Nearsourcing is the Next Best Thing to Reshoring

May 8, 2014
China growing more expensive but can't justify a return to the U.S.? It's time to consider nearsourcing in Mexico.

The basic definition of nearsourcing is to source outside your own facility, but within your own region and not on the other side of the globe. Nearsourcing may have a different meaning depending on the region in which you are located in the United States. For the purposes of this article, the definition of nearsourcing means sourcing in Mexico, which is the meaning understood in California and in other states along the international border with Mexico.

As much as it is would be desirable for all the manufacturing we lost to offshoring in China to return to the United States, it is an unrealistic expectation in the global economy. As logistics costs continue to increase worldwide, sourcing regionally will become the most reasonable course of action for companies with a global market.

Although reshoring through returning manufacturing to America is gaining momentum as wages and logistics costs rise in China, there is still a substantial cost differential for high volume and/or high labor content products. What is a good solution to this problem? Nearsourcing to Mexico may be the right answer.

Nearsourcing to Mexico by U. S. manufacturers began in the 1965 after the “maquila program was initiated in 1965 during the Diaz Ordaz presidency as a means of attracting foreign investment, increasing exports, and fostering industrialization along the U.S./Mexico border.” By the mid-1980s there were thousands of maquiladoras in cities along Mexico’s border with the U. S. Some of my first customers when I started my rep agency in 1985 were maquiladoras owned by U. S. corporations in Tijuana, Baja California, Mexico.

For many years, Americans crossed the border to work in the maquiladora plants as engineers, purchasing agents, department heads and plant managers, but gradually Americans were replaced by Mexican nationals, first the engineers, then purchasing agents, then department heads, and more recently as plant or general managers.

Prior to NAFTA, all production that was generated in the Mexican plants had to return to the country of origin or had to go to a third country. During the first phase of NAFTA from 1994-2000, the maquiladoras continued to benefit from the waiver of Mexican import duties on raw materials while also benefitting from the preferential duty rates on those products that satisfy NAFTA rules of origin. Since then, duties on raw materials that originate in non-NAFTA countries increased, but not as much as originally anticipated.

During the second phase of NAFTA, changing rules made it gradually more difficult to sell to the maquiladoras because persons wishing to conduct business at maquiladoras had to purchase a FN certificate (by the day or year), provide written proof of an appointment, and within a few years, have a passport. If a company was caught having a visitor that didn’t have written proof of an advance appointment, the company was fined. Thus, it became illegal to do what is called “cold calling” on prospects without an appointment.

Recession Hits Maquila Industry Hard

The maquila industry was hit hard by the U. S. recession of 2001-2002, and hundreds of maquiladoras closed along the border. Since I read, write and speak Spanish, I subscribed to a maquila industry newsletter. Every issue was filled with names of companies that were closing plants in Mexico. Many foreign companies in Tijuana abandoned the equipment in their plants to be sold in auction to pay benefits to the Mexican government for employees that had lost their jobs when the plants closed. I had a business acquaintance who survived the U. S. recession by acting as the Mexican government’s representative to handle the auctions.

The recession coincided with China becoming part of the World Trade Organization and the beginning of the trend to move manufacturing to China. Many U. S., Japanese and Korean companies chose to move manufacturing to China rather than resume manufacturing in Mexico. The effects of the recession of 2008-2009 were not as severe as the previous recession on the maquila industry, but it meant that it took nearly the whole decade of the 2000s for the maquila industry in the Baja California, Mexico cities of Tijuana, Tecate, and Mexicali to get back to the level of manufacturing they had in the year 2000.

In my opinion, the San Diego region lost less manufacturing to China than other parts of California and the U.S. because so many regional manufacturers already had long-established plants in Tijuana and Mexicali and didn’t see enough cost savings to move manufacturing to China. This was aided by the fact that San Diego’s manufacturing industry has always had more high-mix, low-volume products than either Silicon Valley or the Los Angeles region.

