Leveraging Cost Reductions in Labor, Supply Chain and Administrative Overhead By Doug Donahue, V.P. of Business Development – The Entrada Group
Mexico shelter operations have always acted primarily as a turn-key solution to access Mexico’s cost effective labor force.
But now, with the current highly competitive environment both for the manufacturers and in offshore manufacturing options from countries in Asia and Eastern Europe, successful Mexico shelters are evolving to cut costs not only in labor, but in supply chain costs and administrative overhead that previously were left to the manufacturer to manage.
According to a study by the Boston Consulting Group: “Industrial companies are facing an unprecedented challenge: how to capture and maintain advantage during the current period of rapid globalization. A main component of a company’s global advantage is cost. Cost advantage derives from several sources including: lower labor costs, lower capital investment costs, lower domestic sourcing costs and larger economies of scale. The reward for companies that meet this challenge is a solid competitive advantage.”
EVOLUTION OF MEXICO SHELTERS
When the shelter model was conceived, over 40 years ago, the concept was actually quite simple. An international manufacturer entered into an agreement with a shelter operator for assistance in the establishment and management of administrative services.
This could either be done under the shelter operators’ legal presence in Mexico or by the manufacturer establishing their own legal entity and contracting the shelter operators’ services.
In the case of operating under the shelter operators’ legal presence, the shelter operator was the one who was responsible for compliance with all Mexican regulations and answered to the Mexican authorities. The international manufacturer was therefore “sheltered” from actions of the Mexican system.
This gave manufacturers the opportunity to benefit from a single cost advantage -- reduced labor. At the time North American manufactures realized a labor cost that was a small fraction of the costs of labor in the United States or Canada. But while the labor cost was dramatically lower, the overall savings were mitigated by increases in other items, such as higher costs associated with the supply and delivery chains, as well as rising administration expenditures, as shown in Exhibit #1.
It didn’t take long for other countries to begin to compete in the offshore manufacturing arena by developing their own systems for low cost manufacturing operations. Manufacturers started to become attracted to other shores particularly to countries in Asia and Eastern Europe. Now, the single focus on lower labor costs is not enough for manufacturers to remain competitive in the global marketplace. So, many Mexico shelter operators began focusing on other costs to help their clients gain competitiveness in the world market.
Many successful operators began leveraging economies of scale to assist clients in reducing supply chain cost, attacking administrative overhead and reducing other costs.
As manufacturers came to Mexico, their supply chains lengthen and became more expensive. The other overseas markets of Eastern Europe and Asia, demonstrated that developing domestic supply chains actually reduced the total delivered cost. Mexico was forced by the market to follow suit.
Businesses and the government began working with domestic suppliers to develop needed supply chains within Mexico. Also, large OEM’s began pressuring their suppliers to start up operations in Mexico.
Following this trend, many shelter operators added new services to their offerings. They began helping their clients find and develop local suppliers. Plus, they helped the first and second tier suppliers to OEMs, move their manufacturing operations close to their customers.
THE NEXT SAVINGS TREND – Leveraging Economies of Scale
The shelter’s power to leverage economies of scale is greatly enhanced when working with multiple companies operating out of the same complex. Their clients share the costs of common needs such as freight, security, administration and maintenance. In the cases of common purchases of goods and services, an effective service provider negotiates the terms and conditions in bulk.
For smaller manufacturers in a centralized location, shipments can be consolidated with other clients both in and out of the manufacturing park, greatly reducing freight cost and allowing for more frequent shipping.
In some instances, workers can be loaned between companies to match production cycles.
Additionally, service providers implementing this model can invest in higher level administrative talent, superior technology and better systems, as they are spreading the cost over multiple companies. This gives all client companies, no matter the size, access to a large pool of qualified staff and top resources traditionally available only to very large companies.
