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September 1, 2013

Mexico’s Expanding Auto Muscle

As Canada struggles to maintain market share, global carmakers are tapping into the rich vein of opportunity to the south.

In the 1540s, the Spaniards discovered rich deposits of silver in Guanajuato in central Mexico, about 200 miles northwest of Mexico City. By the 18th century, Guanajuato’s mines were yielding more silver than anywhere else in the world—a staggering two-thirds of all production at its peak. Stroll the streets of this colonial capital, whose baroque and neoclassical buildings are among the most beautiful in Latin America, and it’s hard not to grasp the extraordinary wealth that has defined its history.

Illustration by Bomboland 

These days Guanajuato and other Mexican states are finding their fortunes increasingly tied to cars and the arrival of global automakers. Mazda is investing $650 million in a new plant that will begin production early next year in Guanajuato, not far from General Motors and Volkswagen plants. But that’s nearly dwarfed by other investments: $2 billion by Nissan in Aguascalientes farther north; $1.3 billion by Ford in Hermosillo, Sonora, about 170 miles from the U.S. border; and $800 million by Honda, also in Guanajuato—all of which will be completing new assembly plants over the next year. Add to this a $1.3 billion investment from Audi, which will open a new plant by 2016, and another $550 million for a new Volkswagen engine plant opened earlier this year in Silao, Guanajuato.

Suddenly, Mexico—not the United States or Canada—is looking like the place to be if you want to build cars. While TV reports, newspapers and online chatter are rife with scary stories of Mexican drug cartels and violent crime, methodical global corporations have recognized that the overarching reality is quite different on the ground in the country’s manufacturing strongholds. They may be hiring security guards for their plants and organizing escorts for their shipments, but such measures are treated as normal business precautions. “I moved down here 10 months ago,” says Keishi Egawa, president and CEO of Mazda Motor Manufacturing of Mexico. “The Guanajuato area is one of the safest areas in Mexico. It’s not much different from the United States.”

Indeed, Mazda and its peers are demonstrating their confidence in this emerging nation with major investments. Their infusions of capital foretell the continuing rise of Mexico’s auto industry and, in counterpoint, the ongoing struggles by Canada’s auto industry to hold on to what it has.

The Big Picture

In broad strokes, the shift is clear: Rewind to 1990 and the United States accounted for 78% of light vehicle production in North America, Canada tallied 16% and Mexico 6%. By 2012, U.S. share had fallen to 65%, Canada’s lingered at 16% and Mexico’s had more than tripled to 19%. While Canada appears to be at least treading water, Canadian observers paint a much darker picture of the country’s current and future prospects.

“It seems everyone is lowering their exposure to Canada,” Dennis DesRosiers wrote in his monthly report for his firm DesRosiers Automotive Consultants, which tracks the industry. He noted that—while GM last year tallied a slight increase in its Canadian production due to U.S. overcapacity—Ford’s Canadian production peaked at 15% of its North American output in 1999; Chrysler’s peak was in 2008; and the labor force for the auto parts and assembly sectors had fallen from 153,000 workers in 2000 to 101,000 by 2012.

Perhaps the most illuminating sign of future decline is new investment, down from about $2.3 billion annually during the past decade to $809 million per year this decade. “Decline is visible in nearly every key metric [we] track,” DesRosiers added in a recent summary aptly titled “The Canaries Are Chirping.” “More worrying is that this deterioration in Canada’s vehicle and parts output appears to be linked not to the ebb and flow of vehicle sales in the North American market … but rather to a long-term reorientation of the production landscape on this continent.”

DesRosiers is far from alone in his assessment. “Canada is not a bad place to build vehicles,” says Tony Faria, director of the Office of Automotive and Vehicle Research at the University of Windsor’s Odette School of Business in Windsor, Ontario. “It’s just that we don’t have any really solid advantages. That’s why we keep coming up short in attracting investment.” Faria ticks off some of the challenges Canada faces:

• “We have a very skilled workforce in Canada, but so does the U.S. and so does Mexico.” Moreover, Mexico’s overall labor costs represent about one-twelfth of Canada’s $61 to $63 hourly rate for wages and benefits. In the United States, the figure for non-union plants is roughly half the Canadian levels.

