Podcast Transcript: Three ways to manufacture in Mexico

Looking to cut costs by manufacturing abroad? Good idea. But where are you going to go, and how can you be sure the investment you make in your chosen foreign market will pay off?

Canadians have many options of course, and one of those is Mexico. Today we are looking at how Canadian companies can determine if Mexico is right for them, and, if it is, how they can set up a presence there and do it right.

I’m Michael Mancini, Editor-in-Chief of CanadExport, the official e-magazine of the Canadian Trade Commissioner Service, Canada’s most extensive network of international business professionals.

With me on the phone is Brad Knight of Riverwood Solutions. Mr. Knight brings more than 25 years of international manufacturing and operations experience, working with original equipment manufacturers and electronic manufacturing service providers in six countries.

Brad, thanks for being here.

Brad Knight: My pleasure.

Michael Mancini: Given your experience, why would Mexico be an attractive option for Canadian firms?

Brad Knight: I think that one of the benefits Mexico brings is a substantial, well-educated labour base right next to the largest market in the world. So literally across the border from Mexico, your labour rates quadruple or more. And since 2000-2010, in that time period, we’ve seen a lot of investment in companies actually designing products and building complex subsystems down in Mexico. So they’ve sort of moved their way up the food chain. The auto industry and aerospace industry are good examples of people making major investments in Mexico to design, build and fabricate in-country.

Michael Mancini: Now, it seems to me that this is maybe mostly attractive for large firms, multinationals. How realistic is a manufacturing set-up in Mexico for smaller or medium-size enterprises?

Brad Knight: Well, you know, the – as the big boys come in, what usually happens is they drag their supply chain with them. And that’s an excellent opportunity for a smaller firm to come in, in support of one of the major multinationals. There’s also the EMS industry, the electronic manufacturing service sector is extremely well represented in Mexico. So if your product is small and you’d like economies of scale, and you don’t want to have to do the toils and tribulations of building your own facility down there, you can always come in through somebody else’s services, like a contract manufacturer.

Michael Mancini: OK, so what would a Canadian company assess when figuring out if Mexico is right for them?

Brad Knight: You know, I think if it’s an in-house versus a out-of-house decision, one of the most basic is the amount of labour that you have to put in your product to build it. If labour is a significant percentage of your product cost, or you have a significant amount of labour involved in production, then I think you need to be thinking about lower-cost regions for that assembly. If you’ve made that decision, then you need to think about the size, the bulk and the mass of this product. If it’s big and bulky, that will force you onto the surface if you’re coming across an ocean, which then adds a lot of time to the process.

Another component to measure in here is whether you have a significant reverse logistics requirement. If you need spare parts, if you need labour to fix your broken thing, then being geographically located close to your end-market certainly is advantageous.

Michael Mancini: How big should one’s operation be here in Canada for you to even begin to think that a move to Mexico will actually be worth it?

Brad Knight: I think one of the difficulties with that is most people are in the “aspire-to-be” mode. And so if you – if your total sales are insignificant today but your product is the next thing, you really need to be planning for production at volume. So I think my answer on that varies on the actual growth plan of your project. If you don’t build many of these things and you don’t put much labour into those things, you’re probably in a very competitive place where you are.

If you put quite a bit of labour in it and you don’t build many of them, you’re going to spend a lot of money working with logistics, getting to and from the – you know, working from your headquarters with your Mexican facility, and there’s quite a bit of money involved in moving engineers back and forth and training and programs. So you really need enough scale to justify the expense of the set-up. Normally what happens, though, is everybody’s planning on building more and more and more every quarter. And so you sort of need to project that into the future and say well, you know, I only do a million dollars’ revenue this year, but next year I’m going to do ten. Where in that curve does my reduction in labour justify the investment? So I think you got to do some math on that one.

Michael Mancini: OK. Well, let’s talk about the options that we can consider.

Brad Knight: Well, I think you really have two choices that are blatantly clear. One is you could build your own facility. Now – well, there’s three. You can build your own facility down there, you can employ a shelter corporation, or you can outsource your product’s manufacturing to somebody else.

So I think what’s happened over the last 20 years is the rise of the multinational contract manufacturers has made it so competitive. In years gone by, people like Hewlett-Packard and IBM have sold their entire manufacturing complexes—and Motorola too – have moved all their manufacturing complexes off, sold entire facilities, product lines and everything to the EMS sector. And what’s happening is, is these very, very heavily automated facilities just get more competitive at scale.

It also allows the EMS to use some of this capital equipment for you for a couple of hours a day because that’s all the demand you have, and still use that equipment for somebody else during the day, so they can even load the capital equipment. And what’s happened literally over the last ten years is it’s almost prohibitive to build your own facility unless you have some niche that few can help you with, and then you got to sort of go it alone. But there’s less and less of that happening.

Literally – because the larger players aren’t doing that, it’s almost impossible for the little guys to do that. And so what the little guy can do is jump on the coattails of the big guy and use the economies of scale of this infrastructure that’s been in place to serve the RIMs and the Apples of the world, and you can niche a little corner off to build your products. I’m very pro EMS sector.

