTEWORTHY INDUSTRIAL STORY

For our purpose we will utilize Mexico's automotive industry. Following is a brief background of the most important manufacturing sector in Mexico. The 50-year history of manufacturing of auto parts and assembly of light vehicles in Mexico is remarkable.

During the period 2006-2008 the sector managed to reach the coveted levels of production at 2 million units, 1.5 million in exports and 1 million cars sold in the domestic market (About half of the domestic sales were imports).

The recession crushed the industry and all the numbers went down by about 25% in 2009. The damage was relatively "mild" since Mexico's auto industry has traditionally followed the fate of its main customer, the U.S., where sales dropped by over 40% that year. Mexico's auto industry had a very quick and healthy recovery in 2010- 2011 reaching all-time record levels for production (2.55 million) and exports (2.14 million).

In 2011, auto industry exports (vehicles and auto-parts) were US$60 billion, representing over 21% of Mexico's total manufactured goods exports. At US$36 billion, Mexico is by far (Canada is second at US$16 billion) the largest exporter of auto parts to the U.S. market. Furthermore, Mexico is now positioned as the 8th largest producer of light vehicles in the world and it is the 5th largest exporter. During Q1-2012, Mexico's market share of new cars sold in the U.S. was 10.3%.

During 2005-2010, Ford, GM, Chrysler and VW collectively invested over US$3 billion in new and expanded production facilities. There are many variables behind this exciting industrial story. Let's review the main drivers of Mexico's auto industry supply chain.

THE REDESIGN OF MANUFACTURING FOOTPRINTS

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. Author Thomas Friedman explains in his bestseller book "The World Is Flat" how the "flattening" of the world happened at the dawn of the twenty-first century. In a few years, the convergence of technology, world events and low cost of labor allowed China to become the center of attraction of the global supply chain, giving China a huge new stake in the success of globalization.

Indeed, companies literally ran to open factories in China with two objectives in mind: To supply the growing Chinese market and gain a cost advantage over competitors to supply the North American market from manufacturing facilities in China. The latter eventually proved to be a very poor decision for most.

The development of globalization had a major setback with 9/11, which triggered significant restrictions in the international flow of goods and individuals. And the great recession of 2008 also slowed the process of globalization as developed nations activated domestic job protection and import restriction initiatives. So the world started to "de-globalize" and in many ways it is getting less flat.

In addition, the price of crude oil started to spike leading to very high transportation costs. And many manufacturers that flocked to China soon realized that they had overlooked many costs such as capital invested in inventory, obsolescence of goods, expensive reverse logistics to correct product defects and very high workers' training costs; all on top of the issue of industrial property rights violations.

It became clear that globalization was receding and world production value chains engaged in a process of restructuring their global footprints, leading the way to a new wave or order in manufacturing 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.

Conceptually, regionalization is globalization taking a step backwards. Indeed, the world is "de-globalizing" and Mexico's auto industry is already one of the largest beneficiaries of this process and will continue to be in the future. As a matter of fact, in large part as a result of regionalization, the following new assembly plant significant projects have been announced to join the already successful auto industry in Mexico:

• Nissan in Aguascalientes: Investment US$2 billion, capacity- 175,000 units/year. Production starts in late 2013.
• Mazda & Sumitomo in Guanajuato: Investment US$500 million, capacity – 140,000 units/year. Production starts in 2013.
• Honda in Guanajuato: Investment US$800 million, capacity – 200,000 units/year. Production starts in 2014.
• Volkswagen in Puebla and Guanajuato (Beetle and Engines): Investment US$1 billion. Production starts in 2013.
• Ford in Sonora: Investment – US$1.3 billion. Production starts in 2013.

In addition, Audi has indicated that it will build an SUV plant in Mexico. A formal and detailed announcement is expected in the near future. Japan's Toyota, Korea's Hyundai, Canada's Magna-Steyr and China's Geely have also stirred rumors about new vehicle facilities in Mexico.