• Canada is less aggressive in attracting investment: “Canada doesn’t offer the major incentives that U.S. states and Mexico are offering.”

• Canada cannot match Mexico’s vast, expanding portfolio of free trade agreements, making it less viable as an export base. “That’s a big, big advantage [for Mexico].”

• Legacy matters less and less. Faria is particularly blunt about this: “The only reason we have what we have is the companies have been here for quite a while”—since 1904 in the case of Ford. These also include GM, Chrysler, Honda and Toyota. “At this point, I can’t imagine another company locating a plant in Canada. We are kind of stuck with the 11 plants we have. I just hope we can hold on to them.” 

 

One thing Canada has going for it, though, is high-quality production. Automotive workers and residents of Ontario can take pride in the latest study by J.D. Power and Associates, the consumer research firm. Its annual “Initial Quality Study” ranks the highest-quality car plants producing for the U.S. market with the least number of defects or malfunctions. Three Ontario plants made the grade in 2013: GM’s Oshawa facility, which makes the Chevy Equinox and Impala; Honda’s Alliston plant, which makes the Acura MDX and ZDX, and the Honda Civic and CR-V; and Toyota’s Cambridge South Plant, which makes the Lexus RX.

The problem is that high grades for quality will not likely calm the lingering unease spurred last year by Chrysler Group CEO Sergio Marchionne. He warned the Canadian Auto Workers (CAW) union, in the midst of contract negotiations, that his company had alternatives outside Canada. “We have other plants, other options,” he told The Globe and Mail, arguing that Canadian costs needed to match those in the United States.

Surely recognizing the hardening realities, Chrysler workers overwhelmingly backed a deal—similar to one Ford and GM workers previously ratified—that froze wages for existing workers for three years and cut the hourly rate for new hires. This came as an aggressive effort by the CAW failed to secure commitments from Chrysler, Ford or GM to make new investments in their Canadian plants.

Mexico’s Powerful Magnet

At the same time, Mexico’s forceful boom is being driven by its low labor costs, the North American Free Trade Agreement (NAFTA), similar free trade agreements with more than 40 other countries, favorable exchange rates pegged to the U.S. dollar, and a strategic location that facilitates exports to North and South America as well as Europe and Asia. An added boost: escalating gas prices that have hastened demand for the small cars made in Mexico.

This shift did not happen overnight, of course. North Carolina-based global strategist and regional planner Michael Gallis remembers a conversation with Detroit executives a decade ago: “They told me, ‘No other nation is as well positioned as Mexico to distribute products to the rest of the world.’”

In fact, Ford, GM, Chrysler, Volkswagen and Nissan have operated plants in Mexico since at least the 1960s. In those early years, vehicles sold in Mexico were required to have a minimum of 60% of their parts produced there. In the 1980s, government policy refocused on export promotion, spurring new GM and Ford plants north of Mexico City and closer to the U.S. border. But the passage of NAFTA loosened trade restrictions in 1994 and eliminated key duties on imports and Mexican content in 2004. To qualify then for duty-free exports from Mexico, at least 62.5% of a vehicle’s content needed to be made somewhere in North America.

Clearly, that love affair is growing with carmakers headquartered outside North America. Exports from Mexico by companies with overseas headquarters rose from amere 10,000 units in 1985 to 1.1 million units in 2012, as Chicago Federal Reserve Bank economist Thomas Klier noted in his recent report on the growing importance of Mexican auto production. In that same period, Mexico’s overall exports of light vehicles quadrupled from 600,000 units to 2.4 million.With the Mexican government signing a record number of free trade agreements by 2012, including those in the European Union, Japan and Israel, it’s no wonder that overseas carmakers recognized Mexico’s expanding advantages as an export hub. “Everybody loves Mexico,” says Sean McAlinden, chief economist and research head for the Center for Automotive Research, based in Michigan. “They never fail to get an agreement.” Today, only Germany, Japan and South Korea export more motor vehicles.

