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Mexico: The Next Manufacturing Powerhouse?

As China’s cost advantages continue to erode with its increasing wages and fuel costs, the trend of nearshoring surges in popularity. North American manufacturers have started to include Mexico in their supply chains to achieve operational efficiencies such as speed to market, lower inventory costs, and fewer supply disruptions. As a result, Mexico’s manufacturing industry has gained tremendous momentum in recent times and industry experts often cite Mexico as ‘China of the West’.

The Changing Global Manufacturing Landscape

“There is always a better strategy than the one you have; you just haven’t thought of it yet” – this quote from Sir Brian Pitman, former CEO of Lloyds TSB, captures the dire need for companies seeking to gain competitive edge. In the current business environment with shrinking profits and increased competition, companies are under tremendous pressure to gain operational efficiencies.

More than a decade ago, when in 2001 China joined the World Trade Organization, it changed the dynamics of the global manufacturing industry. It became the safe haven for manufacturers across many industries and geographies due to significantly lower wages it offered as well as the abundant workforce. However, more recently, with sharp wage and energy cost increases, declining productivity, as well as unfavorable currency swings in China, the global manufacturing industry is witnessing another paradigm shift, as outsourcing production near home has gained popularity amongst North American companies. The economic growth, skilled labor force, proximity to the US market has allured firms to open up their manufacturing operations in Latin America region. Companies are investing billions of dollars into new production capacities in Latin America to serve their North American markets. In 2011, Gartner predicted that by 2014, 20% of Asia-sourced finished goods and assemblies consumed in the USA would shift to the Americas. Although, the entire Latin American region has witnessed an influx of investments, Mexico seems to have outperformed its peers.

Why Mexico? Why Now?

Mexico received a record US$35.2 billion in foreign direct investment (FDI) in 2013 from various countries, of which 74% was directed towards the manufacturing sector. According to a 2014 AlixPartners study, Mexico continues to be the top-choice for North American senior executives from manufacturing-oriented companies to outsource. So what has suddenly attracted manufacturers towards Mexico?

On the one hand, labor costs have seen a sharp rise in China over the past 7 years. Wage inflation has been running at about 15-20% per year and this trend is expected to continue in the coming years. The tax incentives offered by the Chinese government for foreign companies are diminishing, while local energy costs and costs of shipping goods back to the USA continue to increase. As per AlixPartners’ 2013 estimates, by 2015, manufacturing in China is expected to cost the same as manufacturing in the USA. Additionally, going forward, China is set to be more focused on catering to the rising domestic demand, as its domestic businesses grow and consumers are strengthening their purchasing power. These factors have made North American companies to re-think their outsourcing strategies, previously heavily linked to China-based manufacturing. Mexico seems to have seized this opportunity and started to reap the rewards by establishing itself as a lucrative manufacturing hub.

On the other hand, a dramatic improvement in cost competitiveness is driving Mexico’s manufacturing industry growth. Mexico government’s economic reforms, sound policy framework, and investments in infrastructure have boosted investor confidence and attracted several corporations to open their manufacturing operations in Mexico. According to BCG’s Global Manufacturing Cost-Competitiveness Index of 2014, Mexico has positioned itself as a rising star of global manufacturing. Besides having a growing aerospace industry, the country now has positioned itself as a major exporter of motor vehicles, electronic goods, medical devices, power systems, and a variety of consumer products.

Including North America Free Trade Agreement (NAFTA), Mexico has more free-trade agreements than any other country in Latin America. For manufacturers, this results in ease of doing business as well as a range of tax and financial benefits. Additionally, lower wages and energy costs offered by Mexico, strengthens its prospects as an outsourcing destination for North American manufacturers. Mexico is US’ third largest trade partner and has seen its exports to the USA increasing from US$51.6 billion in 1994 to US$280.5 billion in 2013, an increase of a whopping 444%.

