The impact of the North American Free Trade Agreement (NAFTA) on Mexico’s economic and social transformation cannot be understated, a recent article in the Washington Times explains. The earliest effects of NAFTA came in the form of a massive increase in low-skill labor factories near the U.S. border. However, manufacturing in Mexico has evolved, so has its economic climate.
As Christopher Wilson, an associate at the Mexico Institute of the Washington-based Woodrow Wilson International Center for Scholars explains, “What we’re seeing now is a growth of industry in Mexico that requires more engineers. To put a name on it, specifically, we’re talking about automobiles and aerospace.” The growing economy is also affecting the types of workers found in Mexico. “Mexico is now graduating more engineers than Germany every year,” Wilson notes.
Helping to fuel the expansion is a 40 percent increase in Mexico’s GDP since NAFTA. This has prompted the growth of Mexico’s middle class, prompting an emphasis on investment in education and Mexico’s children. This has helped key Mexico’s plummeting poverty rate, down to 47 percent after reaching 80 percent 50 years ago. Other indicators also reflect this new economic reality: 98 percent of Mexican homes have electricity and every year more than 4 million people are enrolled at studies at the university level. This had led to more jobs: in the early part of 2012, Mexico’s population of 112 million had a 5 percent unemployment rate with a per capita salary that ranked it 81 out of 195 nations.
NAFTA has helped pave the way for the new economy in Mexico. Unites States investment in Mexico now reaches more than $90 billion annually, up from $15 billion in the pre-NAFTA days, with Chinese, Japanese and European firms also exploring investments in Mexican manufacturing. In addition to possessing a labor market with negligible union restrictions and a $6 dollar-an-hour average worker pay, Mexico also has a prime location for the ever-important United States and Canadian markets. This has prompted the production of over 2 million new cars and trucks in Mexico during 2011 from 25 different vehicle-assembly factories owned by foreign companies, such as Nissan, Honda, Ford and General Motors. Overall, the growth of Mexico’s share in high-tech manufacturing industries, such as medical devices, aerospace and automotive, has helped change the economic dynamics of a country and allowed it to increase employment and reduce poverty in a way that may have seemed impossible just a few decades ago.
A rising aerospace manufacturing powerhouse may not be the first thing many people think of when they think of Mexico, but one day this may change. Several Mexican cities, most prominently Chihuahua City, have developed a rapidly growing stake in the high-tech world of aerospace manufacturing. Chihuahua has become home to 36 new aerospace plants since 2007 as more of the world’s industry leaders have begun to take advantage of region’s low costs, location and skilled pool of workers.
During times of global financial downturn, companies look to find ways to reduce costs without sacrificing the quality of their goods. This has proven to be a real advantage for areas like Chihuahua. As a recent article in the Washington Times explains, the average cost of manufacturing labor in the region is around $6 dollars an hour, which has driven companies such as Cessna, Hawker Beechcraft, and Manoir Aerospace to open facilities in the city. As Nicolas Maillard, the director of the French-owned company explains, “The real advantage is the cost of labor. In France, labor would account for about 30 percent of the cost of production on an item like this. Here, it’s roughly 10 percent, and we’re closer to the market we’re trying to reach.”
The last part of Manoir’s statement represents another reason why companies are moving to Chihuahua City: its proximity to the United States. For companies looking to establish a foothold in the U.S. market without paying the higher costs needed to manufacture in the United States, the Northern state of Chihuahua represents an attractive option. For companies with facilities in the United States that are looking to reduce manufacturing costs while minimizing the loss of U.S. jobs, moving some of the facilities to cities like Ciudad Juarez and Chihuahua city in Mexico can be a major means to an end. Luis Enriquez, who oversees Chihuahua operations for Nordam (based in Oklahoma), explains that “If it weren’t for this facility, we wouldn’t be able to bid competitively on the global level, and that would equate to a serious loss for U.S. jobs, not to mention the ability of the United States to embrace 21st-century thinking about business.” Mr. Enriquez also notes that outsourcing to Mexico preserves many U.S. jobs that would otherwise be lost of the company was forced to outsource to more distant locales, such as China.
