The Changing Landscape of Manufacturing in Mexico
September 10, 2019
Over the last decade, Mexico has experienced a manufacturing renaissance. Its meteoric rise has been a boom for both the country as a whole and for American companies seeking a manufacturing haven outside of China. Mexico’s proximity to the states and comparative costs of operation have encouraged many businesses to relocate. The shift has been mutually beneficial for both Americans and Mexicans alike.
Although there has been a steady influx of companies manufacturing in Mexico, the logistics of doing so is an important factor to consider. With the political turmoil within the country and President Trump flipping over the playing board in regard to tariffs and trade deals, there have been drastic changes to the industrial landscape—some good, others bad. That said, if you’re contemplating transitioning your business to Mexico or don’t know whether you should be doing offshoring vs. outsourcing, this comprehensive guide will help. Our Mexico manufacturing specialists will be covering trends, shifts, and things to ponder before you make that decision.
The Renaissance of Mexican Manufacturing
In the 1990s, Mexico experienced a serious economic shift under the North American Free Trade Agreement (NAFTA). The trade deal binding Mexico, America, and Canada was transformative for the Mexican economy. Once state-owned companies became privatized, cutting corruption, increasing efficiency, and decreasing cost.
In the space of a few years, the number of maquila plants within the country doubled. Seemingly overnight, Mexico became an export-focused industry. Trade between it and its northern neighbors dramatically increased. Soon, a manufacturing belt of maquiladoras—assembly plants—rose up along the southern border. Previously, Mexico primarily focused on manufacturing clothing; after NAFTA, it was soon competing with China in much more valuable fields such as:
- Automotive manufacturing
- Electronic production
In 2006, the Mexican government sought to gain a greater foothold within the worldwide exports market. They made updates to the Manufacturing, Maquiladora and Export Services Industry program (IMMEX) in order to encourage foreign investment. It stipulated that IMMEX or Maquiladoras could temporarily import goods into Mexico without fees so long as the goods were intended for manufacturing, repairing, and/or transforming. Once these services were completed, the good would be subsequently exported. Companies that operated under this agreement enjoyed several benefits, including:
- Duty Free – No compensatory quotas, no domestic purchase taxes, no VAT tax, lowered custom fees.
- Decreased labor costs – Compared to doing business in the U.S., Mexican labor payment rates have remained stagnant for the last decade at approximately $2.70/hour.
- Skilled workforce – The labor force specialized in the manufacturing process of specific goods. The more they worked on these items, the more efficient and technically skilled they became.
- Decreased shipping costs – Much easier to transport goods a few hundred miles across the border as opposed to shipping from China. U.S. manufacturers saved both money and time on transportation and warehouse costs.
In less than a decade, the manufacturing industry in Mexico experienced serious growth, especially in comparison to South American competitors such as Argentina or Brazil. Its emphasis on the U.S. market, production expansion, and diversification has kept it a highly competitive market. Growth rates include:
- The exportation of aerospace components increased by 14.1%. Now, by 2020, the aerospace sector will reach the 10 largest by sales figures.
- Automotive production increased 4-fold from 100,000 units to 381,000 units in 2017. According to the Automotive Research center, “Mexico accounts for a fifth of all vehicle production in North America and has attracted more than $24 billion in auto investment since 2010.”
- Mexican manufacturing on the whole grew from a $135 BN/year industry in 2005 to a $198 BN/year industry in 2017, which accounted for 17.24% of the country’s GDP.
The Changing Landscape of Manufacturing in Mexico
On September 30th of last year, President Trump successfully managed to strongarm Mexico and Canada into a trade negotiation agreement called the United States-Mexico-Canada Agreement (USMCA). This new restructuring of trade and commerce between the three North American countries sought to address disputes and imbalances that had previously cropped up over the past two and a half decades under NAFTA.
Naturally, the results of this amended deal were a mixed bag for all three countries. For Mexican manufacturing though, which had already seen precipitous growth over the past decade, the deal was largely seen as a boon. Although the deal itself won’t go into effect until 2020 due to a torpid legislation process, it’s expected to have a positive impact on manufacturing in Mexico, especially in the automotive industry. According to a study by Foley and Lardner LLP:
At minimum, USMCA, if ratified, would maintain the vigorous tariff-free arrangement that has underpinned $1.25 trillion in cross-border trade. The agreement would bring a much-needed update to the rules, with modernized intellectual property (IP) provisions and chapters on digital trade, anticorruption, customs and trade facilitation and other improvements. It would maintain Mexico’s status as an attractive place to manufacture… The biggest industry-specific change—for instance, an attempt to increase wages for Mexican auto workers and elevated regional content requirements in the sector—are the ones that most companies can adapt to.
On the whole, Mexican negotiators and business leaders see the deal as a solid update to NAFTA. Three key changes made to NAFTA that have been added to the USMCA that will impact the supply chain and cost of business are:
- The Rule of Origin – 75% of a car or truck’s components must be made in North America, an increase from the 62.5% under NAFTA. According to analysts and government officials, more than 70% of Mexico’s automotive exports already comply with the new rules of origin, so Mexico is expected to receive larger investment as production transfers out of Asia.
- Labor – A movement to allow Mexican workers to form unions, which would improve conditions and wages for the Mexican labor force and thus level the playing field for domestic manufacturers within the U.S. This could likely increase some of the costs of doing business in Mexico while decreasing the wage gap disparity between the U.S. and Mexican manufacturing sectors.
