Verne McPherson, the President and Owner of Tolerance Masters (TM) in Circle Pines, Minnesota, was in a pickle midway through 2004. “We manufacture complex, sensitive machine parts for the aerospace industry,” he says, “but we still grind metal. The companies we sell to were concerned about our costs and how they affected them.”
TM had cut virtually all its production costs to the bone. The only thing left was labor. To survive he had to investigate outsourcing — and fast.
One of his customers, a subsidiary of United Technologies, “induced” McPherson to consider outsourcing, and he learned about the Mexican maquiladora program. Little did he know that his decision to outsource would quickly generate 30 percent growth for TM and produce a modest raise for his US employees.
Jane Biddle, Vice President of global manufacturing research for Aberdeen, says consolidation in many of the original equipment manufacturing (OEM) industry sectors places small and midsize firms like Tolerance Masters at a distinct disadvantage when compared to global competitors. “Improving financial performance now dominates the small manufacturer’s agenda, especially costs,” she says.
“I didn’t want to offshore,” McPherson confesses. “But if I didn’t find a way to blend labor rates, I’d go out of business and all my jobs would likely leave the state anyway.”
Tim Minahan, Aberdeen’s Senior Vice President of value chain research, addresses the core of McPherson’s emotional dilemma: fear of failure vs. fear of losing control. “With outsourced manufacturing, enterprises trade one kind of investment with another. Instead of owning and optimizing assets, they often find their attention shifts to owning and optimizing relationships.”
And McPherson was also concerned about his lack of general offshore and specific Mexican knowledge. The questions swirled: “How do I do business with the government? What’s the effect to my supply chain? What about obligations to my offshore workers?” The clock was ticking. He needed a patron. At this strategic time he was introduced to The Offshore Group (OG) of Tucson, Arizona, and quickly discovered that successfully negotiating the maquiladora path before him, if traveled alone, was dubious at best. Not only were the goods he made affected; so too were business processes, distribution, and operations management.
What McPherson saw confirmed his need to partner with an outsourced “shelter partner” to provide integrated manufacturing support services and manage the intricacies of TM’s Mexican operation. As 2004 turned to 2005, he signed a service level agreement with The Offshore Group.
Mature Outsourcing Borne From NAFTA
TM’s needs precluded distant shoring because McPherson needed a workforce capable of more sophisticated assembly tasks. He felt Asia-Pac countries didn’t yet have the ability to do this complex work to his customer’s satisfaction. Nor did he have the volume that might attract China. “Even if they were interested, the distance is just too big a logistic burden.”
The Offshore Group is one of a small handful of Mexican government-recognized maquiladora licensees that has served as American (European and Canadian) OEMs’ “man on the ground” for its partners, both from its Tucson headquarters and its three production campuses in Mexico.
It partners with medical device, electronics, aerospace, automotive, and optics OEMs to reduce overall costs and limit expenses and risks arising from the establishment of a Mexican subsidiary. The Offshore Group does this by providing HR, facilities management (and development if necessary), payroll and benefits, on-site medical care, supply chain logistics and distribution, environmental services, and assistance in Mexican government and community affairs.
In addition to a growing number of small-to-medium OEMs, OG has relationships with giants such as Delphi Automotive, Medtronic, Parker Hannifin, GE, and Tyco Electronics.
“Time has proven that not harnessing a licensed shelter group could mean years for a foreign manufacturer to realize profits from Mexican offshoring,” says Steve Colantuoni, Director of Market Research for the Offshore Group. “The opening government certification phase alone can take the OEM up to a year, or more if done alone.”
There are numerous challenges to starting a manufacturing operation in Mexico, says Miguel Hernandez, General Manager of Outsourcing Group’s Saltillo campus. “But we can cut a typical 12-18 month total process down to that many weeks.”
“And then there’s the cost of maintaining a presence, which can be very capital intensive,” adds McPherson, who began production four months later in March 2005, “especially if you don’t know the ins and outs unique to Mexican business and culture. Customs alone can be scary.”