Further driving this movement is an infrastructure hospitable to the high-tech world of aerospace manufacturing. Mexico has already established its prominence in the automotive manufacturing industry and many experts feel that this previous rise has laid the groundwork for the growth of aerospace manufacturing. One key aspect is getting many different kinds of manufacturers to open facilities. Jesus Mesta Delgado, the president of Index Chihuahua sums it up thusly: “What we’re planning to do is make Chihuahua a one-stop city. In the U.S., you’d have to travel to seven different cities to do what we’re trying to make possible right here.” Other factors driving the aerospace surge include Mexico’s commitment to intellectual property rights and its workforce. For high-tech industries to thrive, there has to be an ample supply of engineers, and Mexico’s universities are helping to meet that demand. The combination of low manufacturing costs, a prime location and a well-designed infrastructure have fueled the $1.25 billion in foreign aerospace investment in Mexico in 2010, a figure that should continue to grow as Chihuahua City and other regions establish themselves as top aerospace manufacturing destinations.
As we continue to see the reverse manufacturing trend from Asia to North America, we see that companies are facing a common issue related to China’s government regulations and how they handle their value-added tax (VAT) policies. Although China has taken measures to reduce their VAT charges, VAT, still represents a significant “hidden” cost when manufacturing in China.
China uses a rebate program to help drive value-added taxes, Cost and Capital Partners, LLC a explains. The Chinese government issues rebates for VAT for different industries to help increase or decrease the activity of different industries in response to their short term economic goals and desired exports. The VAT rebates vary between 5 and 17 percent and are frequently in flux. As a result, costs to U.S. firms that do their manufacturing in China vary depending on what industries the Chinese government wishes to promote. For example, the VAT rebate for tires was approximately 5 percent in 2008, almost 10 percent in 2009 and then dropped to 0 in 2010. Another factor complicating this issue is that the VAT rebates reach American manufacturers in convoluted ways. The VAT rebates are not directly given back to the United States corporation. Instead, the rebates are negotiated between a Chinese company and local authorities; consequently, instead of money being given to the American company, the U.S. enterprise negotiates discounts with their Chinese partners on their costs based on the VAT rebates and the final commodities that are re-exported from China after value-added processing. To add another layer of complexity, factories in export processing zones do not pay any VAT. Overall, these processes add extra complexity and uncertainty for U.S. companies doing business in China, as it is difficult to predict what the VAT rebates will be and to ensure that VAT rebates are reflected in the U.S. company’s bottom line instead of being rerouted by Chinese partners and requires careful analysis from Chinese consultants and tax advisors to be done efficiently.
By comparison, Mexico handles VATs in a relatively straightforward way. There is no VAT for goods temporarily imported into Mexico for the purposes of value-added production. VAT only applies to goods that will remain in Mexico or that are purchased from Mexican suppliers even within that structure there are simple ways to reduce costs. Companies using a maquiladora can be exempt from VAT for certain types of goods or if the goods from the Mexican supplier are physically delivered to the maquiladora facility. Maquiladoras operating under the IMMEX program are also eligible for more rapid VAT refunds. Because the VAT in Mexico is less variable and easier to reduce, many companies are finding it as a cost saving on their product total landed cost when eliminating this duty in Mexico compared to their applicable China VAT.
Some Mexico shelter services providers take a very proactive role and handle the VAT so the client (a foreign company) receives the full VAT refund since is not part of the cost structure. Overall, the relative simplicity of VAT rebates when manufacturing in Mexico provides a distinct advantage for companies over manufacturing in China, as long as they work with a professional Shelter provider or contract manufacturer that understands Mexican fiscal law and is willing to create a long term partnership with its clients.
