Image credits: Clayton Cardinalli
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Analysis

What is Nearshoring and How Can Mexico Take Advantage of It?

By Alejandro Enríquez | Mon, 10/05/2020 - 11:25

Nearshoring has become a buzzword when talking about the automotive supply chain. Learn more about how Mexico can take advantage of the unique opportunities brought by USMCA and the pandemic.

Globalization is taking a break or is at least changing its ways. This is particularly true for the automotive value chain, which is observing a more regional approach as companies are establishing production closer to where demand is. The COVID-19 pandemic has proven how feeble off-shored production can be, while at the same time boosting advanced manufacturing technologies. 

Offshoring meant to take production outside advanced economies, taking advantage of cheap labor, tax incentives, proximity to raw materials and less stringent regulations found in developing countries. There is also reshoring, which literally implies taking production back to the country where the company is originally from, in most cases the US or Western European countries.

Nearshoring meets both terms halfway. Advanced economies are bringing production closer to home or to where demand is by taking advantage of the opportunities their neighboring developing economies present. This is the case for the US and Mexico, as well as Western Europe with Eastern Europe and Turkey, for instance. The practice is not new but it has been reinforced by the current global conditions. While there were still companies that relied con global suppliers to meet regional demands, trade wars and the COVID-19 crisis are making the regional approach more attractive.

 

The Roaring Decade for Mexico's Automotive Sector

 

Over the last decade, the automotive industry in Mexico benefited greatly from nearshoring practices. Over a 10-year period, Kia, Toyota, Audi, Mazda, BMW, JAC and Fiat – thanks to the creation of FCA group in 2014 – arrived in the country with a long line of suppliers behind them. Vehicle production grew by 66 percent between 2010 and 2019 to reach 3.75 million units in 2019, while exports grew 188.4 percent in value to reach US$11.8 billion as of December 2019. 

 

According to Mexico's Ministry of Economy, FDI in the sector accounted for US$7.4 billion in 2019, after reaching a peak of US$7.8 billion in 2017. Despite the pandemic, FDI in 1H20 showed similar levels to 2012 which can be a good sign. Following the North American Industry Classification system, the two greatest contributors to these numbers are industry group 3361 and 3363, motor vehicle manufacturing and motor vehicle parts manufacturing, respectively. According to Oscar Albin, Executive President of INA, "as vehicle manufacturing volumes ramp up, they have a spillover effect in the auto part sector." 

 

New Driving Forces

 

"USMCA and the COVID-19 pandemic will take Mexico to nearshoring practices," told former Executive President of AMIA Eduardo Solís to Mexico Business News. On the one hand, USMCA's enforcement on July 1 set stringent rules of origin that required greater Regional Value Content (RVC), while creating a new Labor Value Content rule (LVC), as well as steel and aluminum requirements. On the other hand, COVID-19 showed the vulnerabilities of production lines that relied greatly on offshored suppliers, particularly from Asia.
"We must not confuse the decrease in demand caused by COVID-19 with the strengthening of the North American region through USMCA. Although both will foster the transfer of operations to closer locations, USMCA’s new rules of origin will imply a restructuring of OEM operations," says Solís. 

Technological development, meaning Industry 4.0, is also pushing companies to move production closer to where demand is to manage them more efficiently. In its report Globalization in Transition: The Future of Trade and Value Chains, McKinsey notes that "as automation changes the balance of capital and labor, many multinationals are considering investing in new production capabilities closer to end consumer markets to tighten coordination of their supply chains and reduce shipping times. A more automated and digital form of manufacturing no longer requires a large, low-skill workforce." 

Automotive cluster leaders from Mexico's main manufacturing destinations agree that the pandemic is accelerating technological trends further, which indirectly is also driving companies to nearshore their production. "Digitalization strategies are being embraced on the basis of a cost-benefit analysis," told Tarsicio Carreon, President of Chihuahua Automotive Cluster to Mexico Business News. 

 

How Can Mexico Take Advantage of Nearshoring?

 

The scenario is set for the industry to continue growing and global suppliers are aware of that. "The automotive industry is changing and the role of Mexico in the sector continues to be really advantageous," told René Schlegel, President of Robert Bosch México to MBN. As the US-China war continues, it could be the Asian the country the one that leads some of the major investments into the country.

"Yanfeng is relatively young in North America but we are expanding our presence in the region. Our interiors division has cleared the path for other divisions to arrive in the region through Mexico," told Lourdes Cobos, Operations Director of Yanfeng Automotive Interiors Mexico to MBN, one of the largest Chinese automotive suppliers.

Consulting firm savills, in charge of the Savills' Nearshoring Index, presents a ranking of potential nearshoring countries. The index takes into account manufacturing labor costs, electricity costs and infrastructure and trade openness. Mexico is ranked 15th, largely due to cheap labor costs while offering greater opportunity areas in infrastructure and trade openness. 

The major challenge for the country remains in providing certainty for incoming investors. As noted by Daniel Hernández, Director General of the Queretaro Automotive Cluster, "the scenario is most favorable to continue growing. The pandemic did not change the state’s assets for incoming companies. Having said that, the market needs the right signs to generate trust, both at the federal and the global level."

Different regions in the country can present particular advantages depending on what the company is actually looking for. At the same time, there are emerging regions within the country that want to take advantage of nearshoring opportunities. Jalisco, for instance is strongly betting on developing and bringing suppliers focused on electric vehicles, while Tlaxcala is taking advantage of its location near Volkswagen and Audi plants in Puebla. 

All in all, it is clear that Mexico will continue to be a relevant player in the automotive supply chain. USMCA’s rules of origin, greater advanced manufacturing processes rushed by a pandemic and ongoing tensions between the US and Asian markets are presenting a unique scenario for another roaring decade. The country ought to send the right signals for companies to consider Mexico in their investment plans to not let this opportunity slip away.
 

Photo by:   Clayton Cardinalli
Alejandro Enríquez Alejandro Enríquez Journalist and Industry Analyst

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