US Imports from Mexico

 

The mass consumerization of IT, increased competition, and changes in consumer behavior are forcing companies to develop and deliver products at a faster pace than ever before. Manufacturers need to streamline their supply-chain operations in order to be more agile and customer-centric. Mexico’s proximity to the US market makes it compelling for North American companies to nearshore their manufacturing as this can drive transport costs down, increase their speed to market, and reduce inventory cost. Besides, it helps them to avoid supply-chain disruptions and serve the markets better by reducing shipping lead times, ensuring on-time deliveries to customers, and responding faster to customer issues.

In the past few years, North American aerospace companies such as Bombardier, Cessna Aircraft, Honeywell, General Electric, Hawker Beechcraft, and Gulfstream Aerospace have all developed major operations in Mexico. In the electronics industry, 2014 figures from BCG show that Mexican exports of electronics have more than tripled to US$78 billion from 2006 to 2013. This has also attracted the eyes of Asian electronic giants such as Sharp, Sony, Samsung, and Foxconn who invested heavily in Mexico as a part of their outsourcing strategy to effectively serve their North American markets. In 2013, they account for nearly one-third of investment in Mexican electronics manufacturing.

In the automobile sector, Mexico today is the world’s fourth largest exporter of light vehicles. On top of Ford, General Motors, and Chrysler’s significant investments towards manufacturing facilities in Mexico, the country is now gaining traction from the likes of global players such as Nissan, Honda, Toyota, Mazda, BMW, and Volkswagen. By investing in Mexico, all companies have committed to establish or strengthen their manufacturing capabilities there. According to IHS’s 2012 estimates, by 2020, Mexico will have the capacity to build 25% of the vehicles remaining on roads in North America.

Why manufacturing companies are running to Mexico with their manufacturing needs makes perfect sense due to its cheap and well-educated labor force and the proximity that can provide companies a strong supply base to cater the North American markets. Combining these factors with the rising middle-class population and increasing consumer spending across several South American nations, offers manufacturers a strong value proposition not only to use Mexico-based manufacturing to support their established North American markets, but also to penetrate and grow its customer base in emerging South American markets.

Challenging Times Ahead

Despite Mexico’s emergence as a leading destination for manufacturing nearshoring, there are certain pain-points that need to be addressed. Mexican government lowered its growth projections for 2014 after a disappointing economic performance during the first quarter of the current year. As reported by Bloomberg in May 2014, the economy is struggling to re-bound from 1.1% growth last year and many analysts predict the growth to be extremely modest in the short term.

Security concerns top the list of worries due to the nation’s history of drug-related crime and attempts to slip contraband into trucks moving north across the Mexico border. It will be interesting to see how the government plans to keep this under control, and whether these attempts will result in investors’ increased confidence in this market.

Further, despite recent reforms and investments made in infrastructure, there are large gaps that need to be filled. The country has areas with unstable supplies of water, electricity, and gas. In order to compete with the likes of China, and to further encourage the influx of foreign investments, Mexico’s government will have to make continued investments in infrastructure in the foreseeable future.

Additionally, over longer term, as Mexico continues to attract manufacturers from across the globe, leading to growth in manufacturing employment and increase of wages, the country might face a similar challenge to that of China, where labor rates continuously increase over years and cease to be as attractive as they used to be. This can hamper the nation’s competitiveness as a lucrative outsourcing destination. It is now the task for policy makers to develop policies that can enable Mexico to be more than just a source of cheap labor. To maintain good availability of skilled labor both in terms of quality and quantity that can meet the global manufacturing demands is a rather complex challenge.

 

For manufacturers operating in today’s cost-conscious environment, Mexico is becoming their top manufacturing go-to destination to shorten supply chains, cut inventory and logistics costs, and reduce delivery lead times. Although Mexico seems to be on the right path towards establishing itself as the manufacturing hub for the North American markets, it still has a long way to go in order to become the global manufacturing hub. Together with ongoing economic, social, and political reforms, as well as a progressive work environment, Mexico definitely can hope for a bright future as the hotspot for global manufacturing.

