Since the North American Free Trade Agreement (NAFTA) came into effect in 1994, Mexico’s low labor costs have made it a prime location for U.S. companies to base their manufacturing. Initially, there was a correlation between low quality and the low costs of goods made in Mexico. However, over time costs have remained only a fraction of the costs of manufacturing in the United States and China, while quality has risen to world-class levels.
The benefits of operating in Mexico are many—it’s one of the most attractive locations in the world for manufacturing. But there are also growing political and economic concerns affecting the attractiveness of Mexican manufacturing. It’s worth understanding these factors and their potential implications before deciding whether or not to operate across the border.
More than 20 years after NAFTA’s ratification, Mexico has an enviable set of free trade agreements throughout the world. It is a member of the Trans-Pacific Partnership (TPP) Agreement and has nine trade agreements within the Latin American Integration Association (ALADI). Mexico also has more than 46 various trade agreements with more 85 countries across the world, giving it access to more than 60 percent of the world’s gross domestic product.
In addition to the high quality of goods and low labor costs, Mexico has also invested considerably in its rail, highway and port infrastructures. Rail lines seamlessly connect Mexico’s west coast ports in Manzanillo to U.S. cities in Texas and New Mexico, where they continue throughout North America. The easy transportation of Mexican products to consumers in the United States is incredibly potent.
While labor costs have remained low, Mexico’s outstanding management and engineering talent has become synonymous with high-quality manufacturing, and the United States isn’t the only country taking advantage. Chancellor of Germany Angela Merkel recently visited a BMW plant in Mexico, and China is now placing manufacturing plants there as well. With such a vast number of trade agreements, more countries are being tempted to follow suit.
Nevertheless, Mexico also presents some operational risks, and producing there comes with unique challenges. For instance, cartel violence in Mexico has ebbed and flowed over the years. It could become a significant factor with little notice, and companies in the region should be prudent in choosing a location and providing security for their personnel, facilities and goods.
Besides violence, political instability on both sides of the border presents another risk. With the Trump administration continuously threatening to dismantle NAFTA on one side, there are fears that increased trade taxes and subsequent retaliations could be devastating for both economies. With populist leader Andrés Manuel López Obrador gaining political ground in Mexico, it is unclear where the exchanges of harsh rhetoric will lead.
Finally, the recent NAFTA negotiations began quietly, but they are becoming increasingly tortuous. Significant changes to NAFTA are unlikely due to the enormous consequences, but it would be prudent to consider all scenarios when planning major corporate decisions.
Making the Decision
As of now, Mexico remains a competitive manufacturing location due to its proximity to the major U.S. market, low labor costs, excellent engineering talent and ideal transportation infrastructure.
Yet America is becoming more competitive over time. Political instability and the possibility of tax advantages for domestic manufacturing are pushing some companies to reshore operations or stay in the United States. Manufacturing processes are becoming increasingly more automated every year, and Mexico’s comparative labor cost advantage is shrinking as less and less human labor is required.
Deciding to move production to or from Mexico is a major decision that requires careful and honest analysis. Make sure you thoroughly understand the implications by taking these steps:
- Engage in detailed scenario analyses.
Participate in what-if analyses to ensure that you understand and can estimate the impacts of changes in both long-term trends and potential political changes. Manufacturing has a relatively low margin and little room for error. Sudden changes in the costs and availability of raw materials, or changes in taxes regarding cross-border trade, can create drastically different scenarios. In each scenario, the changes may or may not affect your ability to operate in Mexico.
- Plan appropriately for each scenario.
Create a plan for business as usual, but also create a plan for a 5 percent increase in costs of doing business, another for a 10 percent increase, and so on. This prior preparation will provide a significant advantage over competitors if the United States pulls out of NAFTA or enacts a border tax.
- Review automation in your industry.
Review the state of automation in your industry. Then, consider whether the higher costs of an automated, domestic process are worth avoiding the political risks of cross-border production. In all industries, but particularly manufacturing, productivity is at its highest thanks to automation. If your analyses show that operating in Mexico poses unreasonably high risks, then automated technology can help make domestic operations more efficient.
For all of the reasons mentioned above and more, Mexico is and will likely remain (at least, for the foreseeable future) an outstanding place to manufacture goods. However, the benefits over producing in the U.S. have been narrowing over time, and some companies are already reshoring considerable production north of the border. Carefully evaluate and model the pros of operating in Mexico, but keep an eye on the cons—long-term technology trends and political changes may tip the scales in your organization toward domestic manufacturing.
Ambrose Conroy is the founder and an executive team member of Seraph, a management consulting firm that works with clients to transform, relocate or restructure their business operations. Clients include international companies in the automotive, aerospace, energy infrastructure and medical technology/device sectors.