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After China: Is Near-shoring to Mexico a Better Bet for My Business?

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Many U.S. distributors and manufacturers are rethinking sourcing decisions to be geographically more convenient. Learn why the trend toward near-shoring in Mexico has staying power and how your …

Many U.S. distributors and manufacturers are rethinking sourcing decisions to be geographically more convenient. Learn why the trend toward near-shoring in Mexico has staying power and how your business can take advantage of these global trends. The research explores wages, close proximity to emerging markets, infrastructure and geography.

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  • 1. Near-Shoring to Mexico After China: Is Near-Shoring To Mexico A Better Bet For My Business White paper prepared by:
  • 2. After China: Is Near-shoring to Mexico a Better Bet for My Business? 1 The initial wave of outsourcing to China represented a ‘perfect storm’ of conditions – cheap energy, labor, trade liberalization, uncertainty in Mexico and reform efforts in China. In recent years, Morris sees the ‘perfect storm’ going the other way. When the United States granted China Permanent ‘Most Favored Nation’ (MFN) status in 2000 and China acceded to the World Trade Organization (WTO) the following year, American firms increased investments in the mainland. China offered US firms low wages, stable governance, improved infrastructure and capacity to produce on a global scale.1 The production shift to mainland China has resulted in lower consumer prices especially for some manufactured goods like electronics and apparel and higher corporate profits in the short term. More than a decade later, Chinese manufacturing for North American and global consumption poses serious challenges for US-based firms. Global developments including rising Chinese labor costs, design to production to consumption feedback loops, and energy costs force US firms to reconsider production location in China and Asia. A growing trend toward ‘near-shoring’ production in Mexico and elsewhere in Latin America offers advantages for firms competing in the North and Latin American markets. What is ‘Near-shoring’? Near-shoring is the sourcing of labor or services in a location in greater proximity to design, development or final consumption of the final product or service to enhance control, quality, and timeliness of delivery. Other variants include locating services or production in places of cultural or legal affinity to enhance efficiency of service or product delivery. For practical purpose, an apparel-maker based in the US selling to Europe and Latin America primarily re-locating a manufacturing plant from Guangzhou, China to 1 Martin Neil Bailey, “Adjusting to China: A Challenge to the U.S. Manufacturing Sector,” Brookings Institution, January 2011, Policy Brief #179; http://www.brookings.edu/research/papers/2011/01/china- challenge-baily Monterrey, Mexico would be an example of ‘near- shoring.’2 A Perfect Storm in Reverse? In 2001, Chinese manufacturing wages averaged $.60 an hour, far below that of Latin American production costs and a tiny fraction of US costs.3 At the same time, energy costs were low and stable. Crude oil, annualized and inflation adjusted, averaged $30 per barrel in the 5 years before and after 2000.4 Combined energy and labor costs made a move to China sensible for US firms after the trade liberalization process was finalized. The decision to move production to Asia, and China in particular, was built on other assumptions as well. Brookings Institution scholar Andres Rozental notes, “Many other factors, such as availability of skilled labor, infrastructure, certainty of rules and regulations and fairness of the justice system, all play a significant role.”5 A decade ago, China was making substantial progress on all of those indices, so coupled with price 2 The author recognizes that the term of art ‘near-shoring’ varies in meaning depending on context. For a discussion for common variations see, Partners Market “Will the real near- shoring please stand-up?” April 27, 2012; http://www.partnersmarket.com/will-the-real-nearshoring- please-stand-up/ 3 Crossborder Group, “Mexico vs. China, a Perfect Storm 2,” Presentation to Hong Kong Association of Southern California, August 2012, http://www.slideshare.net/CrossborderGroup/2012-mexico- andchinaperfectstormhongkongassocsocalkennmorrisexcerpt 4 “Historical Oil Price Table, http://inflationdata.com/Inflation/Inflation_Rate/Historical_ Oil_Prices_Table.asp; access February 10, 2013 5 Andres Rozental, “Are Mexican Factories Gaining an Upper Hand Against China's?” Brookings Institution, September 18, 2012; For US firms, near-shoring means moving facilities closer to the US mainland to improve communication and control of production without sacrificing cost efficiencies.