- Nonmarket Economies – The USMCA included a provision known as Article 32.10, which lays out the grounds for veto if one of the parties attempts to negotiate a FTA with foreign countries, namely China. This and other clauses introduce tariffs and restrictions for sourcing parts from less expensive Asian countries.
According to a study on USMCA’s impact on the supply chain, U.S. based manufacturers feel the changes made will have a positive economic impact on their company in the long term, but will likely increase costs of operation, which will then be passed on to the consumer. The LevaData Survey states:
- 41% believe production costs will increase by 10% over the next 3 years, and a significant number (26 percent) believe the increase could be 25 percent or more.
- 58% agree these increases will result in higher costs for consumers.
- 39% agree that electronic components costs will be impacted, if not significantly impacted.
- 73% said that employee payroll costs will increase and/or workforce will decrease.
- 36% plan on renegotiating part supply deals so that suppliers are sharing the cots.
- 78% plan to find North American suppliers or identify alternate suppliers to decrease supply chain costs.
Mexican Legal Issues
In December of 2018, Andrés Manuel López Obrador kicked off his 6-year term as president of Mexico and has already faced several political and economic challenges and changes—all of which could have direct impacts on the manufacturing industry. Recent legal factors you may want to consider include:
- Piercing of the corporate veil – In the past, foreign investors were fairly well protected by the corporate veil; legal entities or companies were separated from their shareholders. So, foreign investors could do business in Mexico and be protected from liability related to debts or obligations to the subsidiary. In 2013, a Mexican appellate court ruled that shareholders were, in fact, liable. It remains unclear how Obrador will handle this issue, but foreign investors are advised to speak with their counsel about ways to prevent this and protect themselves from liability.
- Punitive Damages – Recently, the courts of Mexico updated century old laws regarding personal injury cases and punitive damages. In the past, Mexico minimized indemnification related to personal injury cases, but now, that criteria has changed in favor of protecting workers. Similar to wages and unionization, this will increase labor costs and require that manufacturers obtain more thorough insurance policies and labor agreements.
- Corporate sharing – Mexico installed a mandatory 10% annual profit sharing with employees. In the past, manufacturing companies would circumnavigate these rules by putting their employees in an outsourcing or in-sourcing company so that profits were tied to those outfits instead of the operating company. New rules prevent such loopholes and require that companies fairly provide the profit-sharing mechanism, or else face stiff penalties.
- Product safety regulations – Revisions have been made to revamp the product safety regulatory framework within Mexico. These updates are meant to bring it into alignment with worker safety requirements within the states. Although this might increase some input costs, it ensures that the quality and safety of products is superior, thus decreasing liability and recall costs.
- PROFECO – Mexico’s consumer protection agency has been granted increased power to force companies into compliance. Now, there are mandatory recall requirements wherein PROFECO can:
- Remove an unsafe item from production
- Require repair of defective products
- Run product safety investigations
- Impose sanctions on non-compliant manufacturers
While these may be obstacles you may have to deal with, it’s important to remember that there are still a number of benefits of manufacturing in Mexico for U.S. companies. These are just important factors to consider before you make your final decision.
Increasingly, foreign countries have congregated in Mexico thanks much in part to the various factors listed above. This rapid evolution of the Mexican manufacturing industry has decreased costs from manufacturers and streamlined supply chains; however, the changing landscape doesn’t come without its obstacles. These include:
- Transportation capacity – On the whole, Mexico has solid road and rail transportation infrastructure. Both the roads and the rail systems meet international quality standards and extend to the vast majority of the country. In addition, there has been an even greater emphasis on updating and improving the transportation infrastructure that lies closer to America’s southern border.
Despite this, the massive influx of manufacturing within the country has created a situational trucking capacity, especially due to the fact that most Mexican-based trucking companies operate on a much smaller scale than powerhouses such as Fed Ex or Amazon. According to Matt Hamson, CEO of Coronado Logistics, the vast majority of fleets are small with more than 75% of all trucking equipment being owned by those with less than 100 trucks in their fleet. This capacity crunch combined with delays at the U.S.-Mexico border have caused several exporters to turn to ocean liners for U.S. shipment.
- USMCA roll out – Since USMCA is still in the process of being discussed, studied, and implemented, there could be logistical issues that crop up in the future. This and other unclear regulations will take some time to iron out and could cause unforeseen manufacturing costs. In addition, the exchange from truckers and custom brokers might cause initial delays.
- Managing inventories and expectations – Compared to China, manufacturing in Mexico makes estimating products lead times a far simpler affair. Further, it becomes easier to manage inventory and supply chain. This proximity allows products to be made at a faster rate and grants greater oversight and flexibility throughout the process. With that in mind, manufacturers within Mexico still need to be able to adjust and react to disparities between forecasts and customer demand.
Manufacturing in Mexico
Over the last two decades, the Mexican manufacturing landscape has experienced a seismic shift. In order to keep up with the demand, there has been a significant investment in the infrastructure in Mexico so that the transportation, technology and other important infrastructure needs are up to standard. Both Mexican workers and American producers have benefited greatly from these changes as Mexico has emerged as a serious manufacturing rival to China. The carving out of China’s majority share of the market has been particularly beneficial for American producers.
So, should you be moving your manufacturing over to Mexico? We think yes. Although the smoke has not yet cleared from the wake of the USMCA agreement, forecasts point towards continued growth and improved dealings. If you’re considering moving production south, analysts widely agree that you’re getting in at the opportune time.