By Erick Brunet, Managing Director; Samuel Campos, Executive Managing Director; Bob Hess,Vice Chairman; and Gregg Wassmansdorf, Senior Managing Director of NKF Global Strategy
Business expansion opportunities in Mexico are many but not without location decision challenges.
Physically, the country possesses a land area that would cover almost half of the entire European Union’s territory. This large and varied territory is home to almost 130 million inhabitants, more than three times the population of Canada and about 40 percent of the United States. By far the largest metropolitan area in the country is Mexico City with over 20 million people, making it the largest urban region in North America, followed by Guadalajara and Monterrey with approximately 4.6 million people, which makes them similar in size to the Boston and Phoenix metros.
When considering diverse country characteristics and the many factors that drive business location decision-making (sites, utilities, labor market skills, transportation, crime realities and quality of life for personnel, etc.), it becomes clearer that it can be very challenging to select the right place within Mexico that will provide the optimal cost and operational conditions. This article highlights some of the history, regional traits, and factors that are influencing business location strategy in Mexico today.
Mexico’s Economic Emergence and Transformation
In the mid-1960s, Mexico’s economy relied predominantly on natural resources for export income. The next 30 years saw the expansion of the oil and gas industry that became the most relevant industry in the country. For a time in the 1980s, Mexico was the third-largest oil producer in the world.
The next big economic shift in Mexico happened in the mid-1980s when the country began to open its economy by joining the GATT (General Agreement on Tariffs and Trade). This accelerated after creation of the North American Free Trade Agreement (NAFTA) in 1994, which brought Mexico into an agreement that currently governs over 1.2 trillion dollars worth of trade with its most important economic allies: the USA and Canada. NAFTA is currently in the last stage of its modernization: the ratification process by the three countries’ national governments and it will now be known as the USMCA.
Over the last 25-30 years, Mexico has grown to become recognized globally as a powerhouse for diverse industries, including high-labor content sectors and also high-value industries like aerospace and automotive, including manufacturing, R&D, and business services activities.
Various global competitiveness studies conducted in recent years have shown that Mexico ranked favorably − whether based on CEO surveys or operational cost analyses. Project investment is evidence of these findings − such as GE’s Engineering Center (where airplane turbines are designed), or Germany’s Continental automotive R&D Center in Queretaro, or any of the brand name automotive, aerospace, appliance, and other sector manufacturers who have arrived (along with their many suppliers).
Since the early 2000s, the annual number of foreign direct investment (“FDI”) projects in Mexico has roughly tripled in a ten-year period, capital investment has tripled, and jobs created from FDI had quintupled by 2016 compared to 2003. This investment and job creation has been spread across the national economy, with five key sectors of the economy accounting for 40 percent of FDI projects in Mexico − led by Automotive Components, followed by Software & IT Services; Metals; Industrial Machinery, Equipment & Tools; and Transportation.
Capital investment and job creation is location specific. For a deeper understanding, Newmark Knight Frank has divided Mexico into seven main “market regions” that hold similarities in how their governments, labor, and industry groups behave and organize to support sector “hubs” or “clusters”.
The Northwest and North part of the country is famous for the cities of Tijuana, Juarez, and Chihuahua. This border region gained economic traction over the last 50 years with the “Maquiladora” project, which still represents over 45 percent of the jobs in some areas. This program is frequently held responsible for the rapid industrialization of Mexico, especially in high-labor content and low-wage sectors, including electronics and electronic components.
The Northeast region is heavily influenced by Monterrey, which is the country’s largest industrial market with almost 120 million square feet of industrial property and is one of the main contributors to national GDP with around 15 percent of the total. This region hosts some of Mexico’s largest companies like Cemex, FEMSA, Grupo ALFA, GRUMA, and has captured the second-greatest proportion of Mexico’s inbound FDI between 2000 and 2017. This region also includes Nuevo Laredo, a border city with Laredo, TX, which is one of the most heavily used and busiest crossing points for merchandise between both countries.
In the West region one finds Jalisco and the city of Guadalajara, which is called the Mexican Silicon Valley. A vast number of companies have decided to install operations there to develop software, apps, and other digital and tech-related developments. This metro area has a very well-educated population, and a higher proportion of English speaking workers who contribute to the region’s status as the third-largest recipient of foreign direct investment over the last two decades, according to fDi Markets. It remains one of the largest development fronts in the country.
In the geographic middle of the country is the Bajio region, which includes the states of Aguascalientes, San Luis Potosi, Guanajuato, and Queretaro, with some other smaller cities. This “heartland” region has been the location target of many companies and is regularly one of the fastest-growing economic regions in the world. It is here that Nissan, BMW, Mercedes, Infinity, GM, VW, Honda, Toyota, Mazda and others have invested to the point that some call this region the Mexican Detroit. This area combines a skilled labor pool, competitive salaries, transportation access, and high-quality infrastructure for industrial projects.
The most economically significant and urban area of the country is the Central region, dominated by Mexico City, which is home to most of the country’s multinational corporations’ headquarters along with all federal agencies and business services functions. Its metropolitan dominance makes Mexico City a very significant logistics and consumer products market, as well, with over 90 million square feet of industrial space. Greater Mexico City has been the dominant recipient of foreign direct investment into Mexico, absorbing roughly 15 percent of all projects and new FDI jobs.