  • 3. After China: Is Near-shoring to Mexico a Better Bet for My Business? 2 competiveness – offshoring production there garnered huge advantages. Most of the advantages accrued by outsourcing to China have been eroded over the past decade. The Crossborder Group’s Kenn Morris argues that the initial wave of outsourcing to China represented a ‘perfect storm’ of conditions – cheap energy, labor, trade liberalization, uncertainty in Mexico and reform efforts in China. In recent years, Morris sees the ‘perfect storm’ going the other way.6 China’s Disappearing Labor Price Advantage According to the Boston Consulting Group, China’s primary advantage over the rest of the world – low wages – will be erased by 2015 when the hourly manufacturing wage will rise to $6.7 At that price point, manufacturing something in China for the US market is no longer cheaper than in Mexico where wages have been flat and are now below China’s.8 Average wage rises in China are partly to blame on the increased valuation of the Chinese currency, likely to rise even further in coming years, and another unexpected concern – a growing labor shortage. According to the Wall Street Journal, “The pool of Chinese workers is getting shallower. China's one-child policy and cultural preference for boys have led to a shrinking population of young people, particularly the women who work the floors of the apparel and electronics firms.”9 That shortage has driven up labor costs in China, without the necessary increases in 6 Crossborder Group, “Mexico vs. China, a Perfect Storm 2,” Presentation to Hong Kong Association of Southern California, August 2012, http://www.slideshare.net/CrossborderGroup/2012-mexico- andchinaperfectstormhongkongassocsocalkennmorrisexcerpt 7 http://www.brookings.edu/research/opinions/2012/09/18- mexico-china-rozental 8 Tim Johnson, “As China’s wages climb, Mexico stands to win new manufacturing business,” McClatchy News, September 16, 2012; http://www.mcclatchydc.com/2012/09/10/167930/as- chinas-wages-climb-mexico-stands.html#storylink=cpy 9 Justin Lahart and Tom Orlik,” China's Export Pain May Be Mexico's Gain”, The Wall Street Journal, February 6, 2012, http://online.wsj.com/article/SB10001424052970204662204 577201361904633428.html. productivity to make it worth the price. By contrast, Mexico’s average wage is only $3.50 an hour, a dollar cheaper before factoring in the logistics challenges of managing a supply chain half a world away. Calculating the Incumbent Costs of Production Labor aside, the costs of sourcing a good abroad can vary dramatically from location to location. Energy is one of the largest costs for those sourcing materials abroad, both energy for production and transportation. World oil prices have proven to be extremely volatile in the past decade, frequently exceeding $100 per barrel – over three times the oil price average in 2000.10 As a result, the cost of ocean freight from China to US ports has increased significantly.11 Furthermore, electricity rates are actually 4 cents per kilowatt hour higher in China than Mexico.12 At the same time, Chinese 10 Historical Oil Price Table, http://inflationdata.com/Inflation/Inflation_Rate/Historical_ Oil_Prices_Table.asp; access February 10, 2013 11 Crossborder Group, “Mexico vs. China, a Perfect Storm 2,” Presentation to Hong Kong Association of Southern California, August 2012, http://www.slideshare.net/CrossborderGroup/2012-mexico- andchinaperfectstormhongkongassocsocalkennmorrisexcerpt 12 Frank Lange, “Guest Commentary: Mexico – Manufacturing Companies Move Toward Near-Sourcing,” Logistics Viewpoint, April 19, 2012, http://logisticsviewpoints.com/2012/04/19/guest- commentary-mexico-manufacturing-companies-move- toward-near-sourcing/ China’s primary advantage over the rest of the world – low wages – will be erased by 2015 when the hourly manufacturing wage will rise to $6. At that price point, manufacturing something in China for the US market is no longer cheaper than in Mexico where wages have been flat and are now below China’s.
  • 4. After China: Is Near-shoring to Mexico a Better Bet for My Business? 3 government incentives to invest have diminished as property costs have increased in the coastal cities.13 Other related costs of production including taxes, tariffs and regulatory compliance must be factored into the ‘landed costs’ of a good to compare the efficiency of locating in China. For logistics expert Frank Lange, when these are fully accounted for, near-shoring to Mexico proves cheaper.14 A 2011 study by AlixPartners consultancy confirmed Mr. Lange’s hunch – the full landed cost of a Chinese production rose from 2005 to 2010 to 87% of US costs, while Mexican costs actually fell to 75% of US costs.15 Intangible Advantages – Communication, Convenience, and Customers Mexico’s strongest advantage for company’s considering a move to near-shore production is proximity both to corporate headquarters and consumer market. Proximity reduces the total travel time for goods Mexico to US to a fraction of the total time between Chinese origins and US destinations. Ocean freight from Altamira, Mexico to the port of Miami takes 6 days while a similar shipment from China could take as long as a month to arrive. Firms have to factor in the value of lost time as well as the higher incumbent transportation costs from China. 13 Yajun Zhang, “China Begins to Lose Edge as World's Factory Floor” The Wall Street Journal, January 16, 2013, 14 Frank Lange, “Guest Commentary: Mexico – Manufacturing Companies Move Toward Near-Sourcing,” Logistics Viewpoint, April 19, 2012, http://logisticsviewpoints.com/2012/04/19/guest- commentary-mexico-manufacturing-companies-move- toward-near-sourcing/ 15 Crossborder Group, “Mexico vs. China, a Perfect Storm 2,” Presentation to Hong Kong Association of Southern California, August 2012, http://www.slideshare.net/CrossborderGroup/2012-mexico- andchinaperfectstormhongkongassocsocalkennmorrisexcerpt On a practical level, Mexico lines up with US time zones, so business days are concurrent and communication can happen in real-time. Distance makes overseeing production in China is difficult. As Robert Moser, the president of a housewares firm told McClatchy News in September 2012, “You’ve got to get a visa to China, and that takes time. It’s a 16-hour flight, hours to the factory. It’s days at the very least to tackle some of these issues.” 