Following the Big Boys to Mexico

March 20, 2012
For many smaller manufacturers following the bigger clients and building OEM relationships may be the safest -- and sometimes most successful -- entry strategy.

Note: Article originally appeared in the Economist Intelligence Unit as found on Business without Borders

"The infrastructure in Quertaro is every bit as good as in Oklahoma," says Bill Emery, CEO of Southwest United (SU), a $40 million company providing metal processing services to bigger aerospace manufacturers. In 2009, the firm made its first foray into an emerging market, forging a joint venture with Mexico-based Galnik, a supplier of aerospace plating services. The quality infrastructure was a nice surprise, but SU was drawn to Mexico by something more: thriving clusters of original equipment manufacturers (OEMs) and suppliers created by global aerospace clients coming into the country.

Mexico's aircraft manufacturing has become one of the country's biggest growth areas. This is partially attributed to Mexico's proximity to the United States and Canada, which together represent 60% of the global commercial aircraft market, according to the local Aerospace Industry Association (Femia). To date, national and foreign direct investment has totalled about $13.5 billion from over 240 companies, including Aernnova, Bombardier, Cessna, Eurocopter, Hawker Beechcraft and Messier Dowty.

Femia estimates that between 2010 and 2011, total sales in Mexico' aerospace cluster increased by 25% to $4.5 billion. And given that the world's commercial airline fleet is typically over 18 years old, over 20,000 planes will need replacement within the next ten years, so further opportunity beckons.

For some companies, the decision to set up a new emerging market facility was relatively straightforward. Qubec-based Heroux-Devtek (HD), a $360 million manufacturer of aerospace and industrial products, made the move after prompting from some of its biggest clients. But Deshaies adds that companies need to make sure they have the order flow before making a big investment: "If you are an SME that runs from one purchase order to another, it would be hard to justify setting up in the emerging markets. Indeed, the firm's plans to build a facility in Quertaro came on the back of a multi-year contract with Bombardier. It is also pursuing contracts with other clients, with two deals in the pipeline.

Seeking Shelter

When it did enter Mexico, HD opted for a green-field site for its US$20 million investment. Now under construction, the plant will start producing parts by end-2011, with an initial workforce of 40 employees but with capacity for up to 150. It will offer full services -- everything from engineering to manufacturing, assembly, testing and certification -- for aero structure components and assembly, with scope to branch out into landing gear over time.

Several factors prompted HD to go it alone. Time, for starters: the company's interest in Mexico was piqued in 2007, before plans were put on hold due to the 2008-09 recession. During that time, Deshaies travelled frequently to Mexico to understand local operating dynamics. Bigger clients and suppliers already established in the country provided him with a list of "the best" contacts from engineering and construction firms to build the plant to a headhunting firm to build the team. The local state government and Mexicos aerospace university (founded in 2007 as part of the government's strategy to foster the sector's development) were also supportive, with the latter providing specific training needs.

But while these factors helped HD go it alone, they are not always available. A shelter company -- a local start-up service provider that helps handle everything, from administrative and legal support to human resources -- may be a safer bet for some businesses. Complex logistics and Mexico's cumbersome temporary import and export regulations can be challenging for newcomers. For example, businesses can take advantage of Mexico's IMMEX program, which allows temporary duty-free imports from around the world for up to 18 months, if they transform or repair materials into finished goods in Mexico. However, businesses are also required to document the import and export of raw materials and the final products. If they fail to do so, firms face penalties, with cumulative charges added every 15 days.

"Many SMEs make the mistake of hiring a junior export/import clerk or customs broker; then a government audit occurs and the SME finds itself liable for stiff fines and needs a lawyer to sort it out," explains Humberto Santiago, head of Femia's northwest region and president of Tighitco Latinoamerica, a $100 million aerospace supplier with operations across Mexico that provides parts such as sheet metal components. "Shelter companies are well-versed in Mexico's complex import/export environment. They may be expensive but offer a lower risk."

Successful Partnerships for Successful Ventures

For Southwestern United, a local joint venture partner made all the difference. The company had received invitations from customers such as Bombardier, Messier Dowty and HD to come to Mexico, but it wasn't until SU had reassurance that it could navigate the challenging environment that the company decided to take the plunge.

"In Quertaro, the local government introduced us to Galnik, a family-owned business offering coatings to automotive and appliance manufacturers," explains Mr. Emery. The two companies had a strategic fit: Galnik knew the local environment and understood the chemical processes for coatings, while SU brought the know-how and contacts in aerospace. SU also held an important trump card in the form of capital. Access to finance for smaller businesses in Mexico is difficult and expensive, so SU, which owns 80% of the venture, helped stump up the necessary capital.

Owning the majority share gives SU control of the venture's board, while daily operations are overseen by Galnik's executives, supported by a steady stream of SU executives who regularly fly south. These trips have helped deepen understanding of the advantages that Mexico offers, including the country's developing engineering talent. "They are as capable and comparable to engineers you will find in the U.S. or Canada," says Mr Emery, a sentiment shared by others. They also provide a significant cost advantage. Wages for a quality machinist in the U.S. or Canada range between $20-50 an hour, compared with $25 per day in Mexico.

As Mexico's aerospace clusters continue to develop, the case for joining the ecosystem becomes more compelling. And for many SMEs sitting on the fence about investing in an emerging market, following the bigger clients and building OEM relationships may be the safest and sometimes most successful -- entry strategy.

See Also
Nearshoring Fuels Mexican Manufacturing Growth

What to Consider When Nearshoring in Mexico

Innovative Skilled-Labor Solutions in Mexico

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