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Mexico Redux PUBLIC ACCESS

Formerly America's Top Low-Cost Manufacturer, the Neighbor to the South is Repositioning Itself to be an Advanced Industrial Player.

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Associate Editor

Mechanical Engineering 130(01), 23-28 (Jan 01, 2008) (6 pages) doi:10.1115/1.2008-JAN-1

This article discusses formerly America’s top low-cost manufacturer; the neighbor to the south is repositioning itself to be an advanced industrial player. Colantuoni manages market research for Mexico’s Offshore Group, which develops maquiladoras for firms that want to manufacture in Mexico. Maquiladoras import goods from the United States without paying taxes or tariffs, manufacture or assemble them into products, and export them back across the border. Today, Mexico is making more complex and sophisticated products, as well as goods that require fast turnarounds and customization. It has used its advantages to retain business even in industries—computers, telecommunications, and appliances—that seemed a natural fit for China. Management in general is also a consideration for manufacturers. Mexico’s physical proximity to the Unites States and Canada, and the shared business culture of North America make management easier. In many ways, competition from China has been good for Mexico. It has spurred it to move into engineering and manufacturing higher value-added products.

The idea seems almost quaint. Only seven years ago, Mexico was what Steve Colantuoni describes as "the big-box store for low-cost manufacturing." The nation's border fac tories, known as maquiladoras, were turning out high-volume, low-tech, and lab or-intensive products.

Colantuoni manages nLarket research for Mexico's Offshore Group, which develops maquiladoras for firms that want to manufacture in Mexico. Maquiladoras import goods from the United States without paying taxes or tariffs, manufacture or assemble them into products, and export them back across the border. Since the passage of the North American Free Trade Agreement in 1994, there have been no tariffs on those exports

A combination of tax advantages and low-cost labor once gave Mexico a huge cost advantage, especially for labor-intensive assembly work. But a combination of two events early in this decade-a recession in the U.s. and the lifting of tariffs on goods from China-sent Mexico's manufacturing base into a tailspin.

Now, however, Mexico is back on the upswing. It is no longer the cheapest game in town, but it is closer to North American markets than China is, and its factories are trading up. The government is also seeking to expand Mexico's engineering role.

There was a time when many automakers and their suppliers set up shop in Mexican border towns. At their h eight in 2001 , Mexico had 3,730 maquiladoms employing almost 1.3 million workers, nearly half of them making automotive products. Mexico was indeed America's lowcost manufacturing store.

Those Mexican factories were tightly integrated with the U.S. manufacturing economy, according to William Gruben, director of the Center for Latin America Economics at the Federal Reserve Bank of Dallas. Such tight integration proved both a blessing and a curse. In 2001, the maquiladoras were hit by a double whammy that closed as many as one out of every five and by March 2002 had thrown 288,000 Mexicans out of work.

First, the recession that fo llowed the bursting of the dot-com bubble caused demand to plunU11et. Maquiladoras were especially vulnerable because they were so tightly tied to the auto industry. "These are durable goods," Gruben said, "and during a recession when people get into trouble or are afraid of losing their jobs, they stop buying cars."

Second, after 15 years of negotiations, China finally joined the World Trade Organization. This ended most tariffs on Chinese goods. Even with the tariffs, China had become the fourth-largest exporter to the United States, trailing Canada, Japan, and Mexico. Within two years, China had outstripped Mexico and Japan.

China's WTO membership and cheap labor-far less costly than Mexico's-sent a shock wave through many Mexican industries. For example, computer exports from China and Mexico to the United States were roughly even in 2001 . By 2006, Mexican exports had fallen 32 percent while Chinese exports had more than quadrupled. In sectors where both China and Mexico increased exports to the United States, C hina has generally increased them faster.

Today, China is clearly the world's big-box store for low-cost manufacturing. Between 2000 and 2006, its exports to the U.S. nearly tripled to $287 billion. In 2006, it accounted fo r 16 percent of all U.S. imports, and seemed likely to surp ass Canada for the top spot in 2007.

Mexico took the shock of Chinese competition between 2001 and 2003, but since then, Mexican exports to the United States have grown more than 40 percent to $187 billion.

