Manufacturing in Mexico, Part 1: Manufacturing Location Tradeoffs

Manufacturing in Mexico is suddenly a political hot potato of epic proportions, with implications to every company currently manufacturing in Mexico or contemplating a move to, or away from, Mexico. A 20% import tariff on goods made in Mexico could also disrupt supply chains globally and indirectly impact companies who don’t manufacture in Mexico.

Since helping our customers define and implement a global manufacturing and supply chain strategy is a core competency here at Zebulon Solutions, we will try to lay out some of the subtler issues and suggest alternative approaches. Not the political and social implications—we’ll leave that morass for other pundits—but what a 20% import tariff might actually mean to global manufacturing.

Because of the seriousness and complexity of this topic, we’re planning a three-part series:

  • Part 1: Manufacturing Location Tradeoffs
  • Part 2: Comparing Costs Between Regions
  • Part 3: Alternative Manufacturing Strategies

Before we get to the final answer, we need to talk about the many factors and tradeoffs (one of our favorite terms) that impact selection of a manufacturing location.  Labor cost is certainly one such factor, a major one of course, but there are many other issues.  In no particular order (each situation is different, and each product / company may have different priorities), here are some of the other factors that impact the landed cost and hence manufacturing location selection:

  • Tariffs and duties impact landed cost, but also can have secondary impacts on dealing with bureaucracy and the like. It should be noted that only products that meet NAFTA’s Rules of Origin (complicated, but basically what percentage of the content comes from NAFTA vs non-NAFTA countries) are duty-free—many products made in Mexico are already subject to import duties into the US.
  • Logistics costs include both freight in for raw materials and freight out, from factory to end user. Beyond the hard costs, time-in-transit impacts cash flow, inventory and agility. There is also a secondary impact at the bureaucratic level, as any supply chain professional who has seen her product sit in a queue at the border can attest to.
  • Overhead cost is tied to the indirect labor cost (all those engineers and buyer/planners) but also the cost of real estate, utilities and the like.
  • Margins, while really a business model aspect, can vary from region to region
  • Exchange rate fluctuations factor into both inbound materials cost but also the eventual transfer price. Some of this can be hedged, of course, but hedging has a cost too.
  • Supply chain is a huge factor, albeit complicated (it’s how we make our living at Zebulon Solutions). Where materials come from, the cost of moving them to a factory, regulatory and customs aspects, lead times, all of this is important.  And it’s all tied together—it’s called a supply chain for a reason. Building a product in China from 90% US-made parts can be as impractical as building a product in Mexico from 90% China-made parts. And, see above, using non-NAFTA-sourced parts tends to eliminate the NAFTA duty-free designation already.
  • Regulatory environment is a two-edged sword, as companies neither want total chaos—think hijacked shipments or stolen IP—nor do they want a regulatory minefield where everything slows to a crawl.
  • Product quality is a function of the quality of the workforce as well as the processes, with secondary inputs from environmental aspects (e.g. humidity control). Quality impacts unit cost by way of yield, but also has a major impact on warranty costs and customer satisfaction, and in extreme cases product liability.
  • Work force stability and flexibility is also a two-edged sword, as a moribund union-run factory has one set of issues and a flexible factory in a region with high labor turnover has a different set of issues.
  • Facility availability is a significant factor when considering a location move: finding / constructing the right building at the front end or selling / closing a factory at the other end impact any such decision. The quality and cost of utilities also play a role, as do local regulations (e.g. permits and severance).
  • Customer perception and patriotism—Made in America—matter in some markets and for some brands.

Beyond these product-specific issues, there are bigger factors at play.  Capacity for one: despite the political expediency of chanting Jobs, Jobs in truth there is a shortage of manufacturing workers in the US. Likewise, there are not exactly well-facilitized manufacturing buildings sitting idle waiting for tenants in most of the country. Nor is there tremendous excess capacity in China. Any significant move would severely impact other supply-and-demand variables, messing with exchange rates, inflation, wage rates, access to capital, workforce stability and the like. This impacts not only companies actively reshoring, but also long-term US manufacturers if capacity tightens and lead times spike.

And finally, while still trying to stay apolitical, moving a factory is a long-term decision that may not get an ROI for many years, which could easily be beyond the horizon in terms of political stability.

Our next installment will dive into the nitty-gritty of product costing, trying to understand the cost impact of reshoring a Mexico-built widget and compare that with outsourcing to a different low-cost region, China or otherwise.

That’s all for now. And remember to breath.

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