Companies that are looking to move some or all of their manufacturing to Mexico can reap significant savings, but there are areas of managing a business in Mexico that a manufacturer needs to fully understand. One of the more prominent ones is the ways in which the labor and employment laws when manufacturing in Mexico differ from those in other countries, especially the United States. Legal issues that companies need to understand is the importance of employment contractual relationships, termination of employment, severance obligations and other unique aspects of Mexico’s labor law.
Almost all employment relationships in Mexico are based on contracts, ranging from high level executives to direct operators, and union organizations often govern the terms of contracts for rank and file workers. As a result, it is essential that companies create contracts that are as detailed as possible, including specifics regarding working conditions, where and when employees report to work and work breaks. These contracts must also include the salary, a detailed work-schedule, vacation and “rest periods”, holidays and the conditions for overtime. In addition, Mexican law requires companies to provide a 13-month paycheck or some sort of Christmas bonus to their employees. In addition, some employees in Mexico are eligible for profit-sharing, in which companies must pay 10% of their annual profits to employees. These are just a few examples of standard labor law practices in Mexico that may not be observed in other countries.
Thorough and detailed contracts are of paramount importance for companies in the event of any sort of labor dispute. In general, the labor tribunals in Mexico lean in favor of the employees, so it is nearly impossible for a company to defend itself from any labor or employment action brought against them without a written contract. In addition, in any sort of labor dispute the burden of proof is on the employer, not the employee, for the burden of the case. Without a detailed written agreement, the tribunals may side with the employee in any areas of ambiguity.
Terminating an employee can also be a complex process in Mexican manufacturer. Employers can only discharge an employee without further liability for “good cause,” such as fraud, dishonesty, damages to the employer, immoral acts, extended periods of absence or for disclosing confidential information/compromising security. For employees that are not discharged with “good cause,” the employer may be responsible for significant indemnities, including salary and benefits throughout the entire judicial procedure, which can take years. Consequently, it is often advantageous for companies to negotiate with an employee to get the employee to resign; in general, the “severance” then granted to the employee is around 3 to 4 months of salary as well as additional amounts based on seniority.
Because of these unique labor issues, it is imperative that companies looking to expand their operations in Mexico speak with experienced manufacturing service providers “Shelter Services”, which know the "ins and outs" of doing business in Mexico. Many of these issues can be avoided with proper guidance and can ultimately save companies significant time and money from conflicts with unfamiliar labor laws and employment practices.
Approximately a decade ago, China began to make its mark on the scene of the world manufacturing industry. As capitalization caused its economy to grow by leaps and bounds, China’s share of the international production trade also expanded exponentially, driven by a massive workforce ready to provide inexpensive labor to companies from around the globe. Although China’s growth was a boon for many, such as the commodity-rich South American countries that were ready to feed this burgeoning industrial superpower, it looked to be a death knell for the manufacturing industry in Mexico that did not appear to be able to match China in terms of costs.
But as Fiat’s recent $550 million investment in the Fiat 500 production line in Mexico shows, these trends are starting to change. What’s especially telling about this new facility, expected to produce 120,000 vehicles a year, is that while the majority of these units are destined for North and South America, at least some will be headed east. As Felipe Calderon, the country’s president said in a recent Financial Times article, “I think it is the first time that a Mexican vehicle, at least in recent times, is to be exported to China.” In fact, not only is Mexico holding its ground against China, it is even beginning to gain ground in its market share of total US imports, which is the world’s largest importer. The United Nations Commodity Trade Statistics Database notes that in 2010 Mexico accounted for 12.3 percent of all of the non-oil imports into the United States, up from 10.6 percent in 1999.
What has helped drive this sea change? Part of this is that China’s exceptionally low labor costs has proven to be unsustainable, helping to narrow the gap between the cost of manufacturing in Mexico and China. While Mexican wages were 237 percent higher than Chinese in 2002, this figure has shrunk to an estimated 14 percent today, with Chinese worker wages expected to eclipse their Mexican counterparts within the next few years. Even more importantly, rising fuel costs have further eroded into China’s market savings as it has become increasingly expensive to ship materials and finished goods long distances.