Industry analysts predict that these investments will catapult Mexico's production from 2.5 million units in 2011 to 3 million units in 2014 and 3.5 million units in 2015. Export forecasts place the volume at 3.2 million by 2015. The growth projected of 70% in production in just 7 years from 2008, is amazing, even by China's standards.

These investments in auto capacity evidence the regionalization strategies of auto makers. Evidently, their intent from these new facilities is to better serve North American consumers and support their growth plans for sales in the South and Central America markets.

The foresight of Mexico's authorities in the last two decades to develop a network of free trade agreements and commerce alliances in the American Continent is to be commended. Mexico is becoming the regional auto production hub for the Americas' marketplace. Please see in Exhibit #1the new region for auto assembly that is taking form to include Mexico and the southern part of the U.S.

THE ART OF POSTPONING

At the turn of the century, Japanese auto makers started to regionalize their production for the North American markets by establishing assembly plants in the U.S., commonly referred to as "Implants". From their new locations, mostly in southern states of the U.S., being closer to the consumers, they are able to better serve the market. By offering the marketplace custom and varied features in the vehicles and faster deliveries, the implants are actively using the concept of "Post ponement".

According to Dr. Barry Lawrence, Director of the Industrial Distribution Program at Texas A & M University: "Postponement puts off final production until the last possible time that will meet customer needs. The benefits are significant. The product is not produced until demand is well established (better forecasting) and is kept in a raw material or subassembly state until then (lower inventory value and more flexible to market shifts). Inventory value plummets and customer service levels rise."

"A sub assembly or non-differentiated product can be made by a high volume, efficient factory in say Tianjin, and then shipped to Mexico for final value adds before hitting its final markets in the U.S." "At each value add manufacturing stage, the product will gain value and, therefore, cost. The inventory holding cost will decrease for the supply chain since the product does not gain its full value until it reaches its end market.

The improvements will lead to lower supply chain costs and will enable even more differentiation (selection for the consumer)." Dr. Lawrence points out a significant advantage of postponement: "The demand for differentiation is only likely to grow. The ability to differentiation nearly immediately may become the primary competitive advantage in the future."

One of the things that impresses most people when taking an auto assembly plant tour in Mexico is observing at the end of the production line that practically none of the units produced is similar to the one ahead or behind it. They are all different: Exterior colors, interior finishes and even models. The process seems magical.

OEMs accomplish assembling what the consumers have custom ordered, precisely by combining postponement with other supply chain strategies and quality techniques such as Just-in-time, Kaizen, Justin- sequence, digital manufacturing planning and others. The auto industry has gone a long way since Henry Ford said: "Customers can have the car painted any color they want so long as it's black."

GETTING TOGETHER

An "industry cluster" may be broadly defined as a loose, geographically bounded group of similar or related firms that together create competitive advantages for member firms and the regional economy. There are many types of industry clusters. Some of the most renowned clusters include Silicon Valley (Similar firms in collaboration) and Detroit (Hub and spoke, large firms with numerous suppliers).

Originally, the concept of industrial clustering developed "naturally", as firms simply started to get together in an area for reasons of labor, institutional support, buy-sell interests, related divisions and others. More recently, with the reordering of supply chains as a result of regionalization, the development of a cluster is generally planned and intentional.

We can observe Hub and spoke industry clusters of two sub-types in Mexico's auto industry: Single OEM as in Puebla (VW) and Sonora (Ford) and multi-OEM clustering as in the Bajio region. In modern auto industry location strategies, OEMs would not decide to open a new assembly plant without the assurance and commitment from some of their main Tier-1 suppliers to relocate along with them.

For example, you can expect that the new Honda and Mazda facilities will automatically attract a few Tier-1 Japanese firms. Evidently, for any community in Mexico to attract an assembly plant is highly desirable, it represents a guaranty for the development of a cluster, employment and economic development. This is why very attractive incentives packages are offered by the states in Mexico for assembly plant locations. As might be expected also, the process, more often than not, involves high political stakes.

