Mexico’s Changing Business Landscape

What you need to know about Mexico’s transitioning economy—and the challenges and opportunities therein—to be successful doing business south of the border.

Global Busines — RAUL FREYRE, EXECUTIVE DIRECTOR, INTERNATIONAL BANKING, MEXICO OCTOBER 10, 2016

Doing Business in Mexico

Thirty years ago, Mexico’s manufacturing base barely existed—oil accounted for the vast majority of the country’s exports in the early 1980s, and tariffs restricted the flow of finished products to the United States. The following decades brought a series of political, economic and trade reforms, including the 1995 North American Free Trade Agreement (NAFTA). Free trade with the US accelerated Mexico’s industrialization, sending the value of the nation’s exports up 638 percent since the first maquiladoras began assembling consumer goods for the American market. In 2014, total trade volume between the US and Mexico reached $590 billion, making Mexico America’s third largest trading partner.

Today, Mexico is a leader in free trade, and 44 free trade treaties have created a tariff-free global market for goods manufactured in the country. Mexico has become the world’s largest exporter of flat-screen televisions; it’s also home to the world’s seventh-largest automotive industry, and it has a $6 billion aviation sector.

However, as the nation continues to develop as an industrial power, some of its early advantages will likely fade—for example, labor costs are already beginning to rise. That said, the maturation of Mexico’s industrial base will also create opportunities, including the emergence of a middle class hungry for consumer goods. Businesses considering opening manufacturing plants in Mexico should be aware of the risks, challenges and rewards of expanding into this rapidly developing market.

What to Know About Doing Business in Mexico:

  1. The Macroeconomic Advantage
  2. The Industrial Ecosystem
  3. Key Trends
  4. Key Challenges
  5. Strategies for Success

1 The Macroeconomic Advantage

  • Cheap labor has always been a key strength for manufacturing in the developing world. With a daily minimum wage of only $4, Mexican labor has a significant cost advantage over the US and Canada. Mexico’s manufacturing sector also enjoys significant advantages over competing offshore destinations, including:
  • Easy access to the US market. Bringing goods to market from Mexico is far quicker and cheaper than trans-Pacific shipping. Many goods cross the border twice—40 percent of Mexico’s exports contain components or raw materials sourced from suppliers in the US.
  • Ease of doing business. The World Bank ranks Mexico 38th globally in ease of doing business, and it’s the fifth-easiest nation in which to finance a new enterprise.
  • Cost-effective currency. The Mexican peso has depreciated over the past few years, giving exports an added cost advantage. Compared to many developing markets, inflation in Mexico is relatively tame—it has maintained about 3 percent annually. Price stability helps keep manufacturing costs predictable.
  • A massive domestic market. Mexico’s $1.14 trillion economy is the world’s 15th largest, making the nation’s economic base significantly larger than many other low-cost manufacturing countries, including Indonesia, Thailand and Malaysia.
  • A growing population. The generation now entering Mexico’s workforce will be the largest ever, projected to reach 84 million by 2020. Mexico’s demographic future is more certain even than China’s, whose “one-child” policy has created a demographic bottleneck that may cause its workforce to shrink in coming decades, thereby driving up wages.
  • Educational attainment. Nineteen percent of adults in Mexico hold a post-secondary degree, which is double the rate in China or Indonesia. Every year, Mexican universities graduate 110,000 students majoring in engineering, construction and manufacturing.

2 The Industrial Ecosystem

A complex industrial ecosystem has arisen around Mexico’s automotive, aerospace, appliance and electronics sectors. When original equipment manufacturers (OEMs) open operations in Mexico, secondary and tertiary suppliers follow in their wake. The supply chain’s growth has become self-reinforcing—as components and services become easier to source domestically, more multinational firms are moving final assembly to Mexico, which in turn drives up demand for locally-produced components. The result has been a boom in high-end manufacturing, supplanting low-tech sectors like textiles and apparel.

The automotive industry has become Mexico’s strongest manufacturing sector. Mexico is the world’s fourth-largest exporter of automobiles and the seventh-largest producer overall. Virtually all major global automotive firms have Mexican facilities. GM, Ford, Chrysler, Mercedes, Audi, BMW, Toyota, Nissan, Honda, Mazda and Kia will produce a combined 5.1 million light vehicles in Mexico in 2016, and manufacturers are planning to invest another $15.8 billion in new capacity this year. As Mexico eclipses Canada’s automotive sector, the geographic center of North America’s automotive industry moves approximately 14 miles further southwest every year.

Mexico’s automotive components industry is also booming: Eighty-nine of the world’s top 100 components manufacturers are operating in the country. Manufacturers often export parts to the US for final assembly, taking advantage of short transportation times to new plants in Texas and Mississippi. The average car assembled in America now contains some $4,000 in Mexican-made components.

The Mexican aerospace industry has also grown rapidly, expanding at a 20 percent annual rate between 2010 and 2014. Eighty-four international aviation suppliers have invested a combined $3.1 billion in Mexican operations that employ around 21,000 workers. In 2014, over $1 billion in aviation components flowed across the border for final assembly in the US. Airlines have also seen the opportunity to move maintenance, repair and overhaul operations to Mexico—12 maintenance, repair and overhaul centers currently refurbish airlines in Mexico, including eight facilities doing complex engine overhauls.