However, just as in real estate, location is also a big factor. Mexico’s proximity to the United States means faster shipping times---two to seven days as opposed to the 20 to 40 needed for transport from China. This is key for U.S. companies as they rely on third-party advice to guide their just-in-time manufacturing, a strategy that allows companies to reduce costs by shrinking their inventories. Mexico’s geography has also allowed it to be open to trade agreements with other countries. It’s 44 international trade agreements mean that companies can open manufacturing plants and source materials from a wide range of countries while avoiding hefty duties. Mexico’s prime location pays off in other ways as well; for one thing, there is less of a culture-clash for U.S. executives when working with Mexico, and Mexico shares the same time zones in the United States. This makes it easier for different business partners to communicate, aided by the fact that most university-educated people in Mexico speak English. Overall, Mexico’s setting provides a real edge to companies who are already realizing that the conventional wisdom---that China is the place for inexpensive manufacturing---may no longer apply.
Read More on Why Manufacturers are Relocating to Mexico
Maquiladoras in Mexico have a long history in different regions of the country, particularly for cities such as Ciudad Juarez. The maquiladora program was originally developed in Mexico in 1965 as a job-creation program, Robert Gilmer, Vice President in Charge of the El Paso Branch of the Federal Reserve Bank of Dallas, explains in a recent article in El Paso Inc article titled “Maquilas and El Paso Economy”; Although maquiladoras continue to be an important part of cities such as Juarez, they have evolved over the years to be part of an industry that combines technological innovation with Mexico’s thriving workforce.
Manufacturing in Mexico changed after 2001 when three different events had near devastating effects on the industry: the United States went into a recession, China entered into the global manufacturing market and the September 11th attacks led to heightened border security. The weakened U.S. economy and tighter border regulations reduced Mexico’s biggest consumer (the United States), while China’s low-cost labor threatened to undermine the very foundation of Mexico’s maquiladora program: low wages. The recession hit the manufacturing industry particularly hard and led to prolonged declines.
Many of the manufacturing sectors that had Mexico’s lowest wages, such as textiles, apparel and toys, fell victim to this recession. However, as Robert Gilmer and Roberto Coronado, a Sr. economist at the Federal Reserve Bank of Dallas in El Paso explain, Mexico was able to adapt. Rising fuel costs have meant that shipping large, bulky or fragile items across the ocean became prohibitively expensive, forcing some of those industries to nearshore their operations again. Mexico’s wealth of universities also allowed it to combine a well-trained and veteran workforce that was able to handle increasing technology demands. Finally, Mexico’s superior intellectual property control helped the maquiladora industry recover, gradually leading to a steady influx of higher-paying jobs.
One of the cities that has most been able to benefit from the resurgence of the maquiladora program is Ciudad Juarez due to many factors that make manufacturing there particularly desirable. First of all, the Northern city has three different public universities: the Instituto Tecnologico de Ciudad Juarez, the Universidad Autnoma de Ciudad Juarez and the Instituto de Estudios Superiores de Monterrey. These have helped establish a highly skilled group of workers and engineers that are able to staff the factories. As a result, Juarez has become home to over 300 maquiladoras that have formed highly specialized “clusters”, allowing them to achieve excellence in fields such as automobile manufacturing, medical devices and electronics and the aerospace industry. Although this new maquiladora model does not produce jobs at the same rates as the old model, the jobs are higher-paying and help provide some of the driving force that is fueling the expansion of the Mexican economy. Truly, the maquiladoras have been forced to evolve but have survived the changes of 2001 to come back in a different, more resilient form.