16 Communication is also easier, with much higher rates of English fluency in Mexico and Spanish in the US than Chinese-English fluency. This linguistic and cultural affinity intersects with the strong and stable legal and regulatory system present in Mexico. The challenges of doing business in Mexico are known to many US firms. In contrast, unpredictable Chinese regulatory and tax regimes have proven more difficult to navigate– adding substantial unanticipated costs.17 For other firms, intellectual property concerns make doing business Mexico more appealing. According to Forrester Research, Mexico guards intellectual property rights much more strongly than China where theft of patents and technology is rampant.18 The convenience of and ease of communication with Mexico allows US firms to be more customer facing, with shorter and more easily managed supply chains. 16 Tim Johnson, “As China’s wages climb, Mexico stands to win new manufacturing business,” McClatchy News, September 16, 2012; http://www.mcclatchydc.com/2012/09/10/167930/as- chinas-wages-climb-mexico-stands.html#storylink=cpy 17 Douglad Donahue, “Why Manufacturers Are Choosing Mexico Over - and in Addition to – China,” Area Development, August 2012, http://www.areadevelopment.com/BusinessGlobalization/Au gust2012/why-manufacturers-are-nearshoring-to-Mexico- 292711.shtml?Page=2 18 Sam Cinquegrani, “Nearshoring: A Smart Alternative to Offshore,” IT Today, 2008; http://www.ittoday.info/Articles/nearshoring.htm The full landed cost of a Chinese production rose from 2005 to 2010 to 87% of US costs, while Mexican costs actually fell to 75% of US costs. Ocean freight from Altamira, Mexico to the port of Miami takes 6 days while a similar shipment from China could take as long as a month to arrive.
  • 5. After China: Is Near-shoring to Mexico a Better Bet for My Business? 4 Simply put, with production in proximity to US headquarters and consumers (North and Latin America), firms can adapt to circumstances quickly. With volatile energy costs, major natural disasters like the Japanese Tsunami, and uncertain demand, shorter supply chains allow firms to carry less inventory and make fewer predictions of the macroeconomic future.19 In addition to the practical benefit of lower inventory and storage costs, the shorter supply chains linked to Mexico offer firms flexibility to meet customer needs as they arise. A Latin American Hub For US firms, Latin America remains a large and growing market. In 2011, Latin American traded $800 billion with the US – three times what it did with China. Mexico has consistently been at the center of this north-south trade relationship.20 Anchored by NAFTA, Mexico has embraced free trade with the region and is leading an effort to expand it with the Pacific Alliance bloc of Mexico, Peru, Colombia, and Chile.21 As a result of this integration with North America and economic ties to the south, Mexico is the largest importer and exporter in Latin America. To grow Mexico’s competiveness, then-President Felipe Calderon announced a huge investment of public and private dollars in an infrastructure program of $37 billion to improve ports, highways, railways, roads and airports. His successor President Peña Nieto plans to triple Calderon’s funding for infrastructure to improve logistics for international trade. The National Infrastructure Plan (NIP) includes 1500 kilometers of railways linked to Mexico’s ports. The NIP includes 19 Lisa Harrington, “Near-Shoring Latin America: A Closer Look,” Inbound Logistics, March 2012; http://www.inboundlogistics.com/cms/article/nearshoring- latin-america-a-closer-look/ 20 Shannon O’Neil, “U.S. is still Latin America’s biggest trading partner,” November 16, 2012, Voxxi; http://www.voxxi.com/us-latin-americas-biggest-trading- partner/#ixzz2KZqAGHsk 21 Randall Woods and John Quigley, “Latin America Commits to Open Trade After Protectionist Year,” Bloomberg News, January 28, 2013, http://www.bloomberg.com/news/2013- 01-28/latin-america-commits-to-open-trade-after-year-of- protectionism.html continued modernization of Pacific and Atlantic ports, the expansion of the Port of Veracruz and new port facilities at Lázaro Cárdenas, Manzanillo, Altamira, Dos Bocas and Tampico.22 Considering Mexico In deciding to relocate production, the rush to China proved hasty for many US firms according Tom Page director of customer solutions, international regions for UPS, "Most companies decided to move production using one-dimensional reasoning, based on labor costs, which represented 70 to 80 percent of the criteria considered."23 Over the past decade, that singularly advantage has been largely eliminated although the many disadvantages of Chinese production linger. There is good reason to think the trend toward near- shoring in Mexico may have more staying power since Mexico’s wages have remained stable, there are growing markets both to the north and to the south of Mexico for its goods, and improved infrastructure will keep Mexico competitive. Furthermore, Mexico’s primary advantage – proximity – is unlikely to change in the coming decade. 22 US Department of Commerce, “How to Successfully Navigate the Public Procurement Process in Mexico” Export.gov; December 2012; http://export.gov/industry/architecture/initiativesandupcomi ngevents/mexicoinfrastructure054717.asp 23 Lisa Harrington, “Near-Shoring Latin America: A Closer Look,” Inbound Logistics, March 2012; http://www.inboundlogistics.com/cms/article/nearshoring- latin-america-a-closer-look/ In 2011, Latin American traded $800 billion with the US – three times what it did with China. Mexico is the largest importer and exporter in Latin America.