Lastly, the Southern part of the country is immensely rich in natural resources and beauty, including large rainforests and the amazing sights of the impressive Mayan Riviera. This region has stayed focused on the energy sector (oil, gas, and hydroelectric power plants) and tourism. This region faces several infrastructure challenges and connectivity issues that makes economic development and diversification more challenging. It is also a region that has been tied to chronic Central American border struggles and political upheaval—something the U.S. and Mexico governments are working on together to improve.
Location Decision Making
Mexico offers a wide range of diverse location options to allocate industrial, R&D, technology, and business services investment projects. Having the proper data and experiential information to evaluate and qualify corporate decision drivers that push investment to one area or the other is of vital relevance.
In our experience, we have seen differences of nearly 25 percent in labor-related costs between competing Mexican cities. However, cost is only one consideration. Mexico generally provides a demographic advantage over the U.S., Canada, and western European countries in terms of recruiting a younger workforce. However, educational participation rates at high school and university levels are lower in Mexico, which has consequences for long-term talent pipeline forecasts. On the positive side, a strong focus on industrial-related programs within the Mexican post-secondary system is reflected in the prevalence of technological institutes, technological universities, and polytechnic universities. Skill levels by occupation must be carefully assessed before choosing a new business location. Other factors must also be carefully assessed.
Mexico’s electricity market is currently in the process of deregulation and a competitive market now exists for large industrial users. However, that electricity market is still evolving, and large cost differences exist around the country. Variations in transportation costs can be underestimated if physical geographical features are overlooked, and new infrastructure investments in road, rail, and seaports continue to change the economic landscape. Also, studies by the American Chamber of Commerce of Mexico have identified international firms incurring additional operational costs on security-related issues, though security concerns vary geographically as well.
Industrial site availability, quality, and supportive infrastructure capacities are critical and challenging location criteria in Mexico. For example, automotive assembly plants located throughout the Bajio region have motivated certain property developers to assemble a network of first-rate, shovel-ready industrial parks. The continuous need for sites to support Tier 1 and Tier 2 suppliers in this region has led less-sophisticated developers to try and satisfy the demand but with less successful outcomes. In one recent Tier 1 supplier site selection effort (400 jobs, 25 acres, $100 MM CAPEX), Newmark Knight Frank identified 37 sites in four Bajio region states, yet only seven were truly viable, and just three remained after competitive projects reduced the options list during a four-week project timeline. Issues around site quality, control, capacities, and readiness will remain critical location factors for focused due diligence.
Economic incentives are another decision factor that are highly contingent on industry, location, project size, and method of engagement with government officials. Companies often wonder if they are getting the best proposal by working with the development agencies directly, and the answer is generally no.
In Mexico, there are two types of incentives: those that are Statutory and that all development agencies should be aware of, and those that are Discretionary and are sometimes not even well-understood by senior and local authorities that change with political elections. To understand these opportunities, investors must be aware of who has the authority to offer and provide each type of incentive for specific project types.
At the federal level, tax credits are most common and available only with support of specific federal agencies with R&D and labor development packages. These programs are in flux or at risk of cancelation with Mexico’s recent election. At the state level, typically payroll taxes, cash grants, land donations, and infrastructure investments are offered. And at the local level, companies need to ensure that they will have the support of local agencies and officials to get clearances and permits to continue with investments without delays and setbacks. Unfortunately, there have been high-profile, publicized examples where the incentives process has not been effectively managed and Mexican project investments have suffered as a result.
New Government, Trade, and the Future of Mexico’s Inbound Investment
In February 2017, as NAFTA renegotiations proceeded, Ildefonso Guajardo, then Mexican Minister of the Economy, stated that “countries would be watching to see how Mexico, Canada and the U.S. define the future of trade relations.” Those negotiations are done, and companies now await the ratification of the new USMCA so investments and supply chains around North America can adjust to a “new normal.”
Growth in total trade between Mexico and the United States has averaged nearly nine percent annually for the last 25 years. However, over this time, Mexico has had a truly global perspective on attracting new investment and spurring export-led growth. Mexico has established more free trade agreements (FTAs) than almost any other country in the world and now has 12 FTAs with 46 countries.
As of December 2018, Mexico has installed a new government headed by Andrés Manuel López Obrador. This is the first left-of-center government Mexico has elected in 70 years, and the country’s new president has promised “peaceful-but-radical” transformation. The scope of change to come is uncertain socially and economically, but there appears to be a commitment to existing trade agreements.
Amidst low oil prices and depressed federal revenues, the government is likely to continue attracting foreign direct investment that has driven so much capital investment, employment expansion, and income growth across Mexico. In 2019 and beyond, location decision making for new investments will require even more care as economic incentives may be reduced and other policy changes will impact Mexico’s investment attraction regime.
The authors are consulting leaders at NKF Global Strategy, the corporate consulting division of Newmark Knight Frank, one of the world’s largest commercial real estate services firms.