Intellectual property is one of the most important resources for any manufacturer. Although the protection of IP is important for ensuring that competitors do not gain access to confidential industry information and manufacturing processes, it also plays a major role in protecting the integrity of a company’s brand from counterfeit goods. Counterfeiting damages a company’s brand in two different ways. First, it siphons off demand for the company’s actual products by supplying some consumers with goods not from the company, eating into market share without providing any actual revenue to the company itself. Counterfeit goods also can hurt a brand’s image, as these goods are often of poorer quality. One of the biggest hazards of working in distant countries such as China is its rampant counterfeit industry, which is often at least implicitly tolerated by the government.
Because it can be so difficult to combat illegitimate goods in China, many companies benefit from nearshoring by keeping their manufacturing closer to home in countries with better intellectual property protection laws, such as Mexico. As a member of the North American Free Trade Association (NAFTA), Mexico follows the guidelines established by the first international trade agreement that has obligations regarding the protection of intellectual property. The drafters of NAFTA realized that IP enforcement is a critical part of the principles of market access and non-discrimination. If one country does not take steps to protect the intellectual property of its trading partners, trade is negatively impacted. Part of what makes NAFTA’s position on intellectual property so effective is its three-pronged approach. First, all members of NAFTA have established minimum standards for intellectual property protection that they must meet. Secondly, NAFTA requires enforcement of these standards at the borders of NAFTA states, which is where much of the damage due to counterfeiting is done. Finally, NAFTA has a dispute-settlement program that penalizes countries that do not take adequate steps against intellectual property infringements.
Overall, Mexico’s participation in NAFTA is a major selling point for companies looking to move their manufacturing out of the United States but do not want to have major problems with counterfeit goods. Manufacturing in Mexico has a long-standing reputation as a protector of intellectual property rights that allow businesses to work there without having to worry about potentially catastrophic supply chain breakdowns, allowing them to maintain stability throughout their supply base by working with reputable and regulated manufacturers.
Although China has historically been one of the top destinations for companies looking to lower their manufacturing cost, many companies now understand the benefits of having their manufacturing closer to home, in lower cost countries like Mexico. Transferring manufacturing to Mexico, however, can be a daunting project, as it requires companies to establish new facilities, supply chains and to negotiate the logistics of opening operations in a new area. Hiring a turnkey contract manufacturer can be an important step in easing this process.
Turnkey manufacturers in Mexico offer a full-service solution: they develop supply chain services, handle material acquisitions, inspect incoming materials for quality control, oversee assembly and quality control tests and are directly involved with price and quality negotiations with suppliers. One of the main advantages of working with a turnkey contractor is that it allows your company to not be troubled with the logistics of setting up a new operation in Mexico, freeing your organization to focus on its core competencies. So if a company is wondering whether it is feasible to move their manufacturing to Mexico using the same scenario as its operations in China can know that the answer is: it’s feasible.
There are two main steps to finding the right turnkey contract manufacturer to begin operations in Mexico. The first is to find the right manufacturer. The ideal organization has the necessary capabilities for making the new product, including experience in the industry, the right equipment, experienced labor force, quality programs in place and an established supplier base. The second step to initiating this transition is to sit down with the turnkey contract manufacturer and to look through all of your specifications to make sure that the turnkey organization is a good fit for you.
Ideally, in this meeting you can go through one product line and take a look at its entire bill of materials (BOM). The advantage of this sort of meeting is that it allows you and the turnkey group to go through the bill of material line by line and look at the costs of manufacturing in China versus the costs of manufacturing in Mexico. This will allow you to see what savings can be reaped by working with the Mexican manufacturer, especially when the costs of fuel and shipping are factored into the final cost estimate. This also allows the turnkey company to evaluate your business and compare its needs to its own established supplier base; if need be, the turnkey group can import supplies from Asian manufacturers until a North American base can be found or developed.
Finding an experienced turnkey contract manufacturer can be the difference between a protracted and stressful establishment of a manufacturing base in Mexico and a smooth and easy transition. The best organizations works closely with clients to set up and regulate the new operation (including supplier negotiations and quality control). This frees up your organization to focus on what you do best without having to negotiate unfamiliar territory. As a result, turnkey contract manufacturers can result in a significant cost reduction for clients and allow them to allocate more resources into product development without suffering a dropoff in product quality.
