Renewed commitment to Mexico.

The recent coverage of the debate about immigration legislation brought to mind the interest and concerns about low-cost labor that were much in the news back in 1994, when the North American Free Trade Agreement (NAFTA) went into effect. The concern then was the potential for a wholesale shift of production to Mexico--immortalized by H. Ross Perot as the impending "giant sucking sound." It is true that the U.S. trade deficit with Mexico in the automotive sector did rise dramatically--almost tripling in the first five years of NAFTA--but the bigger impact on the U.S. trade balance has been from other parts of the world. The rise of China and other Asian countries is illustrated in a comment one auto supplier made to us last year, "Mexico is so '90s."

Some parts manufacturers have gone through a two-part shift in pursuit of cost-competitiveness over the last 10 years. One company described it this way: "We opened a maquiladora in McAllen, TX/Reynosa, Mexico, in 1996 for the lower labor cost, because our product was fairly labor-intensive. In 2004, we started looking at the next phase. Our labor was $2.25 in McAllen vs. less than 60 cents an hour in China. The competition went there, so we formed a 50-50 joint venture in China, and by the end of this year, we will have transferred production from Mexico to China. We did it to reduce labor cost, but also because China has developed a supplier base. Mexico never did--it just relied on doing assembly of components shipped in." Other suppliers have gone directly to manufacturing in, or sourcing from, low-cost Asian countries without the intermediate step of Mexico.

There are indications, however, that attention is turning back to Mexico. For example, at the OEM level, GM is building a $600-million plant in San Luis Potosi to begin production in the 2008 time frame. Hyundai is studying the possibility of a Mexican assembly operation and at least three Mexican states are vying to be selected. Freightliner is building a $300-million facility in Saltillo, with production slated to begin in 2009. Nissan invested nearly $1.3-billion in retooling its Aguascalientes plant over the past couple years to expand production and use its plants there and in Cuernavaca as an export base to Europe and Latin America, as well as to the U.S. and Canada.

The supplier's comment about the lack of well-developed supply base in Mexico is supported by the head of Nissan Mexicana, who was quoted recently as saying that the company is now emphasizing improvement of the Mexican supply base in terms of quality, cost, and delivery. The fact that many of Nissan's Tier Ones in Mexico are divisions of Asian or U.S.-based companies that tend to import parts and components is viewed as an impediment to Nissan's ability to maximize the benefits of the low-cost location. And, of course, when an OEM turns its attention to that kind of issue, the pressure begins to cascade down through the Tier Ones to the lower-tier suppliers.

This can create a difficult spot for a supplier to be in, for a variety of reasons. One reason is that it is not universally true that it is cheaper to produce parts in Mexico than in the U.S. Raw data on labor rates can be appealing--one source says that direct labor hourly rates range on average from $1.87 up to $2.57, and that graduating engineers in Mexico start at salaries of $15,000, while their experienced counterparts command $25,000 to $35,000. Detailed analysis by efficient, automated U.S. processors, however, indicates that parts can be produced more cheaply here.

Freight savings can be a primary driver of the pressure, at least from the Tier Ones, aside from any desire to raise the level of the Mexican supply base. "Our customer wants us to be in Mexico for better total cost, because of lower logistics. It would give them a comfort level to have us there," one company told us. The problem for suppliers serving multiple demanding customers in Mexico is that, "Mexico is a big country. Our customers are spread out--some are on the west coast, others are in Mexico City. That's 800 miles apart. Customers want us to put plants there, but it would take three of them."

So, as always, the perennial challenge for automotive suppliers is how to meet customer needs and expectations in a way that still bears in mind the supplier's own best interests. Part of the original thinking on NAFTA was that it would lead to equilibrium at a different, smaller level of pay disparity between the U.S. and Mexico. If that had been the case, perhaps the current debate about how to handle illegal immigration would not be so acute. While decisions on how to address operations in Mexico will be challenging for individual U.S. companies, it will be to the overall benefit for both countries if there are rising opportunities for automotive employment in Mexico.

Melissa Anderson

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Melissa Anderson, Vice President, IRN, Inc.