after china: is near-shoring to mexico a better bet for my business?

Near-Shoring to Mexico

After China: Is Near-Shoring To Mexico A Better Bet For My Business

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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.


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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/SB10001424052970204662204577201361904633428.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.


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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/August2012/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.


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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/initiativesandupcomingevents/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.