There was one industry that could not move manufacturing to China and that has remained especially strong in Baja California: the aerospace and defense industry. According to the report “Aerospace & Defense Manufacturing in Mexico,” released in August 2013: “Mexico is home to more than 260 aerospace manufacturing facilities and a 31,000 strong, highly-skilled direct industry workforce.” Major U. S. defense companies such as BAE Systems, Lockheed Martin and Delphi established plants in Mexico during the late 1980s and early 1990s. Baja California leads with 28% of Mexico’s aerospace and defense industry exports, and Baja California has the only Binational Aerospace Cluster in Mexico. 

“Mexico currently attracts 5% of the total number of licenses granted by the State Department of the United States for the production of dual use goods and technologies.” Mexico has been proactive in pursuing more aerospace and defense business by joining the Bilateral Aviation Safety Agreement (BASA) between the U. S. and Mexico, the international Wassenaar Arrangement (WA), and the Nuclear Suppliers Group.

Some of San Diego’s aerospace and defense industries that have manufacturing plants in Baja California include: BAE Systems, Cubic Corp., Gulfstream, Lockheed Martin and UTC Aerospace Systems. Other U. S. aerospace and defense manufacturers in Baja California are Delphi Connection Systems, Eaton Aerospace and Honeywell. The state of Queretaro, a few hours south of Mexico City, is home to such companies as Bombardier Aerospace, GE Infrastructure, ITR, Curtiss Wright and Eurocopter.

Under NAFTA, the Buy American Act requirement for the U. S. Department of Defense to purchase products that contain a minimum of 50% U. S.-produced content is waived, so defense and aerospace companies are allowed to purchase products made in Mexico and Canada.

Also, under “the Manufacturing, Maquiladora and Export Service Decree, the IMMEX program allows for goods, raw materials and components to be imported into Mexico on a temporary basis, duty-free and VAT-free, as long as they are returned abroad within the established timeframes (most are 18 mos).”

In addition, a Special Aerospace Tariff Section 9806.00.06 “allows for free imports to assemble and manufacture aircraft or aircraft parts when companies have the Certificate of Approval to Produce issued by the Ministry of communications and Transportation.” Section 9806.00.05 allows “goods for repair or maintenance of aircraft or aircraft parts…to also be free of tariffs and have administrative advantages for companies.”

When is Nearsourcing the Right Decision?

You may ask when nearsourcing is the best decision if you cannot achieve enough cost savings to return manufacturing to the U. S. It may be the best decision in the following cases:

  • Proximity to U. S. customers is important
  • Product labor content is between 20-30%
  • High mix, variable products, mid-volume production
  • Intellectual Property protection is important
  • Faster delivery/responsiveness than from Asia
  • Product has substantial U.S. part content
  • Mexico/Latin America are key markets
  • NAFTA benefits fit your products

For California manufacturers, especially in southern California and San Diego, the main advantages of nearsourcing in Baja California compared to China and other parts from Asia are:

  • Right across the border from San Diego
  • Minimal Intellectual Property risk because of strong Mexican Intellectual Property laws
  • Labor costs are now 14.6% cheaper than China
  • Lower utility rates
  • Direct connection to major transportation centers
  • Industrial real estate lease rates that are 1/3 less than China
  • Mexico’s workforce is highly skilled and educated
  • Low average turnover rate of 2.6% reported in 2011
  • Mexico graduates more engineers/year than U.S. (about 115,000 vs. about 50,000)

As a strong advocate for American manufacturing, I want as much as manufacturing as possible to reshore to create more good paying jobs in order to rebuild our middle class. However, I would rather see U. S. companies nearsource parts in Mexico than source them halfway around the world in China. The Mexican government isn’t using the U. S. dollars they gain from our trade deficit to build up their military, and Mexico doesn’t have any nuclear missiles aimed at the U. S. as does China. It is an advantage to our country if Mexico creates more good-paying jobs in the manufacturing industry to grow their middle class. To me, nearsourcing to Mexico seems like a win-win solution for strengthening the middle class of both countries.

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