Regionalization, postponement and clustering influence the footprint of industries in different ways and time frames. For example, in the electronics industry, supply chains are pushed to the limit to cut costs and time to market in a speedy fashion. In Mexico, Asian electronic contractors such as Foxconn, Asus and others have aggressively established operations in Tijuana, Juarez and Reynosa to serve U.S. consumers as they order new custom lap-tops, desk computers, telephones and also take care of repairs and warranty work.

Lenovo's largest investment outside of China in Monterrey, in a large manufacturing plant with a 5 million PC annual production capacity in recent years represents the "ultimate" example of the force and relevance of regionalization. Earlier, Lenovo had bought IBM's ThinkPad PC division, and the plant in Mexico "will be contributing to a more streamlined and efficient regional supply chain".

The aerospace industry moves at a different, longer-term speed. Airbus and Boeing have indicated that they will do "something important" in Mexico once the supply chain is robust. In the mean time, they are encouraging some of their home suppliers to start establishing operations in Mexico.

COST, COST, COST

The original compelling reason for off-shoring or near-shoring manufacturing was to reduce cost. And it is still at the top of the list of many supply chain decision makers. Although the analysis has shifted from just savings in labor to total landed cost and further to total cost of product ownership.

Wrong relocation decisions to China, the great recession, vendor cost pressures and other "rectifying forces" in the business and supply chain environments have certainly honed the analysis skills of many decision makers. For them, we offer some data that suggests the level of cost competitiveness that Mexico has.

Please refer to Exhibit #2 that compares the projected average workers wages for the U.S., China and Mexico through 2020. These graphs were projected using the real exchange rates and producer price indexes for each country with data from HIS-Global Insight. Please note in the graph how China goes from under US$1.00 in 2005 to over US$7.00 per hour in 2020. This is particularly true for the coastal areas. Lower wages may be found in inland China.

Mexico is expected to be at about US$5.00 per hour by 2020. But there is an important thing when comparing Mexico and the U.S. And this is that the gap between their wages in 2010 was US$22.10, and in spite of relative higher percentage increases in Mexico, the gap actually widens in 2020 to US$24.80.

So the wage difference and competitive advantage between the countries will not disappear but it will actually improve over time. Exhibit #3 illustrates a sample of the results of KPMG's 2012 Guide to International Business Location cost. We selected auto parts, plastic and metal components and precision manufacturing to compare in various locations.

KPMG's analysis is very thorough, it includes wages, materials, utilities, administrative and sales costs, taxes and other items concentrating just on the local portion of the operation.

But, and this is a big "But", it does not include important items such as transportation to markets, cost of inventory, cost of training and other items that should be considered by the decision maker to arrive at an accurate and true bottom line.

NEW CONSIDERATIONS

During recent years, global OEMs and their suppliers are facing new variables that influence the value chain of manufacturing. In response to consumer advocates and public opinion, the industrial media has raised concerns about three new items that will affect the supply chain in low-cost regions: Workers' factory environment and working conditions; problems with tainted and unsafe products; and the potential environmental impact of production processes.

In a recent study of emerging markets, the Deloitte Global Manufacturing Industry Group examined these issues, surveying more than 650 executives from both developed market and emerging market companies to learn how manufacturers are responding to the intense scrutiny of product safety, quality, and environmental issues.

The following is their conclusion: "In response to these concerns, companies are taking steps in several areas, including more rigorous vendor selection, detailed contract requirements, and frequent on-site supplier visits. In general, executives surveyed said that concerns about product safety, product quality, and environmental issues were likely to lead manufacturers to source more from emerging markets that have stricter standards; to produce more from company-owned facilities in these locations and to provide more information to customers."

Undoubtedly, the above initiatives will translate in higher costs in the supply chain. But this will only be in the short-term. In the long-term, the market will reward those value chains that are worker, safety and environment friendly.