• Thursday, April 19th, 2012

April 19th, 2012

All eyes are on Mexico as the cost of manufacturing in China rises, forcing businesses to rethink their global sourcing strategies. Companies that once flocked to China because of its massive pool of cheap labor and attractive government incentives are now finding themselves at risk of losing the advantages that brought them to China in the first place. A number of factors are to blame: a diminishing population of low-cost workers, rising production costs, and government-controlled incentives to favored industries at the expense of those seen as less vital to China’s growth.

Although China’s minimum wage rates have been increasing by more than 15 to 20 percent per year according to a study by management consulting firm Cost & Capital, China’s overall wage cost remains far lower than that of Mexico, its closest low-cost competitor. It would be logical that companies without a firm understanding of their true landed costs might look at the labor costs per hour between the two countries, which were $1.40 and $5.93, respectively, in January 2012, and determine that China is still the preferred manufacturing point. However, over the next five years, industry projects that China’s wage cost will increase by 80 percent, a far sharper rate than in the past. Moreover, the growing cost differential between China and its low-cost competitors overall — from supply chain to labor to currency to other less tangibles like regulatory costs or value-added tax (VAT) policy fluctuations — is starting to erode the China advantage.

Companies that know their true landed costs account for factors such as energy costs, currency valuation, shipping costs, transit time, and taxes and tariffs. For example, currently, electricity is cheaper in Mexico than it is in China. In fact, China’s electricity cost per kilowatt-hour (kWh) stands at 15 cents, while the cost per kWh in Mexico is 9 cents. Currency valuation against the U.S. dollar (USD) is also telling. The Chinese renminbi (RMB) is expected to appreciate at an annual rate of 3 to 5 percent for the next three years relative to the USD, while the Mexican peso continues to depreciate. Finally, trans-Pacific freight costs are expected to increase 5 percent annually over the medium term. A similar December 2011 study comparing variable cost components between the United States, China, India and Mexico, conducted by the financial consulting firm Alix Partners, predicts that multiple variables of the costs of production could equal costs in the United States by as early as 2015.

In Mexico, safety and stability issues do exist, but overall there’s a business landscape in place that is very appealing to manufacturing companies. The country has a well-educated workforce and a maquiladora system that eliminates tariffs for products exported to the United States.

Moving manufacturing operations to Mexico would seem to have clear advantages — but only if those advantages can be fully leveraged by a particular company. A third-party logistics provider can help clients determine if a move to Mexico makes sense by asking some key questions in addition to ensuring they understand their total landed costs:

  1. How is an increased level of agility going to impact your ability to sell more? If you’re a garment retailer that has to shift quickly with seasonal changes and you need to be increasingly responsive to the needs of your customer base, a 40-day lead time to accommodate ocean carriage from China can be highly damaging.
  1. How important is sustainability within your operations? More customers are becoming very concerned about green supply chains — they want to know where product is being sourced for both safety and environmental reasons. China doesn’t have a reputation for strict environmental regulations, while Mexico has worked closely with the United States to improve environmental standards since signing NAFTA.
  1. Do you know who your vendors and suppliers are working with at every point in the supply chain? If your supply chain involves multiple vendors and suppliers, then the chances are high that those partners are utilizing the services of a network of subcontractors. If those subcontractors begin to have trouble accessing electricity or sourcing raw material as is happening in China today, it could have a damaging ripple effect on your entire supply chain.
  1. How important are intellectual property (IP) rights to your business and how much control do you believe you should have over them? China is notorious for disregarding IP rights, while Mexico is generally seen as being a far more stable environment.
  1. Are you shipping controlled or protected products? A growing number of companies are running into more regulatory issues shipping out of China and would like to keep operations closer to home. Moving operations to Mexico may simplify this for some companies, particularly as the United States has made it very clear that they are going to start to bolster enforcement actions on products that aren’t in compliance with U.S. trade requirements.

All signs point to the fact that near-sourcing to Mexico is no longer a short-lived trend, but — for the right company — is a strategic business formula that has staying power. A Wall Street Journal headline that ran earlier this year, likely said it best: “China’s Export Pain May be Mexico’s Gain.”

Frank Lange has over 20 years of international experience in the supply chain industry, focused on Asia, Europe and Latin America. Currently responsible for Menlo’s global strategic investment out of its headquarters in San Mateo, Calif., his most recent overseas posting was leading Menlo’s operations in China, based in Shanghai.

Category: China, Mexico, Nearshore
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