Consumer electronics and home appliance manufacturers have also prospered in the post-NAFTA era. The electronics industry has become the world’s sixth-largest, and Mexico is the single largest exporter of flat-screen television displays. Most major American appliance brands have expanded operations in Mexico, taking advantage not only of cheap labor, but also benefiting from free-trade access to markets throughout Europe and Latin America.

3 Key Trends

Mexico’s economic development is driving the nation’s transformation from an agrarian, low-income nation with a low-wage, low-skill workforce to a middle-income industrialized nation that is globally competitive in cutting-edge manufacturing.

A series of economic reforms have opened up Mexico’s oil, gas, electricity and telecommunications sectors to foreign investment. As the global oil glut fades, Mexico’s energy industry could see a renaissance. The entry of competition into Mexico’s protected utilities and telecom sectors could improve reliability and lower prices in the coming years.

The automotive industry is already leading Mexico’s transition into a high-skill manufacturing center, and this shift should accelerate over the coming decades. As the nation’s industrial base matures, the spillover effect of rising demand for higher skills will likely drive up productivity and wages, displacing low-skill industries like textiles and apparel.

4 Key Challenges

Mexico’s development presents tremendous opportunities, but it can also create challenges for companies moving into the country, including:

  • Education: While Mexico’s educational system is superior to most developing nations’, educational attainment lags far behind American standards. The UN’s education index places Mexico (at 0.638) significantly ahead of China (0.610) but far behind the US (0.89) or Canada (0.85). Some workers may require remedial education before they are ready to step onto a high-tech assembly line.
  • Culture: Despite the modernization of Mexico’s economy, roughly half the workforce is employed in informal enterprises. For workers coming from past jobs in agriculture or working in small, family-owned shops, the transition to a highly regimented and closely supervised manufacturing environment can be jarring. Employees who are used to operating in workplaces governed by personal relationships and informal agreements may have difficulty adapting to the “checklist” culture of modern assembly lines.
  • Turnover: For workers possessing the skills demanded by high-tech manufacturers, the sector’s rapid growth is constantly creating opportunities to switch jobs. In Juarez’s maquiladoras, vacancy rates are approaching 10 percent as new factories poach skilled workers from their competitors. Wages at new automotive plants have risen to between $1.15 and $2.30 per hour—far cheaper than labor in the US, but many times higher than Mexico’s official minimum wage.
  • Infrastructure: Major elements of Mexico’s electrical grid, transportation infrastructure and water supply are in disrepair. Rail service is virtually nonexistent outside the largest urban areas, and rural highways can be slow and treacherous. Electricity is more expensive and less reliable than in the US, and water supplies in the arid regions near the northern border are already strained by the demands of industry. To avoid downtime, many factories have been forced to install private generators inside their facilities. Private generation now supplies almost 35 percent of Mexico’s electricity.

These challenges could hamper productivity; per-capita worker productivity is roughly one-third of the US average. For some businesses, however, the potential savings from cheap labor may be offset by logistical hurdles and the difficulty of maintaining a robust supply chain. Regulatory issues can also present difficulty—the World Bank Group ranks Mexico 106 (out of 189) in ease of registering property, and 92 for total tax burden.

5 Strategies for Success

  • Focus on effectiveness and efficiency when launching operations. Your facility’s location and the scope of its operations can take advantage of Mexico’s strengths: Central Mexico offers abundant labor and a robust automotive supply chain; Mexico City is the heart of the domestic consumer market; and the northern border region provides the quickest access to US consumers.
  • Emphasize the importance of labor force development. A rigorous program of recruiting workers with the right skills and screening potential employees for cultural fit can improve productivity and retention. Offering a competitive package of compensation and benefits will likely minimize turnover, and investing in training programs can boost your workforce’s flexibility and capabilities.
  • Cultivate strong and open relationships with customers, suppliers and workers. If your Mexican counterparts view you as a valuable long-term partner, they may be eager to lay the foundation for productive collaboration.
  • Target investments for long-term growth. Growing prosperity in Mexico is rapidly changing the labor and consumer markets. An operation whose profitability is predicated on rock-bottom labor costs may find itself increasingly pressured by wage inflation. But a factory that builds consumer goods with an eye towards the expanding domestic market will likely be positioned to capitalize on the growth of the Mexican middle class.
  • Harness the skills and innovation of the local workforce. The lack of educational opportunities for most Mexicans means that there is untapped potential in the workforce. If given access to training and advancement opportunities, many workers will likely prosper in a dynamic industrial setting.

Mexico’s development may be cast in a negative light by some—in terms of lost American jobs and displaced workers—but industrialization will likely bring prosperity to both sides of the border. American companies will be more competitive if they can take advantage of the strengths of both nations, and the growing market for consumer goods in Latin America will make Mexico an important strategic partner for international trade.