Mexico Rises

A widening cost advantage could propel U.S. companies toward Mexico as they 'nearshore' their production

Mexico Rises..

Although Asia has been a standard choice for outsourced production in the last few decades, many U.S. companies are starting to consider Mexico as a better option.

Called 'nearshoring' or 'nearsourcing,' the strategy is quickly gaining momentum, according to the Boston Consulting Group (BCG), which estimates that higher manufacturing exports to Mexico could add $20 billion to $60 billion to that country's economy within the next five years.

Thanks to the North American Free Trade Agreement (NAFTA), U.S. manufacturers of every type could benefit, a recent BCG report noted.

As Mexico stands poised to become the new China, there are several reasons for the major shift:

Lower labor costs

Mexico's labor costs are particularly competitive when compared with other economies, according to BCG.

By 2015, average manufacturing labor costs in Mexico are projected to be 19 percent lower than in China, where wages are rising quickly. When the numbers are adjusted for output per worker, Mexico's labor costs will be about 30 percent lower.

"The labor rates are one of the main drivers that make Mexico so attractive to manufacturers, especially because the reason why many companies switched production to Asia was because they could get lower labor costs," said Michael Zinser, a BCG partner who leads the firm's manufacturing work in North America.

Although there's some perception in the marketplace that Mexico offers "cheap labor” — or unskilled labor — that view is off the mark, believes Chris Anderson, founder of San Diego-based 3D Robotics.

In a recent New York Times op-ed, Anderson pointed out that Mexico graduates about three times as many engineering students per year compared to the U.S., and the result is that some machine specialists are easier to find in Tijuana than in California.

Shorter supply chain

One important factor in the growth of nearshoring is the increase in the price of air freight, said Karen Donohue, associate professor in supply chain and operations at the University of Minnesota's Carlson School of Management.

These increases have resulted in the need to transport more goods by boat, which substantially increase lead times and create inconsistencies in the match between supply and demand for goods traveling from Asia to the United States, Donohue noted.

"While the lead time advantage offered by a Mexico location, versus Asia, may be small for air freight, it is large for maritime shipping," she said. "So, this change in mode of transportation gives Mexico a relatively new advantage."

According to BG Strategic Advisors, a Florida-based consulting firm specializing in supply chain management, importers have historically spent about 15 percent of their shipping costs on fuel. In 2009, that cost zoomed up to 40 percent.

Since Mexico is close enough to the United States to take advantage of over-the-road shipping and shorter flights, fuel costs for importers will be lower, and that leads to greater manufacturing efficiencies and lower expenses.

U.S. manufacturers can also be closer to customers that might reside in the southern part of the country, or even in Mexico itself. For example, Marion, Ohio-based TODCO, a producer of overhead truck doors and ramps, moved its manufacturing operations to Mexico to reduce shipping costs to West Coast customers.

That, in turn, led to more customer development in Southern California, according to Jim Frazzini, TODCO's vice president of operations. Because many automotive manufacturers have offices in the Baja region of California, TODCO discovered that gaining entry to that market — by using nearby Mexican manufacturers — provided a significant boost to the company's customer list.

Similar time zones

Never underestimate the power of being able to talk with a manufacturing partner during the standard workday, noted Josh Green, CEO of New York-based B2B global trade platform Panjiva.

"With Asia, there are significant delays in terms of communications, unless you want to be on the phone in the middle of the night," he said. "Simply being in the same time zone or only a few hours' difference can have a significant effect on operations."

Most notably, a company's development team can talk with a manufacturer several times a day during a product refinement process, which can lead to much shorter turnaround time in manufacturing. A product that may have taken weeks to create in Asia can take days to refine in Mexico.

"At this point, many people have accepted that the process will have large delays because communication is often by email," said Green. "That's just the norm of doing business in Asia. But when they start to see the advantages of being able to pick up the phone during the day and talk through a process, leading to faster turnaround, they'll gravitate toward Mexico more often."

Less working capital needed

Because of faster turnaround time on product development and logistics, companies will likely need less upfront investment when pursuing a manufacturing strategy, said Jan Van Mieghem, Professor of Operations Management at the Kellogg School of Management at Northwestern University in Evanston, Ill.

"Shorter lead times result in the need for less working capital," he said. "You're required to take less inventory out of the supply chain so you're able to be more nimble."

When doing business in Asia, for example, a company might have to put a significant number of components on boats in order to make the cost worthwhile. Since Mexico is closer, limited inventory could be shipped instead.

That might lead to faster turnaround on prototype development and small-scale product manufacturing. That could also open nearshoring to smaller companies that may not have considered outsourcing production due to higher costs associated with the strategy.

Van Mieghem added that many companies, when doing a cost analysis, often forget to add the administrative expenses that come with offshoring, such as getting inventory through customs or dealing with shipping delays when products are sent by boat.

"When looking at the numbers, a company might find that they may have to pay a little more when nearshoring to Mexico, " he said. "But when they add in factors like administrative costs and easier collaboration, then those costs change."

Mexico’s challenges

Despite Mexico's advantages, there are still challenges that crop up with nearshoring to the country, particularly compared to Asia.

Security is the most pressing issue, and U.S. companies may end up spending part of their manufacturing funds on security forces to protect Mexican employees.

Zinser of BCG noted, though, that many find the tradeoff to be worth the expense.

"There's always the perception that workforce safety will be an issue, and depending on where you locate your manufacturing, you may have to deal with that,” he said. “But many companies find that they're getting such an attractive set of economics they're willing to deal with that risk."

In general, Mexico has begun to recognize issues like these and to deal with them internally in order to increase manufacturing clout. For example, the country is starting to put together "manufacturing zones" geared toward specific industries and designed to bring manufacturers and suppliers together, Zinser noted.

He added that the industries likely to see the biggest production gains are computers, electronics, appliances, machinery and transportation goods. These industries tend to have higher labor inputs and stringent logistical requirements, leading to several of Mexico's new manufacturing zones geared toward those sectors.

With more attractive labor costs, shorter turnaround times in the supply chain, and more efficient logistics, it's little wonder that Mexico is drawing attention from U.S. manufacturing.

"Definitely, Mexico should be on any company's shortlist when considering a manufacturing strategy,” Zinser said.

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