How to Make Nearsourcing Manufacturing in Mexico Work for You?

Introduction

With tariffs followed by COVID, manufacturers are under all kinds of pressure to keep up production and maintain profitability while containing costs, and to do so in face of a stunted supply chain. The fact is that things are very different now than they were just five years ago. Sourcing and supply chain professionals are at a crossroads, having to evaluate the options:

• Should manufacturers continue to outsource internationally and risk long lead times and shipping delays?
• Should manufacturers adopt a nearsourcing strategy even though it may increase tooling costs
• Is there another strategy that would allow manufacturers to reap the benefits of both?

This white paper examines global outsourcing and North American near-sourcing strategies to give U.S.- based manufacturers new insights – and options – for doing manufacturing in Mexico right.

Sourcing Strategies

Sourcing professionals are being challenged by engineering and marketing teams to explore alternative options to give manufacturers competitiveness, as well as agility in development and fulfillment.

For sourcing executives of U.S.-based manufacturers, there are two choices from which to choose:

1. Nearsourcing: Produce the product in a U.S.- or Mexico-based facility.

2. Outsourcing: Send production to Asia (China, India, Vietnam, etc.).

Sourcing Has Changed

Since the pandemic, it’s become trendy to bring production back to the U.S. from Asia or, at the very least, to keep it in Mexico. Today, sourcing is marked by rising transportation costs, increased tariffs on production in China, and a push to go (or return) local. There’s an overall climate of “something’s got to change” with outsourcing, which is making it attractive for U.S.- based manufacturers to consider (or reconsider) North American sourcing.

Nearsourcing vs Outsourcing: Which is Better? 

Because sourcing and supply chain professionals are facing a new paradigm, they must consider building more for flexibility and resilience rather than relying on uncontrollable geopolitical factors.

Thanks to a combination of geopolitical uncertainties, tariffs, and a global pandemic, near-sourcing has proven its worth in delivering these benefits:

• Inventory cost savings, including reduced opportunity costs, storage costs, and unsold inventory costs
• Quick response to stock-outs
• Production flexibility and lower machining costs
• Decreased transportation expenses

Outsourcing is not without its own benefits. China, India, and Vietnam offer plenty of advantages to manufacturers, especially when considering fundamental expenses, such as labor and changeover costs, speed of development, and inhouse diversification.

Manpower Cost for Production and Changeover

Asian countries have long had a distinct advantage over the West due to their lower cost of living. They have also built a lot of capacity in manufacturing plastic, metal, and electrical components. Wage disparities are even more significant as specializations increase. For example, while production labor difference between China / Mexico / US is $5.50 / $6 / $15, maintenance hourly labor difference is $15 / $20 / $45.

Bottom line: Asia’s labor costs are hard to beat.

In-House Diversification

If needed, many Asian suppliers, especially in China, can integrate other aspects of parts production, such as providing castings, painting, or machining.

Bottom line: Asian suppliers’ overall production costs tend to be more affordable than outsourcing subprocesses.

The Nearsourcing Advantage

When demand variance is volatile, and transportation costs are high, near sourcing offers unique and significant cost advantages.

Transportation

Global transportation costs via container or air typically add up to a significant cost chunk of the product cost (PC). However, in a regular logistics situation, these costs are almost comparable to trucking for near-sourcing options like Mexico. The bulk of these costs, of course, can be offset and even reduce simply by mixing production parts with other parts, thereby ensuring a full container.

Cost of Overage

The costs associated with excess inventory can be divided into two broad variants:

1. One-time demand: In this scenario, the cost of underage/excess inventory is the cost of the product unsold or, if applicable, the cost of the product less the scrap value.
2. Continuous/regular demand: Demand may vary, but it does not end. In this case, the cost of underage is calculated using such costs as inventory carrying and storage cost, along with a small probability of the product not being sold.

Advantage:

• The ability to produce smaller batches with reduced time between production and sales

 Results:

• A better forecast that helps minimize overage costs

Cost of Underage

The cost associated with less inventory also can be divided into two similar scenarios:

1. One-time demand/production cycle: For underage, this refers to the profit/margin loss resulting from lost demand. Depending on the industry, a goodwill loss also may be added.
2. Continuous/regular demand: In this scenario, this refers to the expediting cost plus the goodwill cost.

Advantage:

• Expediting costs include production changes and local costs only

Results:

• Substantial savings on expediting costs since there are no additional air freight or container expediting costs, plus inland/local costs

Carrying Inventory and Price Comparisons

Nearsourcing shortens the time between production and sales. Unlike outsourcing, which leads to capital being locked in the inventory, near-sourcing helps free up capital.

Because of the aforementioned factors, it doesn’t make sense to only consider the production cost (PC) price. Instead, consider all the costs involved. This is known as the landed cost and is a sum of these costs: production costs, transit costs, overage costs, underage costs, and capital lock costs.

Tooling Costs

All custom components need special tooling to make components. This applies to castings, moldings, forgings, and most other manufacturing processes. Purchasing and engineering teams must launch new tooling before production can even begin. These tooling costs can be significant. Tooling skill and hourly rates for toolmakers in U.S. and Europe are very expensive, with toolmakers routinely being paid $35+ per hour rates.