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Turkey – When Being ‘The Gateway to Europe’ Wasn’t Good Enough

As with several emerging markets, Turkey’s automotive market slowed down in 2012. The ongoing crisis in Europe limited export opportunities (declined by 8% y-o-y) while domestic economic woes drove vehicles sales down (by 10% y-o-y). Although this came as a setback to the industry, which recorded strong growth during 2009-2011, the industry has bounced back as sales rebounded in the first two months of 2013.

In the last few years, Turkey, to the surprise of many industry experts, has emerged as an attractive automotive production destination. Several international OEMs, such as Ford, Hyundai, Toyota, Renault and Fiat, have set up production units in Turkey, largely to cater to growing domestic demand and as an export hub to Europe. At the same time, leading automotive OEM, Volkswagen, which has a significant presence in Turkey, remains an exception – Volkswagen does not have any plans to establish production capability in Turkey, and this has led Turkey’s Economy Minister to threaten the company with a 10% tax on the company’s imports.

The emergence of Turkey as an automotive production hub has primarily been driven by government incentives and subsidies to this sector. At the turn of 2013, the Turkish government announced incentives to encourage investment in the automotive industry as it targets USD75 billion in automotive exports over the next decade. Salient features of the incentives are as follows:

  • The investment scheme is an extension of a programme launched in 2009 and will offer tax breaks of up to 60% for new investments, up from 30% in 2012

  • Projects eligible under the latest revision include vehicle investments of more than USD170 million, engine investments of more than USD43 million and spare parts projects of more than USD11.3 million

  • Incentives in the lowest band include VAT and customs rebates, employee cost contributions and subsidies on land purchases

Turkey’s path to success as a preferred destination for manufacturing and as a growing automotive market has not been easy. There are several challenges facing the industry that have the potential to severely impact growth and expansion of the sector.

The Challenges

  • Overdependence on Europe for Exports – In 2012, Europe accounted for 70% of Turkey’s automotive exports and the country suffered in 2012 due to weak demand from the continent. As an immediate step to curb the impact of the ongoing Euro crisis, automotive OEMs are expected to shift focus towards the Middle East and North Africa to reduce its dependence on the unstable European markets.

  • High TaxationSpecial consumption tax and VAT raise the domestic purchase price of a vehicle in Turkey to 60-100% of the pre-tax price. For instance, the price of a Ford Focus 1.6 Trend without tax is EUR15,259 in Germany whereas the same vehicle costs EUR11,000 in Turkey. While the German government imposes a 16% tax, making the final price of the car EUR17,700, the Turkish government imposes a tax of 64.6% making the price EUR18,132. In this context, if Turkey becomes a full member of the EU, it will acquire a larger share of the European market because of lower price before taxation. Turkey also has a higher tax on luxury cars compared with the EU while tax on gas is also one of the highest in the world.

  • Resistance from Labour Unions in the EU – Labour unions in EU are against the transfer of automotive production to Turkey while some car producers prefer to move to other emerging economies such as China and India which have experienced rapid growth in productivity.


While automotive OEMs face several constraints in the Turkish market, the opportunities seem to outweigh the challenges. Using Turkey as a production hub to cater to regions beyond Europe, such as Middle-East and North Africa is a potentially significant opportunity for automotive OEMs. At the same time, booming domestic demand should continue driving growth of players such as Volkswagen, General Motors, Ford, Hyundai, Renault and Fiat.

Even though 2012 temporarily put the brakes on rapid expansion, the Turkish automotive industry is expected to remain an attractive destination for manufacturing and a promising market for sales.
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Part I of the series – Mexico – The Next Automotive Production Powerhouse?
Part II of the series – Indonesia – Is The Consecutive Years Of Record Sales For Real Or Is It The Storm Before The Lull?
Part III of the series – South Korea – At the Crossroads!