McAlinden expects Mexico’s share of North American production to rise from 19% to 25% over the next five years, with a big boost from demand outside its traditional markets. “They really do want to sell more cars in the developing nations,” he says. “They can’t just depend on a handful of markets like Europe, Japan and the United States.”

Nissan exports to more than 100 countries from Mexico, although the large majority of its cars head for the United States. Operating in Mexico for more than half a century, Nissan last year produced 684,000 vehicles—and failed to keep up with demand throughout the Americas. Its goal: increase manufacturing capacity to more than 1 million units with more than 14,500 workers, up from its 11,500 last year.

“This longtime vision of using Mexico as a strategic base has evolved and accelerated in recent years,” says Maria-Eugenia Santiago Echandi, communications director for Nissan in Mexico and Latin America. While Nissan exports some 80% of its output, the company also tops the domestic scene with five of the 10 best-selling cars and a 25% market share. The new $2 billion investment in north-central Mexico takes advantage of a second Nissan plant and key suppliers nearby. 

Mazda Chooses Mexico

When Mazda opens its new $650 million facility early next year, the plant will represent its largest investment outside Japan, including new operations planned or opened in Thailand, Russia, Malaysia, Indonesia and China. This is one key piece of Mazda’s structural reform announced in 2012 to help ensure its survival. “In order to get out of the Japanese-centric business model” and address profitability hurt by exchange rates, says Mazda’s Egawa, “we needed to expand our overseas production capacity.”

Sources: Thomas Klier and James Rubenstein, “The Growing Importance of
Mexico in North America's Auto Production,” Chicago Fed Letter, May 2013;
Wards Auto Info Bank.

 

This fall, Egawa’s team will begin pilot production at the new plant—“right on schedule,” he notes. By June, Mazda already had 400 employees on the payroll with the intention of ramping up to about 1,500. The current crew consists of about 200 from Japan, including engineers, trainers and 20 Japanese interpreters. Most of these employees will return to Japan in the next year. “My plan is to localize the people, the management and the supply chain,” Egawa says. “This is my challenge. We have to do that.”

Egawa, who arrived in Guanajuato after 18 months in Hiroshima as Mazda’s managing executive for emerging markets, has reason for optimism. His human resources staff is receiving three or four times as many applications as it needs, he says, “and the people are very diligent and enthusiastic.”

Rising Sophistication

That should come as no surprise. According to a report from ProMexico, a Mexican governmental group designed to strengthen international investment and exports, the auto sector employs more than 645,000 people. This represents workers for light and heavy vehicle producers as well as 1,100 auto parts manufacturers, more than 300 of which are first-tier suppliers. Moreover, 111,400 engineering and technology students graduated in Mexico in 2012 alone, another sign of the country’s burgeoning talent pool. (According to data published by UNESCO, there are 18% more engineering, manufacturing and construction graduates per capita in Mexico than in the United States.)

For casual observers who may have missed the rising sophistication of Mexico’s car manufacturing, the expansion of innovative design centers (now more than 30) and the addition of new awards for high-quality plants have put to rest outdated images of sweaty, dilapidated facilities with dirt floors. Ford’s state-of-the-art Hermosillo plant in Sonora, which uses hundreds of robots and employs some 3,800 workers, can produce 62 Fusions and Lincoln MKZs per hour at full tilt. This factory exported more than 300,000 cars last year, mostly to the United States, but also to such far-flung destinations as Saudi Arabia and Senegal.

Life south of the U.S. border can often seem daunting and dangerous—with good reason. But with clear and accelerating economic progress, it’s hard to overestimate Mexico’s potential. “Sometimes we bring companies that are coming to Mexico for the first time,” says Arizona-based Eric Nielsen, a director of the U.S. Commercial Service, which assists U.S. companies seeking to expand their international trade. “They are almost invariably surprised by the sophistication of what’s going on there.”


Steven Beschloss is an award-winning editor, journalist and filmmaker. His work has been published in The New York Times, New Republic, Chicago Tribune, Village Voice, Wall Street Journal and Parade Magazine.