More and more companies are deciding to offshore manufacturing to countries like Mexico and China. China has had the edge but Mexico workforce now seems to be the country of choice for the majority of American manufacturers for a variety of reasons.
In addition to secure, dedicated facilities along the U.S. border, Mexico has the youngest workforce in the world at age 29. In addition, its educational system is now producing significant numbers of highly trained workers. In particular, 90,000 engineers are currently graduating from Mexican universities every year. Combining these factors with the proximity of our southern neighbor produces a significantly reduced lead time versus their Chinese competitors and decreases costs across the board.
Shorter Lead Times = Reduced Costs
Many companies worry that security and safety procedures will severely impact any train or truck traffic originating in Mexico. The U.S. and Mexican governments have recognized this concern and implemented procedures, in particular C-TPAT certification, to ease any fears.
The result is a dramatically shortened lead time from Mexico vs. China. The standard example show a Chinese shipment taking 2 days to port, 14 in ocean transit and 10 days to Chicago. The same trip from a Mexican facility on the border including customs takes only 5 days.
As you can imagine, the cost savings are significant; the approximate cost from China is $5300 vs. $3000 from Mexico for a standard 53” container. The latest low cost country (LCC) analysis performed by Alix Partners confirms Mexico as the lowest cost provider.
The Predominant Choice
As mentioned, manufacturing in Mexico is the overwhelming choice for companies considering the move. A recent poll indicates that Mexico is preferred by 63% of the respondents, almost ten times more than its nearest competitor, Brazil. In addition, most of Brazil’s output is for home consumption and is not available for export to the United States.
The Obvious Solution
Outsourcing to Mexico manufacturers located on the border provide lower freight costs, improved speed to market and reduce inventory costs as fewer goods are in transit. The result is an opportunity for U.S. companies to lower costs and ease management’s burden. In addition, the specter of rising fuel prices can only further widen the disparities and lead times between Mexico and China.
The emergence of dedicated manufacturing zones in many Mexican cities has prompted a surge in U.S.-Mexican cross border traffic and trade. These zones, in transportation corridors, like Ciudad Juarez, are specifically targeted at producing finished goods for consumption in the United States. They offer a host of benefits from lowered manufacturing costs and improved logistics to expedited customs inspections and tax benefits.
The latest statistics from the United States Department of Transportation show a significant increase in the numbers of trucks and trains crossing both northern and southern borders of the U.S. While border truck traffic with Canada rose less than one per cent, Mexican cross border traffic was up over 2.6%. Train traffic had an even more dramatic rise with Canada rising 2% while Mexican train traffic rose over 9%.
The increased utilization of Mexican manufacturing facilities has contributed substantially to this rise. Many Asian manufacturers, including Nissan Corporation, have rebased their manufacturing operations in Mexico to take advantage of the improved situation. American manufacturers have also recognized the potential for improved productivity and profitability by using cross border manufacturing facilities. In particular, Ford Motor Company has announced plans to open operations south of the border in the coming year.
Expedited cross border trade requires companies to become C-TPAT certified. This Customs-Trade Partnership Against terrorism certification requires time, expertise and experience. While many are eager to attain this certification, the actual number of approved companies is still quite few. Benefits of the program for manufacturers include secure transport of goods from the manufacturing facility to final destination, priority customs inspections and dedicated cross border lanes.
Manufacturers interested in this process should contact a C-TPAT certified turnkey manufacturer. These companies can help any company in the U.S or abroad to plan, develop and implement a cross border turnkey solution for their manufacturing needs.
The restrictions on truck and train traffic placed by the three governments of the United States, Canada and Mexico can only get more complicated. An experienced turnkey manufacturer can make the process far easier and more cost effective.