Not only is th e pace of growth quickening, but the types of exports are changing as well. Gruben sees it in the data. Despi te the decline in maquiladoras and their employees star ting in 2001, the absolute value of their outpu t kept rising. "That suggests automation," Gruben said. He added that factory owners are switching from labor-intensive assemblies to more sophisticated products. Maybe Mexican fac tories can no longer compete with China's low wages across the board. But NAFTA, proximity to the United States, and better intellectual property protection and rule oflaw remain potent advantages. Many maquiladora owners, encouraged by two successive pro-business Mexican adIrunistrations, have begun to refocus their manufacturing operations to move up the technology ladder.

Today, Mexico is making more complex and sophisticated products, as well as goods that require fast turnarounds and customiza tion. It has used its advantages to retain business even in industries-computers, telecommunications, appliances-that seemed a natural fit for China. In fact, Mexico may soon rank among the few nations that manufacture large aircraft.

Powerbrace Corp.'s Saltille factory. Like many new manufacturers in Mexico. it chose to locate inland from the border.

Data: U.S. International Trade Commission

Grahic Jump LocationData: U.S. International Trade Commission

WHEN EDUARDO SOLlS. WHO HEADS THE INVESTMENT PROMOTION EFFORTS OF MEXICO'S MINISTRY OF ECONOMY. FIRST BEGAN STALKING AEROSPACE EXECUTIVES. THEY WERE SKEPTICAL. The nation's entire aerospace infrastru cture consisted of six manufacturers of components. "Six years ago, we were a totally blank page," Solis said.

Yet Solis was very clear about the companies he wanted to attract. T hey were businesses that would transform Mexico into a knowledge-based economy. "We wanted to take Mexico from low-cost manufacturing to important but low-cost engineering," he explained. "We wanted to transition to m.ore value-added sectors, more design, more engineering."

Aerospace was the perfect poster child for that type of economy. At the manufacturing level, making aircraft requires close tolerances and careful assembly. At the engineering level, manufacture involves constant changes and world-class project management. Moreover, aerospace companies cannot possibly make every part themselves. From con'lposite panels and landing systems to sophisticated avionics, they outsource major components. Solis was betting that vendors would follow a major aircraft manufacturer to Mexico and hire local skilled workers and engineers.

Fortunately, Solis co uld point to an industry that already looked a lot like his model: automobile parts. Today, Mexico accounts for nearly 30 percent of all auto parts imported by the United States, as well as 15 percent of all vehicle imports.

Many autom otive maquiladoras are making more demanding products than in the past. Solis points to Ford Motor Co., which made the entry-level Focus in Hermosillo. In 2005, it announced plans to invest another $1.2 billion to switch the plant over to make the more upsca le (and demanding) Lincoln Zephyr and Mercury Milan, as well as the Fusion, Ford's competitor with the Honda Accord and Toyota Camry.

Ford's suppliers are investing roughly $800 million in nearby factories, exactly the kind of pull-through Solis is seeking. Japanese and European companies and their vendors have also opened maquiladoras to supply their U.S. fac tories.

He could also point to firms that did "important" engineering in Mexico. In 1995, Delphi Corp. (formerly General Motors Corp.'s parts division) es tablished an engineering center in Ciudad Juarez. In the past, most Mexican engineers focused on production-related issues. Delphi's engineers did research, development, and design. Over the past 12 years, it has grown to 2,200 engineers, from 860, and is now Delphi 's largest engineering center.

Other automakers took note. General Motors, Ford, and Chrysler have also set up engineering centers in Mexico. Intel Corp., which established an engineering center in Guadalajara, is searching for Mexican Ph.D.s to stock its new research arm. General Electric Co. has opened a small engineering center in Queretaro to support its power and airplane turbines, has consistently added engineers, and now has hundreds working there.

The push in engineering did not happen by accident. Mexico h as always had strong engineering schools. "We're graduating 130,000 engineers per year. About 60,000 to 65,000 of them are in IT, but the others are in all fields at all levels," Solis said.