The benefits for OEMs can be numerous, including, but not limited to, realizing high engineering requirements, more sophisticated products, less reliance on expensive automated processes, and better just-in-time production and delivery management due to Mexico’s proximity to the US. Normally there is negligible negative impact on the supply chain.
Multiple Partnership Benefits from Maquiladora Relationships
History has shown that outsourcing to Mexico (or any offshore destination) is cash-intensive, especially in the beginning. For McPherson, this is where the partnership features of a maquiladora service shelter were critical. Because some of OG’s revenue originates from Mexican sources (government rebates, employee service fees, and other tertiary streams), the company often uses this income as financial leverage to fund partners’ quick start-ups, with the provider recouping the money later.
“We pay the government fees and most of the initial costs assumed by the OEMs, knowing we’ll get it back in the long run through the service fees they pay us,” says Colantuoni. “So we have to be diligent in picking our partners because they directly reflect our bottom line. They have to commit to this program too.”
The cost savings for an OEM through a maquiladora service shelter can be profound; in Tolerance Master’s case, a bit more than half of what a similar unit produced in McPherson’s Minnesota plant costs after factoring transportation, government and customs fees, employee wages and benefits, and back-office management.
TM’s raw materials go through Tucson to his plant in Guymas, Mexico, and the finished goods pass through Mexican customs into OG’s Arizona distribution hub, then on to its customers. “The integration of all these services makes it easier for us, plus we have virtually no liability in Mexico,” adds McPherson.
Aberdeen’s Minahan suggests outsourcing relationships that collaborate across the entire value chain work vigorously to streamline the product development process, improve manufacturing capability, reduce product cost, and improve responsiveness to demand. “OEMs that fail to grasp these important concepts, regardless of where they outsource, will find their manufacturing strategy is not very valuable,” he concludes.
Sophisticated Mexican Goods, Lightning Speed-to-Market
Mexico is no longer the only source for cheaper labor, says OG’s Colantuoni. “But the trick for us is to identify the higher-end OEMs that fit Mexico’s profile and will benefit the most. And our cultures mesh better than the distant providers,” adds Hernandez. But just as significant a driver comes from McPherson. “American business law is much closer to Mexico than China, so our intellectual property is better protected. Some of our products go into US military aircraft, so that was a point we had to consider.”
The qualified employees McPherson found in Mexico produce high-quality parts. And he says his supply chain quickly began moving at virtually the same pace as when all of TM’s products came from Minnesota. Today, almost a year after start-up, 20 percent of his workforce is now in Mexico and his “just-in-time” supply chain is humming efficiently.
“In the old days, OEMs built to order. Now they build directly to stock,” says Aberdeen’s Biddle. “They have to anticipate what customers will order, then produce it only when the orders come in. This puts tremendous pressure on the supply chain that outsourcing partners must be sensitive to.”
The maquiladora industry contracted about 20-25 percent between 2000 and 2003 as many of the lower-end manufacturers flocked to the far shores. But lately, it’s begun a gradual rebirth. OG’s activity has risen 18 percent during that period because the offering is transforming, according to Hernandez. “We see fewer low-end OEMs and more advanced manufacturers coming down that require more sophisticated workers. This is why we continue to compete.”
While considering his maquiladoran outsourcing venture, McPherson was warned by a contemporary that the process would be arduous and protracted. “He did it alone and it took eighteen months to get up and running. I did it in four. The day we began production, I called him from the floor at the Guymas plant. He heard the hum of my machinery over the phone and couldn’t believe it.”
Lessons from the Outsourcing Journal:
- Total savings to sophisticated OEMs through maquiladora shelter service outsourcing providers can be as great as two-thirds off typical American manufacturing and delivery costs.
- By sharing time zones with the US and Canada, Mexican manufacturing outsourcers shorten transit time within the supply chain and make “just-in-time” delivery more attainable.