Mexico’s maquiladora industry offers near-shorers an attractive vehicle for setting up a manufacturing base, but it is no quick fix – nor is it all the country has to offer. Companies should consider all their options.
Tesla’s new factory has put the spotlight on Mexico as a centre for manufacturing. It is, says automotive manufacturing expert Sandy Munro, “a genius move” that could unlock the key to making a more affordable model. But although the move might be a smart one for Tesla, it lacks at least one thing: originality.
In fact, the path to Mexico is well-trodden by manufacturers. The country has long sought to capitalise on its proximity to the US market to offer international businesses a base with competitive wages and global trade-friendly programmes and ecosystems. Recent challenges with trade disputes and supply chain disruption affecting Chinese outsourced operations have served to accelerate that trend.
For evidence, you only have to look at the maquiladoras (or, maquilas) – foreign-owned, largely duty-free and tariff-free production factories found all over Mexico, dating back more than half a century. The Border Industrialisation Program (BIP) that began in 1965 lowered duties on machinery, equipment and raw materials to enable foreign firms to use factories to import raw materials and export goods with a lower cost.
It has been a key pillar in the country’s efforts to attract foreign investment ever since. By the mid-1980s, maquilas were the country’s largest source of foreign exchange – ahead of tourism. A decade later and they were the largest industry in Mexico after petroleum. In 2021, they accounted for 58% of Mexico’s manufacturing GDP, the majority of its manufacturing exports and almost half (48%) of industrial employment.
From theory to practice
If it is an old concept, the maquila has had a new lease of life in recent years. The trade war with China and, more recently, logistical problems following the pandemic have seen many revisit their outsourcing strategy. Particularly for US businesses, Mexico offers an attractive nearshoring alternative.
A company manufacturing equipment for the shipping industry that RSM’s team of cross-border experts advised is a good example. Benefitting from the increased demand for shipping post-pandemic, the manufacturer sought to increase its capacity. However, when looking at the costs and time of expanding its Chinese base, the company realised Mexico, where it already had a manufacturing facility, offered a more attractive alternative.
When considering the shipping costs and delivery times, they realised expanding into Mexico could see substantial savings. In total, for a project boosting production by about $100 million a year, choosing Mexico over China resulted in estimated savings of between $5 million and $8 million. Much of the savings came from lower logistics costs when shipping products and materials between China, the US and Mexico.
It is just one of many such cases, with companies across industries benefiting from a move to Mexico, though automotive companies and electronics manufacturers are probably the most common.
When they started many years ago, maquiladoras were fairly labour-intensive operations that did not necessarily require a lot of skilled workers, but that has evolved. Nowadays, there are maquilas manufacturing everything from landing gears for the aerospace industry to microchips and medical instruments that require very sophisticated manufacturing processes.
Taking on the challenges
Even the example above was not without challenges, however. The company required significant support in reorganising its legal structure, tax strategy and supply chain management to make it work.
For others, such as the recent case of a rubber products manufacturer, the process is even more challenging. The business already had a fully-fledged factory in the country and planned to turn this into a maquila.
At the beginning, they thought it would be very simple, almost an overnight process.
Yet, this was not the case. As the company worked with RSM’s cross-border experts to develop a roadmap for the transformation, the complexity became clear: everything from logistics and customer relationships to tax strategy, customs and trade regulatory frameworks needed to be re-considered.
To take one example, it is often misunderstood that the maquila offers tax breaks. In fact, it only allows duty-free and tariff-free imports of raw materials, machinery and equipment (and these benefits come with stringent requirements in terms of compliance and reporting). There are no breaks in terms of income tax, for example. In fact, conversion to a maquiladora at times results in a greater income tax liability in Mexico, compared to other manufacturing arrangements.
While the maquila offers a relatively simple income tax regime, it also provides less flexibility than the regular regime. The latter provides more flexibility for tax planning, such as transfer pricing policies, or choosing an advantageous depreciation methodology.
Even without complications, it takes time to set up a maquila, dealing with tax authorities, environmental regulators, customs – Mexican and US – and others. There is more to it than just writing a letter to the government. In some cases, working through the various factors with advisers, companies conclude that a maquila is not the best vehicle for the business.
Even if it is not, Mexico’s attractiveness as a production centre is clear. There are competitive labour rates, proximity to the US, as well as having trade agreements beyond the US, with a large number of countries, including China. In fact, for those selling to the latter, using a manufacturing operation in Mexico might provide the opportunity to mitigate the effects of the trade barriers that have risen in recent years.
A maquila is an option for many looking to nearshore their manufacturing operations, but not the only one. When it comes to Mexico, there is much more to consider.