Since 2001, Mexico has also given companies incentives for using local talent in research, design, and other high-level engineering work. "They can apply a 30 percent credit from their spending on research, design, or process development toward their taxes," Solis said. "That not only includes labor, but also training, equipment, and other associated expenses."

Even in 2001, Solis could point to a handful of aerospace firms that prospered in Mexico. Labinal, part of France's Group Safran, makes complex wire harnesses for military and commercial aircraft. It designed the complex harnesses for the new Boeing 787 Dreamliner and has won an outstanding supplier award from Airbus SA. Spain's lTP and Mexicana Airlines operated a company that made aircraft parts and did repairs. Honeywell International Inc., which makes major aerospace components, also began making additional investments in Mexico in the late 1990s.

Bombardier assembles its Q400 in Toronto from components manufactured in China and Mexico. It believes that assembling the entire aircraft in Mexico will provide a cost advantage.

Grahic Jump LocationBombardier assembles its Q400 in Toronto from components manufactured in China and Mexico. It believes that assembling the entire aircraft in Mexico will provide a cost advantage.

BY 2004, 61 AEROSPACE COMPANIES HAD SET UP SHOP IN MEXICO. WHEN SOLlS AND CANADA'S BOMBARDIER INC. BEGAN SERIOUS DISCUSSIONS, HIS BLANK PAGE HAD BEGUN TO FILL OUT.

Bombardier was ready to listen. It is the world's third largest manufacturer of civilian aircraft, after Boeing and Airbus. It is a strong supplier of small regional and business aircraft, but faces a stiff challenge from Brazil's Empresa Brasileira de Aeronautica S.A. Embraer's wage advantages, already significant on lab or-intensive aircraft assembly, have increased as the Canadian dollar has continued to climb in value against the dollar.

Bombardier Aerospace is already a global manufacturer with operations around the world, according to the company's vice president of engineering and supply chain, Jean Seguin. It operates major facilities in Montreal, Widlita, and Belfast. It also sources some components, including a turboprop fuselage, from China.

"We saw Mexico as a way to improve our competitive advantage," said Seguin. "From a logistical standpoint, we're in the same time zone so we can talk with our engineers and we can use truck shipping. The whole logistics chain-from our facilities and our vendors to our customer base-is easier than dealing with Asia. The fact that we were going to build a new facility ourselves would help make the transition a lot faster than if we worked with an outside partner like we do in Asia."

Bombardier was initially concerned about the local workforce. Unlike the automotive industry, where workers do the sam.e job every day, aerospace tasks change frequently. "In automotive, you repeat the same action every four minutes," Seguin said. "On a fast aerospace program, you might repeat an operation every seven days. Workers need to master a different set of processes and skills to do this."

Bombardier worked with the Mexican government to establish a training program for factory workers. Many of them have the equivalent of high school plus two and a half years of technical training. The company brought in workers from its other facilities to start things going, but quickly hired Mexican supervisors from other facilities or promoted them from the factory floor.

The company also hired engineers to support the production work. They include industrial engineers, who oversee manufacturing, and liaison engineers, who work with the company's Canadian designers to oversee changes or rework.

Bombardier chose a site in Queretaro, a large city with a brand-new airport located in the populous central valley north of Mexico City. It designated two areas for production. One was electrical harnesses. Bombardier tends to make its harnesses in-house. The work is labor-intensive, especially when customizing harnesses to handle aircraft upgrades.

The second was aerostructures. Bombardier, which launched ah110st one new aircraft annually since the 1990s, sends a portion of this work to outside vendors. "If we didn't, we could never have grown like we did," Seguin said. The company is already making fuselage and flight control surfaces, like wing flaps and tail elevators and rudders. It hopes one day to assemble entire airplanes.

The company started operations in a temporary facility outside the airport in May 2006. "Basically, the operation met all of our expectations. We found some really good, qualified workers. They are very dedicated, producing high-quality work. Frankly, the skill sets, quality of work, and their dedication met all of our milestones," Seguin said.