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Indonesia – Is The Consecutive Years Of Record Sales For Real Or Is It The Storm Before The Lull?

Part II of our Automotive MIST series brings us to Asia – Indonesia, now the second largest South-east Asian automotive market.

Indonesia, South-east Asia’s biggest economy, is now set to become the region’s largest automotive market as well. While Indonesia sold more vehicles than Thailand for the first time in 2011, the land of white elephants made a strong recovery in 2012 and regained its status as the biggest automotive market in the region. This, however, wasn’t enough to take the sheen off the performance of Indonesia’s automotive market in 2012. The country crossed the 1 million mark (vehicles sold in a calendar year) for the first time, surpassing expectations and beating all forecasts. This is the third consecutive year of record sales and represents something of a gold rush for automotive OEMs.

Indonesia achieved GDP growth of 6.2% in 2012 only slightly lower than the 6.5% it clocked in 2011. Over the past decade, its GDP growth has averaged 5.7%, highlighting a positive domestic economic environment. Rising average income levels has created a burgeoning middle class (half of its population of 240 million). Low borrowing costs, rising purchasing power, cheap subsidized fuel, reduced inflation and currency stability have positively influenced the automotive sector. Huge construction projects and mining investment drove the demand for commercial vehicles.

It is no surprise, then, that car-makers are lining up to increase output, with both incumbents and new entrants making large investments to improve their production capacity in the country. The market is currently dominated by Japanese OEMs, with a share of almost 90%. Toyota (along with its affiliate Daihatsu) accounts for almost half of domestic sales, while Mitsubishi, Suzuki, Honda and Nissan are the other important players (in that order).

The Japanese automotive OEMs are on a massive expansion drive in Indonesia – major automotive OEMs and over 50 automotive component makers from Japan committed an investment of about USD 2.4 billion in 2012 to boost production capacity. Car production is expected to increasefrom 900,000 units in 2012 to 1.5 million units in 2015.

  • Toyota Motor Manufacturing Indonesia (TMMI) is building two manufacturing plants at a combined cost of USD 534.4 million to double its annual production capacity to 240,000 units.

  • Suzuki Indomobil Motor, a joint venture between Suzuki Motor and Indomobil Sukses Internasional plans to spend USD 782.6 million to double its annual production capacity to 200,000 units.

  • Nissan Motor plans to invest USD 400 million to increase production capacity from 150,000 to 250,000.

  • Honda Motor is building an automotive plant that would triple its production capacity to 180,000 per year. The plant is expected to be operational by 2014 and create 2,000-5,000 jobs.

  • Astra Daihatsu Motor, a joint venture between Daihatsu Motor and Astra International is spending USD 233.1 million to boost capacity from 330,000 to 430,000 units.

  • Isuzu Astra Motor Indonesia (joint venture of Isuzu Motors and Astra International) and Krama Yudha Tiga Berlian Motors (subsidiary of Mitsubishi Motors) are investing USD 111.1 million and USD 27.8 million, respectively to expand their production capacities.

Other fringe players such as GM, Ford and BMW are also expanding their presence while Tata Motors also recently entered the market.

  • In August 2011, GM announced that it would be resuming operations at its plant in West Java which has been shut since 2005. The company is investing USD 150 million and the plant is expected to be operational by this year.

  • BMW also recently doubled its production capacity through an investment of USD 11.15 million.

The next step up for Indonesia is to come out of Thailand’s shadow and establish itself as an export hub. In 2012, exports accounted for 45% of Thailand’s automotive industry while the corresponding figure was only 16% for Indonesia. After the floods in Thailand in 2011, automotive OEMs are keen on diversifying production and Indonesia has emerged as the manufacturing hub at about the right time for them. Consequently, OEMs have committed over USD 2 billion to expand their production capacities in Indonesia.

