The Challenges with Near Sourcing from Mexico

Here are 11 reasons why U.S. companies are finding it so difficult to use Mexico as an alternative sourcing partner.

In the wake of tariffs in 2018 followed by Covid in 2020, 2021, 2022 … most of the manufacturers who relied on China and other Asian countries for their products have been forced to reconsider their sourcing strategy.

How?

By looking to Mexico as their primary sourcing agent. For U.S. manufacturers, this near-sourcing solution seemed like a great problem-solving strategy – and it was.

Until it wasn’t.

That’s because developing Mexico as a near-sourcing strategy has been another story. In fact, for too many Fortune 500 companies, it’s proving to be far tougher than expected.

Here are 11 reasons why:

1.) Tier 2 Supplier Development

In the 1980s and 1990s many OEMs, especially for the automotive and appliance industries, set up manufacturing Mexico. They also required their Tier 1 suppliers to set up manufacturing operations across Mexico.

Since then, these Tier 1 suppliers have grown substantially, becoming large-scale integrators and assemblers in their own right. And, as they have been divesting their manufacturing plants and businesses, they, too, have been outsourcing many of their component manufacturing and small assembly work; this time to Tier 2 and 3 suppliers, such as Magna, Black & Decker, Whirlpool, and others.

Right now, however, the network of Tier 2 and 3 suppliers in Mexico is not as well developed across most commodities and processes, including injection molding, iron foundries, die casting and forging. This means that Mexican suppliers remain under-invested.

2.) High Cost of Capital

It’s a fact: Business lending in Mexico is stringent and collateral-based. Interest rates have ranged from 3.5% to 8.5% over the last 10 years and many of the asset-based loans in Mexico are in U.S. dollars.

The exchange rate for Mexican pesos, on the other hand, has ranged from 12 to 25.5, adding more volatility in interest and principal payment schedules. This means that small- and medium-sized businesses typically will have a difficult time getting loans in Mexico at favorable terms.

3.) Collateral for Loans

In our research here at MES, we’ve found that most of the banks in Mexico simply will not lend to businesses that don’t have Mexico-based land, buildings, savings accounts as collateral. Even our organization, a multimillion-dollar U.S. company founded in 2004 with a strong company presence in Mexico, was unable to get a simple quote for a loan. Why? Because we do not own buildings in Mexico.

4.) Uniform Commercial Code (UCC) Filings

The UCC is a comprehensive set of laws that govern commercial transactions in the U.S. It is not a federal law, rather it’s a uniformly adopted state law. UCC is widely regarded as the “backbone of American commerce” because it allows lenders and banks to freely loan money to manufacturers, registering which assets are available in case the manufacturer or borrower goes bankrupt.

No U.S. or Canadian bank will loan for any assets, receivables, or inventory being held in Mexico. In fact, U.S. lenders will not even allow a manufacturer to lease equipment that’s being operated in Mexico. This is because the Mexican government does not have an equivalent to UCC filings. In other words, in case of default, the U.S. lender cannot claim the assets that they borrowed against.

This makes it very hard for U.S. manufacturers to borrow and to put assets in Mexico. And unless they’re publicly traded companies or have secondary financing from private funds, this often stops U.S. manufacturers from investing in Mexico at all.

5.) IMMEX/Maquiladora Certification

IMMEX is Mexico’s program that allows for the temporary import of goods and services so they can be manufactured or assembled in Mexico, then exported without payment of taxes.

Many Tier 2 and 3 suppliers with good capabilities do not register themselves for IMMEX. Unfortunately, this is short-sighted on their part, but done primarily to avoid labor audits, VAT tax filings, and to circumvent following some of the safety and environmental requirements.

While these suppliers may have good technical capabilities, most North American customers avoid using them.

6.) Payment Terms

It’s common for Fortune 500 companies to have payment terms of 60+ days. That’s because OEMs and Tier 1 companies have sophisticated spend and purchasing processes. Unfortunately, their Tier 2 and 3 suppliers do not. So, Tier 2 and suppliers often struggle with the demand for longer payment terms.

7.) Supplier Agreements

Most of the large OEMs and Tier 1 suppliers require their smaller suppliers to sign tenuous and imposing supplier agreements, penalizing them for late or early delivery, quality defects, and quality incidents. Tier 2 and 3 suppliers are usually very concerned about taking on those types of performance responsibilities – so they don’t.

8.) Product Liability Coverages

Many customers require suppliers to have product liability coverages from $1-5MM USD. These insurance policies cost upwards of $50,000 annually, so most smaller suppliers will not commit to them.

9.) FCPA

Publicly traded companies require their suppliers to sign and implement Foreign Corrupt Practices Act (FCPA) statements. Smaller suppliers are often reluctant to sign those policies focused on Anti-corruption and Anti-bribery requirements.

10.) Labor Policies and Cost Hikes

The Mexican government has been rather labor friendly with double-digit minimum wage increases over the past 6 years. While minimum wage in Mexico is still lower than in the U.S., many established companies find it difficult to attract and retain labor. This is especially true in highly industrialized towns with competing job opportunities, such as Juarez, Monterrey, and Tijuana.

As such, many Tier 2 suppliers have adopted robotics, thereby nullifying the labor cost benefits achieved in Mexico. Plus, the United States-Mexico-Canada Agreement or USMCA is expected to put further pressure on domestic content and labor cost policies.

11.) Warehouse and Office Rental Expenses

In our research for 3PL services as well as in comparing warehouse costs near our headquarters in Ohio with Monterrey, Mexico, we found that leasing rates for buildings were higher in Monterrey. Electrical and utility rates also are higher than in the U.S., restricting the cost benefits in Mexico that were once more obvious.

How can you overcome these challenges?

Finding, developing, and sourcing manufacturing in the neighboring country of Mexico is not as easy as it was even just a decade ago. These 11 challenges are proof of that.

Despite the challenges, however, labor costs in Mexico are still lower than in the U.S. It’s also easier to find workers in Mexico than in most parts of the United States.

So, if you’re looking to de-source China or another Asian country due to long lead times and high shipping costs, MES believes that Mexico still offers the best opportunity to source components, assemblies, and manufacturing capabilities. Contact us to learn more.