"Bombardier is doing it the right way," noted Doreen Michelini, whose Chicago consulting firm, China Mexico Solutions LLC, helps companies establish manufacturing offshore. "They did not just put in a factory and start building airplanes. The first thing they did was to build a school. As they train employees, they will bring more work down. They've also built an industrial park only for their direct suppliers, suggesting that they will do more manufacturing here."

The ability of large companies to pull suppliers to Mexico has proven critical to Mexican economic growth. Even then, relocation is a business decision. Many of the same factors that played out in Bombardier's decision to build in Mexico play out for other companies as well.

Canada's Rocand Industries Inc., for example, makes expensive molds for plastic. The company opened a small facility in Monterrey, where it adapts n10lds for customers. "Automakers start with a design, but after a month or two, they often modifY moldings to combine parts or adjust the look," said Rocand's president, Andre Rochette. He plans to keep production and engineering in Canada, and use the Mexican plant to remachine molds.

Powerbrace Corp. of Kenosha, Wis. , makes doors and locking systems for railcars and trailers. It opened a 115,000-square-foot plant with 150 employees south of Monterrey in May 2004. Production runs range from dozens to thousands of products at a time.

According to Powerbrace's president and general manager, Mike Weber, "The Monterrey region has extensive metalworking capabilities and some very outstanding engineering and technical schools. We thought we would have to teach our people about just-in-time supply, Six Sigma, and continuous materials management, but we found they already knew these things. We're already exceeding our pelformance metrics, such as unit cost, first pass quality, and safety."

Monterrey, however, is part of a larger manufacturing operation. Powerbrace imports some castings, forgings, and metal parts from China. It keeps its engineers in Kenosha, where its factory competes on projects in which speed and customization matter more than price.

The Intec Group of Palatine, Ill., specializes in molding plastic around metal and wire in everything from door latches and fuel pumps to sensors. It has plants in the United States, Asia, and, since 2003, Guaymas, Mexico.

"I will tell you this, in terms of manufacturing capability, our Mexican facility is the best in the fleet," co-CEO Scott Perlman said. He said that the company is not in Mexico to chase cheap labor.

"No, we're in Mexico because our customers are there," he said. "Our direct labor content is about half that of the United States, but all other costs are on par with the U.S. Our overhead for high-level managers and plant supervisors is real close to what it costs here. Land and building costs are the same. Energy costs are higher. Nor do they have the same infrastructure there, and most of my materials require sophisticated plating so that's an additional cost."

NO LONGER THE BORDER

Foreign companies opening plants in Mexico are breaking with the tradition of the maquiladoras on the border. They have bui lt plants farther south. Rocand Industries Inc. has a plant in Monterrey, about 90 minutes south of the border. Powerbrace Corp . is an hour south of Monterrey. Intec Group in Guaymas is five or six hours south of Tucson, Ariz. Bombardier, outside Mexico City, is farther still from the U.S.

Many complaints about border cities are well known . They attract transient workers, who move there for jobs but never really put down roots. Shifting populations make crime and drugs an issue. There is also intense competition for workers.

"The competition for labor goes beyond just the cost," said Scott Perlman of Intec. "Recruitment is a major cost. The in vestment we put in our people is huge, and then your customers and other companies lure them away. We wanted a more stable situation."

"The reason why you don't have that in the interior is that people have friends and family so they ' re rooted," said Steve Colantuoni of Mexico's Offshore Group. "Businesses pay lower wages, they have a more stable workforce, and they don't need extra perks to keep people in place. If you're shipping 100 truckloads of product a week, you want to be near the border. Otherwise, you're better off in the interior. "

When M ike Weber of Powerbrace began scouting for a 10 cation, he found there were two industrialized Mexicos. "One is old industry, with dirt floors, no heat, and poorly trained and disciplined workers. The other is modern, capitalintensive, and clean, with welltrained and disciplined workers. Some even wear uniforms. What I saw in this new Mexico looked every bit as good as in the United States."

Many interior cities have worked hard to create a culture that makes advanced manufacturers welcome.

According to Ralph Watkins , a senior international trade analyst at the U.S. International Trade Commission, "If you go to Monterey, it has a very good secondary education. They try to train students for the jobs that are out there. Lots of jurisdictions are not as enlightened. They don't have linkages between schools and businesses."

