How to Think About Manufacturing in Mexico
There are several conditions that affect new investment and business development in foreign countries. These include the quality of infrastructure, location, potential added-value capabilities for production, logistics and business support services. Yet researchers from the Texas-Mexico Trade Corridor consortium at Texas A&M University’s Global Supply Chain Laboratory have found that companies often make decisions about where to put new facilities using inaccurate assumptions and without considering all the relevant variables.
The location decision is usually based on the potential ROI. Although a relatively simple equation (revenue minus expenses, divided by asset investment), ROI has many complex components. The most important of these, risk, is not actually in the equation. Risk, in this case, is simply the probability that the estimates for revenue (forecast), expenses or asset requirements are incorrect. Properly, that is rigorously, assessing these risks is crucial to any location decision.
An Emotional Issue
In Mexico it is no secret that security can be a primary risk consideration for companies that want to locate there. But we have found that security cost estimates for any offshore locale are often miscalculated, usually on the high side, because of the perception that spending too little would endanger the enterprise and its employees. However, security is a manageable process and it is becoming more so as companies gain experience, since many of the world’s fastest growing markets present security challenges.
Even so, our research at Texas A&M has shown that the security cost was almost inconsequential in the ROI equation when compared to more general relocation costs, including new leases, acquisition of land, construction, tenants’ improvements, the impact on the supply chain and the costs for partner suppliers.
When risk is calculated thoroughly these days, Mexico, despite the publicity about drug cartel violence, is viewed as a country with major competitive advantages for U.S. manufacturers over many others, including China. Our research is showing that violence has had a limited impact on location decisions. That said, the National Council of Industry Chambers in Mexico has indicated that most of the impact of the so-called War on Drugs has been on small and medium-sized enterprises, many of them suppliers of large corporations. These companies have been forced to make adjustments, such as investing in security equipment, hiring escorts and providing training on preventative measures, in order to continue operating amid the amplified violence.
Larger companies have continued their expansion in Mexico because of the market opportunities and the fact that their supply chains, increasingly, cannot support shipping across the ocean. Furthermore, as the research demonstrates, providing adequate security can cost less than most companies realize.
Automotive and Aerospace: Anchors for Manufacturing in Mexico
Vehicle and aerospace manufacturing offer excellent examples. The North American Free Trade Agreement (NAFTA) and global economic demand have combined to make Mexico an increasingly important player in the automotive and aerospace industries. States that are capturing many of these investments are in Central Mexico, such as Puebla and San Luis Potosi, and the Bajio region in west central Mexico. These high growth regions offer major infrastructure improvements like the Arco Norte, the 223 km highway that provides transportation to the NAFTA highway corridor, which connects the Canada, United States and Mexico trade blocs, as well as linking to major ports. The federal government and local communities are offering various incentives to businesses that want to relocate.
The result: Currently, 90 of the top 100 auto parts companies in the world have production operations in Mexico. Eighteen of the main original equipment manufacturers have facilities in Mexico, with 11% of all cars and light trucks sold in the United States manufactured in those facilities. As the automobile industry continues to strengthen in Mexico, it creates jobs and opportunity in the United States as well. Mexico imports computer systems, software and high-tech components from U.S. companies that support this industry.
Mexico is now the eighth largest supplier to United States in the aerospace industry. According to the Mexican Federation of Aerospace Industry, there are 260 aerospace companies, with 79% focusing on manufacturing. These companies still import most of their raw materials and supplies, however. Only 10% of the aerospace suppliers are Mexican firms. For the United States this means opportunities for American companies to provide materials such as specialized steels, aluminum and titanium are increasing.
The outlook now is that the United States-Mexico partnership will continue to grow and strengthen. This will depend on successful government offensives against the drug cartels. But, just as important, it will rely on continuing incentives in Mexico to support value-added manufacturing and the new market opportunities that will result. At the same time, companies must also understand the importance of realistically and accurately calculating all cost factors in order to understand the real impact of security challenges on their operations.
Esther Rodriguez Silva, Ph.D., conducts collaborative applied research in the area of regional development for the Texas-Mexico Trade and Bringing Manufacturing Home Consortia. She is a project manager at the Latin America Initiatives in the Global Supply Chain Laboratory at Texas A&M University and can be reached at esther@entc.tamu.edu.