An observation of the tooling cost in North America would show those costs to be roughly 3X to 5X of the cost of tooling development in Asia. Add in longer lead times of 10-12 weeks in North America versus 6-8 weeks in China, and tooling costs are a major factor for determining both the break-even point and profitability.

A Real-World Example: Monterrey Motors

To meet customer demand, automotive manufacturer Monterrey Motors expanded its available options. Its lineup now includes two engines, four transmissions, a hybrid, and a special electric vehicle (EV) model as evidenced by the following components:

Assumptions

To be clear, Monterrey Motors needed four different tools, rather than one. Their next challenge was to find the break-even point and determine their sourcing strategy.

• A1 and A2 are made on similar tools.
• A2 requires machining.
• B2 and B3 are made on similar tools that require machining.
• C1 and D1 need separate tooling as cast parts.
• Assume all variants have the same cast weight and require similar processes/inputs with similar takt times.
• Since 2 of the 5 variants are machined, the cost of machining is at 38% of actual cost.
• Transportation costs are kept at Dec 2020.
• Jan 2021 levels as current transportation costs are artificially inflated
• Raw material costs are based on Jan 2021 Index (SMM for China, AMM for US and Mexico).
• Tariffs are removed since they are considered an external influence.
• The selling price is at $10.00 and 17,500 units, on average, are sold every month.

Here’s an at-a-glance look at the full set of assumptions:

Landed Cost Comparison

Based on these assumptions, the landed cost (comprised of PC, transit, overage, underage, capital lock) is:

• China: $8.77 (Appendix 1)
• US: $9.09 (Appendix 2)
• Mexico: $8.53 (Appendix 3)

In this example, looking only at landed cost, Mexico would seem to be ideal. It does, after all, have the advantage of lower costs, as well as nearsourcing’s inherent advantages. However, Mexico lacks one thing in comparison to China/Asia: cost-effective tooling manufacturing capabilities.

They, like many, are dependent on other tooling manufacturers, which typically leads to tooling costs running about 4X the cost of China’s. That equates to a very high initial expenditure, which then extends the time it takes to get to the all-important break-even point.

Break-Even Comparison

In this instance, the following breakeven points demonstrate the point at which Monterrey Motors can expect to see net profits:

• China: 7-8 months
• Mexico: 17-18 months
• US.: 24-26 months

If the visual graph of the break-even comparison were extended, it would show that Mexico eventually takes over China in overall costs at about month 38. What this means is that Mexico is a viable option if the project is a long-tail project.

If the visual graph of the break-even comparison were extended, it would show that Mexico eventually takes over China in overall costs at about month 38. What this means is that Mexico is a viable option if the project is a long-tail project.

Another Solution: Tooling in China, Production in Mexico

Perhaps the best approach is to reap the benefits of both by manufacturing the tooling in Asia, then moving it to Mexico for production.

This strategy works especially well when nearsourcing is a requirement, as in the case of high-mix, low-volume (HMLV) projects.  In such instances, manufacturers will want to get a tooling price from a specialized tooling manufacturer, validate the tooling, ship it across the pond to Mexico, then re-validate the tooling and trails at the end production point.

Despite the increase in the initial cost of tooling, this has proven to be a more cost-effective solution over having the tooling built in North America.

Comparing the Alternative
Assuming that each tooling’s landed cost is $60K ($45K to build the tooling, $15K for testing and transit), the break-even point for tooling in China and transporting it to Mexico is 11-12 months, whereas tooling and production in Mexico is 17-18 months.

If the scenario were carried out further, the nearsourcing option – tooling in China, production in Mexico – would surpass the outsourcing option at around month 32. This real-world example demonstrates that combining nearsourcing with outsourcing can keep costs low while enabling a comparatively fast response time.

Conclusion 

OEM manufacturers looking to increase development times, lower upfront tooling investments, and reduce breakeven times can look to good global manufacturers to help them develop tooling in lower-cost countries, such as China, India, and others, and move the tooling to manufacturing suppliers in the U.S. or Mexico.

Both nearsourcing and outsourcing have their advantages and disadvantages, and neither is a one-size-fits-all strategy.

So, even though costs from the U.S., China, and Mexico are somewhat comparable after assuming all associated costs, China’s cost-effective tooling can be a differentiating factor – which is why OEM’s seeking to determine their sourcing strategy will find it imperative to calculate landed cost.

Nearsourcing to Mexico can be a viable option in situations where demand variability is high. Mexico also is a viable option when a project has a long life or when an organization can afford to shoulder long-term returns.

Often, however, speed-to-market is what dictates a sourcing strategy. Projects are typically globally sourced if the product is already well-established in the market.

About the Publisher

MES is an expert in helping manufacturers find global sourcing solutions that are beneficial to them, including providing cost comparisons for having tooling made in China and moved to Mexico for production. MES has been working with the “tool up in China and transfer to Mexico” option since early 2021 when the benefits of producing in Mexico became verifiably clear. This hybrid-style sourcing operation has a medium return time yet offers other benefits in the long run. Because this strategy requires solid planning and stellar coordination efforts, the launch process may require an additional 6-8 weeks for tooling validation and transit to Mexico. MES leverages its vast network of tooling manufacturers in China to build tools, maximizing its logistical setup to transport tooling to Mexico at a considerably reduced cost. For more information, visit mesinc.net or contact an expert at info@mesinc.net.