Watkins, whose analytical work is wellknown among those who study border economics, made it clear that he was expressing his views and not those of his agency. Then he added:

"It's a real struggle. If I were investing in Mexico, I would not put my operations in most border cities, where there is a lack of progressive thinking among politicians. Are they corrupt? Not necessarily. But they're oldline politicians who got ahead the old way and don 't have a vision for the future.

"There are some cities on the border, like Reynosa, Juarez, and Mexicali, where enlightened and educated young leaders have tried to build good relationships between their cities, regional governors, and investors. If you go further into Mexico, this is where the engineers from Monterrey Tech go to live because they also want to get away from the personal security problems of the border."

Perlman's long-term goal is to do more product development in Guaymas: "Our customers are doing more and more product development in these regions and we will have to follow suit."

While some skills are common, others are not. "Yes, Mexico is getting more technical, but yo u have to make sure the people in your area have the right skills," Michelini said. "Most small compani es don't have a year to train people. I ran a metal stamping plant for four years, and there were not a lot of tool shops down there. No one ever taught them to make tools or progressive dies. I have clients that wanted to locate to certain areas, but th ere was no one they could hire." D espite a growing emphasis on education, the workers in her factory had not gone beyond elementary school, and she bemoaned a still-common lack of urgency among business people.

Ralph Watkins, a senior international trade analyst at the US. International Trade Commission, also sees room for improvement. Widespread individual tax evasion forces the government to raise more revenue from business. He also favors reforms that give companies more flexibility in how they use workers, and faster regulatory approvals.

Mexican workers lead the world (including the United States, Switzerland, and Japan) in a survey of employee engagement by Towers Perrin.

Grahic Jump LocationMexican workers lead the world (including the United States, Switzerland, and Japan) in a survey of employee engagement by Towers Perrin.

Data: U.S. International Trade Commission

Grahic Jump LocationData: U.S. International Trade Commission

WATKINS HAS STUDIED THE IMPACT OF CHINA ON MEXICAN EXPORTS AND BELIEVES MEXICO HAS CERTAIN ADVANTAGES OVER CHINA. Many are due to its proximity and integration with the US. economy.

Mexico, he says, is most competitive in products with a high weight-to-value ratio, such as motor vehicles, auto parts, large- screen TVs, and major household appliances. It is also strong where quality or intellectual property protection are important, such as medical devices and electronic controls. Mexico also holds an advantage when supplying industries that require just-intime d elivery, c ustomi zed products, and frequent design changes.

Michael Hetzel, a Chicago-based vice president at ProQC International, a quality consulting firm, echo es Watkins. He believes China is often more expensive than people think.

China is clearly at a disadvantage.for products with fast life cycles. "They're sensitive to shipment delays, so you have to carry more gap inventory and do more clearing out at the end of life cycle."

Managing China's supply chain has grown increasingly complex and expensive. "The Pacific carriers are running full out and there are materials shortages in China," H etzel said. "If you look at iron ore, it costs more to ship it to China from Latin America than it does to make the products in Latin America."

Others see it as well. "Our plant in Mexico can almost compete with China, where we pay people $150 per n10nth," said Intec's Perlman. "Everyone assumes China will always be able to outcompete everyone, but we don't see a significant difference."

Management in general is also a consideration for manufacturers . Mexico's physical prox imity to the US. and Canada, and the shared business culture of North America make management easier.

In many ways, competition from China has been good for Mexico. It has sp urred it to move into engineering and manufacturing higher-value-added products. Bombardier remains the poster child of that change.

According to Solis, "Every country in the world has to take China very seriously. We're on an important quest to find our own niches. But we have some very important strengths."

In brief, he sums up the pitch for his country: "We have the right platform, the right location, and the right business climate for n1anufacturing."

As with many medium-size companies, Powerbrace followed its customers, first to the southern u.s. and then to Mexico. Here, brake beams await shipping.

Grahic Jump LocationAs with many medium-size companies, Powerbrace followed its customers, first to the southern u.s. and then to Mexico. Here, brake beams await shipping.

Copyright © 2008 by ASME
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