CHOOSING A SHELTER
While the new generation of Mexico shelter offers competitive cost advantages at every level – labor, supply chain, capital investment and administration, they are not the only operator referred to as a “shelter.” Shelter operators can offer many different things. While all should help a manufacturer operate in Mexico without establishing an immediate legal presence, other services can range from simple consulting to a service provider that completely integrates every aspect involved in setting up and operating a manufacturing facility in Mexico. So, as you search for a shelter provider for your business, it is crucial to dig deep and uncover exactly what services they offer, as well as how they can affect the cost effectiveness of your facility in Mexico.
START UP SERVICES
While every shelter provider does help their clients establish manufacturing in Mexico, there are companies that have a specialized service dedicated to simply getting you up and running. Typically, they then turn over complete management and legal control to the manufacturer after set-up.
These start-up model can quickly and easily set-up operations in any location in Mexico. Operating under a short to medium-term contract, they assist in site selection, logistics, facilities licensing, can help in the initial selection of key Mexican personnel, legal requirements and other crucial aspects.
International manufacturers can usually pick and choose individual services offered. The start-up model does not necessarily provide any support after the operation is underway.
Cost savings in this type of shelter operation is usually limited to labor.
Manufacturers seeking this simple type of services typically have a strategic reason to establish an independent operation that outweighs the importance of having access to many other cost-saving benefits that other shelter providers can offer.
OFF-SITE MANAGEMENT SERVICES
The benefits of using a Mexican shelter can extend far beyond a quick and easy establishment of a Mexican facility. Many shelter companies provide services that continuously support their clients’ operations.
This management model assists in the initial start-up. Usually they provide the facility in one of their established locations, usually under a long-term lease.
After the set-up the client can choose from a menu of management services involving administration and management of services such as human resources, payroll, accounting services, facilities management, logistics, procurement, worker transportation, medical services, import/export and many other operational services.
The services this model is leveraging typically include: Human resources, payroll, accounting services, facilities management, logistics, procurement, worker transportation, medical services, delivery services including software and many other operational services. Other important services may also be included such as: compliance with labor and safety laws as well as government, labor and community relations.
Often the management is performed from a shelter office that may be in the park, cross town or in some cases hundreds of miles away. Although the shelter operator may have clients in many areas, they still are trying to centralize as many of these functions as possible to leverage economies of scale. This makes it difficult for the service provider to offer the cost benefits of an efficient centralized operation that is focused on leveraging the economies of scale of all their clients in one manufacturing location.
ON-SITE SHARED SERVICES
There are shelter operators that combine start-up and management services with centralization that maximize economies of scale to provide added cost savings and efficiency to their clients. Operators of shared-services facilities handle every support aspect while their clients completely control the manufacturing process. Service providers focused on this model, create an environment that allows each client to develop its own corporate identity and control its own production process. This environment utilizes a centralized administrative center that provides the service provider with the leverage and economies of scale to actively reduce overall administrative cost.
These providers bring several of their clients together to operate in a in a single industrial park. Start-up in this situation can be extremely fast and affordable since the operational environment already exists. It is simply tailored to meet the needs of individual clients.
The service company provides the facility. Typically, since the real estate is treated as part of the operator’s inventory, space requirements can be flexible. This can give manufacturers the opportunity to easily scale their operations as they need, without a huge up-front investment in facilities.
Shelter operators using this model are better able to leverage the resources of all its clients in the centralized location. The clients not only share the costs of common needs such as freight, security, administration and maintenance. In most cases the provider can leverage economies of scale negotiates the terms and conditions in bulk.
By design shelter providers using the on-site shared services model is best able to provide cost-saving benefits to their clients at every level.
Every provider is different, so it is important to inventory your needs and ensure that your shelter provider can competently address all your requirements. When interviewing potential shelter service providers it is absolutely critical to ask them directly to demonstrate their ability to reduce you total per-unit cost.
Today’s shelter operators should be able to show you through metrics how they are accomplishing economies of scale. These should give you detailed, current and relevant performance information on the efficiencies of the shelter operator and its ability to meet the goals of its established clients. The operator should be able to show cost savings across the board in labor, supply chain costs and administrative overhead. Their data and analysis should be transparent and their answers clear and to the point. Only then can you be sure of exactly how setting up a Mexico operation will reduce your costs and increase your profits.