Viva Mexico!

17 December 2007

Susan Mucha

Mexico is back on the map for global EMS companies. Susan Mucha explains why it is time they should break for the border!

The last five years have seen both increasing investment and retrenchment in Mexico’s electronics manufacturing services (EMS). The investment comes from companies adding greenfield or expanding existing operations in Mexico as the country came back in vogue post-9/11 and telecom-driven recession. The retrenchment comes from shifts in regional popularity. As someone who spent four years as a corporate officer in a then-Mexican EMS and shelter company, I’d like to comment on the myths and realities of the Mexico EMS market.

In the 90s, the general wisdom was that the interior was a better place to locate because the borders had high turnover. Guadalajara, already famed for tequila production and mariachis, became known as the Silicon Valley of Mexico. The myth was that costs were cheaper and labor was more skilled in that region. The reality was that a number of large OEMs had operations there and told their EMS providers that if they wanted the business, operations needed to be set up in Guadalajara. A follow-the-leader pack mentality ensued and many companies located to the region. A similar phenomenon developed in Monterrey, but at least Monterrey had good highway connections to the border.

Another 90s myth was that Mexico was only good for high volume production. The reality is that the combination of close proximity to the U.S. and a low labor cost make it ideal for higher mix products, or those with varying customization requirements.

In the last five years, EMS companies have finally discovered that a good facility in a city close to the border can cut costs through rapid response and higher mix projects are widely deployed. For example, product shipped from a factory in Juarez, Mexico by noon is usually through customs and on a U.S. highway by 6 p.m. the same day.

Comparatively, product built in the interior may need to be shipped air freight or trucked for more than a day in-country, justifying the high volume requirement. Similarly, while a U.S. manager on the interior may have to be paid a premium which includes upscale housing provisions and family-related expatriate support costs such as private school tuition, those working in a border region simply commute back and forth across the border every day. As a result, overhead may be lower in border regions. The end result is that some companies are shrinking or closing interior production capability in favor of border regions. Other companies focus on the border alone in site selection. It is important to note that interior region factories still make good sense if the products produced are for internal consumption in Mexico. Mexico’s automotive and appliance industries are very strong in the interior regions.

The downside to the border region can be higher turnover, but the reality is that turnover is often more a function of human resources expertise and compensation packages than geography. Areas in Mexico with strong unions tend to have less turnover and lower wages, but may have labor shortages in periods of rapid growth since unions control the labor supply. The reason union regions have lower wages than non-union regions is because the turnover in the non-union environment drives wage inflation. Areas with heavy Japanese investment, regardless of union status, often have higher wages because Japanese companies have traditionally compensated at above market wages. The real secret to reducing turnover isn’t higher wages, but instead a combination of competitive wages and a good working environment. Mexican workers are family and relationship oriented. It is not unusual to see companies sponsor sports teams, Mother’s Day luncheons and other quality of life activities as part of focused relationship building to retain workers.

The labor market is also surprisingly good and has both skilled and unskilled labor. Many of Mexico’s engineers earned their degrees while working in Mexican factories. Mexico’s universities and technical schools provide good training in most industrialized regions. It is not unusual to find technical personnel who have training in Six Sigma, Lean Manufacturing, Toyota Production System and a number of other quality improvement disciplines in addition to an engineering or trade school degree. Management personnel have often worked for Fortune 50 OEMs and gone through extensive employer-sponsored management training.

Crime and drug trafficking can be a problem, particularly in the border regions. In Mexico City, the crime risk is primarily robbery and kidnapping. In the border regions it tends to be car theft. Drug traffickers typically don’t target business people who aren’t involved in the drug cartels, but it is not uncommon for public places such as streets, malls or restaurants to have shootouts between rivals, particularly if cartels are fighting for dominance in a region. Anyone caught in the line of fire is at risk in those situations. The main business consideration relative to drug trafficking is ensuring that any trucking companies used have adequate security precautions to ensure that the truck is not re-routed to a warehouse and reloaded with contraband in transit to the border. In border cities those precautions may include driver background checks, GPS tracking, unique security seals, timing the route and even having spotters in high locations visually watch the truck’s progress from a factory to the border.

There are a wide range of EMS providers located in Mexico varying from global Tier Ones to Mexican job shops. The important consideration in supplier selection is picking a company that has right skill sets, quality focus and business model to meet the project requirements. As with China, you get what you pay for and even when using a higher cost supplier you are typically paying less than with a U.S. factory. A good rule of thumb is labor content. If the labor content is over 30%, the project is generally cheaper to produce in Mexico. If it is highly automated, it is important to evaluate landed cost to determine if logistics costs make the U.S. a better option. Support services such as program management, project launch and engineering change order implementation should be carefully evaluated as facilities are audited prior to selection.

For companies looking to establish a factory in Mexico, there are actually three options. The first two are similar to options in any other country: purchase an existing operation or establish a greenfield factory. But, Mexico offers a third opportunity known as shelter. The shelter concept evolved a few decades ago when Mexico had laws restricting foreign business ownership. Those laws have since changed, making shelters technically unnecessary, but the benefits provided in elimination of learning curve make the option still popular with some companies. Under the concept of shelter, the shelter provider sets up the legal business entity in Mexico under their umbrella. They typically provide the building, labor, employees and utilities. They handle permitting and pay taxes. All of these expenses are marked up and charged to the “customer” company. The customer company provides the equipment, process know-how and factory management. In essence, they manage a leased facility, leased employees, leased human resources function, leased logistics services and leased accounting function. But, a shelter provider’s expertise in buying goods and services, recruiting and retaining high quality employees, or providing the best tax strategy may offset some of the markup.

An EMS company using a shelter provider will outwardly appear the same as a wholly-owned operation. The cost structure, because of fees and markups, may be higher, but in some cases, the company may be working more efficiently than a wholly-owned competitor. IF the shelter option is chosen it is important to define the termination clause in initial contract negotiation to preclude the possibility of having to pay expensive termination charges when converting to a wholly-owned operation. Some shelter providers will support a transition to wholly-owned operations after a set time period. Others try to keep their shelter clients by forcing them to literally start over if they want to leave the shelter. Discussing termination costs upfront helps determine which business model is in play before the provider is selected.

The bottom line is that outsourcing to or locating a factory in Mexico can have advantages. However, Mexico is a country that has both good and bad points. Mexico is old world culture, a skilled high technology manufacturing location, a poor agrarian society, Montezuma’s revenge and the Wild West all rolled into one country. Making good outsourcing or site selection decisions require careful analysis. There is value in talking to multiple companies and looking at several regions before final decisions are made.

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