Michael Mancini: Now, you also talked about a corporate shelter service. What is that, and what does that involve?

Brad Knight: Well, there are companies in Mexico who will literally, say, own a building. They have infrastructure, power, electricity, sewer, water. And you can come in and say I would like to rent 4,000 square feet from you. Maybe it needs to be air conditioned, I need 250 employees. And that shelter company will hire the employees for you, they’ll manage the employees, they’ll manage the facility infrastructure. You bring in your technical competence and your product, and perhaps your capital equipment, and you have a ready-made facility sitting there for you. It’s a nice stepping stone to getting into your own facility. So some big companies even use a shelter company as a way to enter a market. Because in the end, if it doesn’t work out for you, really all’s you owe is a long-term lease to the shelter company.

Michael Mancini: Right. Would you say that this is perhaps a very attractive option for SMEs?

Brad Knight: You know, I think it’s one of the safer options for an SME, though if you’re in – if you’re in a sector serviced by the contract manufacturing, the – by design the industry only demands four or five percent profit margins. So you don’t have to share much So I think the shelter organizations, if you’re thinking that you’re going to have a very large facility yourself because your economies work that way, I think a shelter organization is absolutely the way to get started – or one excellent way to get started.

Michael Mancini: OK.

Brad Knight: You know, like if you’re going to move anywhere in the country, if you’re going to build a facility anywhere in the world, if you’re going to build a facility, the infrastructure support is critical. And how much power’s at the curb? Is there power at the curb? When we built in Guadalajara, Mexico we had to run seven miles of high-tension electrical out to our campus. Billions of dollars. We also had to put in our own sewer treatment facility. So we were out there treating our own sewer, making our own electricity. It makes it much more difficult making this decision with wildcard variables like, can I get access to a data line. You come into a shelter organization or a contract manufacturing, all that infrastructure’s in place. You can touch it, you know it’s there, you know how much it’s going to cost, and you can begin using it immediately.

Michael Mancini: What are some of the main differences in terms of cost?

Brad Knight: Yes. Normally the shelter costs are individual, and you commit to them individually, like I need 5,000 square feet of space. So that’s kind of tricky. Do you need 5,000 square feet of space, or do you really need 10,000 square feet of space? And I might need 3,000 square feet today but I need 15,000 square feet in two years. So trying to understand that in a shelter organization is the variables in the cost. The building probably costs the same, the labour costs the same. The margins will be a little higher in the shelter business than the contract manufacturing.

But with the contract manufacturing solution, they price by unit price. They come back and say your handset is a hundred dollars if you buy 10,000 of them, it’s 97 cents if you buy a hundred thousand of them. So it’s much easier for you to run your business with the known variables of cost per product than it is the unknown variables of infrastructure.

Michael Mancini: And how long would it take to set up this corporate shelter corporation?

Brad Knight: You know, if you go into a shelter corporation, if they have space available it can happen very, very rapidly. That’s one of their biggest advantages, is they have facilities wired, plumbed and ready to operate. And so literally weeks and you could be building something in Mexico under the shelter organization. If you were going to build your own facility, when we built the Flextronics campus in Mexico we bought land in August and began first articles on the 4^th of July the next year.

But that was, you know, a major effort. There were three, 400 contractors on that campus.

Actually the contract manufacturing option, you don’t worry about any of that. That’s the – that’s the problem of the EMS, is he has to hire the people, he has to worry about the duties, he has to worry about the taxes, working with the unions. All of that happens with the contract manufacturer or the shelter organization. Now, with the contract manufacturer, you literally say I want 10,000 cell phones please, and negotiate when you’re going to get them. With a shelter organization, you say I need 10,000 square feet and 300 people to build 10,000 cell phones. And then if you go do it yourself, you need to worry about the permitting, the building, the construction - everything falls upon you and your responsibility to figure that out.

So in the progression of regulation ease, I guess you would say, the contract manufacturer, you can literally place a purchase order with their parent group and they worry about the rest of it. The shelter organization, you’re more intimately involved with the technology and the production of the product, but you’ve sheltered yourself from the real estate and the labour issues. And then the most complicated of all is to go down and buy a piece of land.

Michael Mancini: Brad, thanks for taking the time to chat today.

Brad Knight: You’re welcome. Any way we can help, please give us a call.

That was Brad Knight of Riverwood Solutions speaking to me from Las Vegas.

Well, that’s all for this podcast edition of CanadExport. Go to CanadExport.gc.ca for more audio podcasts and feature articles on international business topics.

You should also visit TradeCommissioner.gc.ca for more information on how our trade commissioners can help you in Mexico.

You can also stay connected to us and other leading Canadian companies by joining the Trade Commissioner Service Group on Linked In. So go to LinkedIn.com and search for the TCS.

I’m Michael Mancini signing off for now.

To download our other episodes, just go to www.canadexport.gc.ca or go to iTunes and use the searchword “CanadExport.”