Underlying Growth Potential

  1. Vehicle ownership levels in Indonesia are very low at 32 per 1,000 people, compared to 123 cars per 1,000 people in Thailand, 300 cars per 1,000 people in Malaysia and around 460 cars per 1,000 people in developed countries. Hypothetically, to reach the same penetration rate as its neighbouring countries, Indonesia would require additional 108 million cars on the road. Given that Indonesia is the fourth most populous country in the world, the potential is obvious and these statistics fuel belief that despite the record sales, there is significant scope for continued rise in sales. Industry experts forecast annual sales of 2 million cars by the end of the decade and by then the country would have long since overtaken Thailand as the region’s biggest automotive market.

  2. In 2013, the Indonesian government announced the ‘Low Carbon Emission (LEC)’ program to spur the development of eco-friendly vehicles to include hybrid cars, electric cars and ‘Low Cost Green Cars (LCGC)’ – vehicles with efficient fuel consumption. With the automotive industry ready to commit USD 4.5 billion on the project, Indonesia has the potential to be a major player in the LCGC market if the government goes ahead with its promise to provide tax incentives and other support for the production of these LEC vehicles. The project will completely change Indonesia’s position in the global automotive industry and may also transform the landscape of the domestic industry by boosting car sales in the long term. With bigger volumes generated from LCGC program, manufacturers operating in Indonesia could also catch up with Thailand by exporting to new markets, particularly other developing economies.

  3. Over the years, automobile manufacturers have been notorious for their penchant to establish production set-ups close to component suppliers – to the extent possible. Indonesia has now reached a stage where it has a substantial base of local component suppliers, making the country an even more attractive destination for vehicle production, and with OEMs now planning production expansion in the country, this should further stimulate growth of the components industry.

The Challenges

The success story is not without its woes though. The economic meltdown in Europe and critical challenges in the domestic market will potentially slow down growth if not addressed timely and properly.

  1. Fuel Subsidy – The Indonesian government wants to reduce the fuel subsidy to free up funds to invest in the development of the country’s infrastructure. The government had planned to increase the fuel prices but the proposal was shot down by the parliament in March 2012. The price increase is, however, inevitable and once the proposal does go through, it increases the total cost of vehicle ownership and maintenance, thereby reducing purchasing power of vehicle buyers. (Read our Perspectives on India’s fuel subsidy struggles: India – Reducing Reliance on Diesel)

  2. Enforcement of Minimum Down-payment – To prevent the risk of a ‘car loan bubble’ the government reduced the Loan-to-value ratio (LTV) to 70% when borrowing from banks to buy cars – essentially forcing buyers to pay more down-payment than before. Loans account for 70% of all new car purchases in Indonesia and although it did not affect vehicle sale in 2012 it is expected to have an impact on sales in 2013.

  3. Dependence on Japanese OEMs – With Japanese OEMs accounting for almost 90% of the Indonesian automotive market, Indonesia is overly reliant on Japan. This became evident during the 2011 earthquake in Japan, when disruptions in supply chain were felt across ASEAN, including Indonesia. Although automotive sales in Indonesia did witness impressive growth, such dependence acts as a hindrance and might hold the country’s automotive industry back from fulfilling its potential in the long run.

So, is the upswing in the Indonesian automotive market for real or is it tempting to deceive again? After sticking with the country as other companies bailed out during one of its periodic meltdowns, Japanese auto OEMs are now benefiting from the consecutive years of record vehicle sales in Indonesia. And the extremely low vehicle penetration rate highlights the huge underlying potential. However, critical challenges remain and the country must tackle them effectively if it wants to become the preferred manufacturing hub in the ASEAN region.

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We study the South Korean automotive market in our next discussion. Being the most developed automotive sector amongst the MIST countries, we try and understand the underlying growth potential in this Asian giant and evaluate the challenges faced by OEMs and component suppliers.

Mexico – The Next Automotive Production Powerhouse? – read the first part of our MIST series.

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