Episode 9: How to Choose a Shelter Service Provider in Mexico
In this episode, Ricardo Rascon welcomes back David McQueen to discuss how to choose the right shelter service provider in Mexico. Prior to joining Tetakawi, David was the president of two Canadian companies who expanded into Mexico using shelter service providers.
To begin, David explains that Mexico’s shelter service program was set up over 30 years ago with the idea to provide foreign manufacturers with an easy way to operate in Mexico. It allows a foreign company to do most of the things they would do if they were independent, but they don’t have to have a permanent establishment. It begins with a contract which advises the Mexican government that this company will be coming in and operating. Shelter service clients are protected from liability of Mexican officials. In order to qualify for a shelter service, a company must be doing some kind of transformation of their products and meet the IMMEX standards.
Organizations can find a shelter service provider several different ways: searching online search engines, Mexico’s INDEX organization, through their own network, industry events and podcasts. There are currently 25 shelter providers in Mexico. A good starting point for finding a match is to begin searching within your company’s preferred general region. If you don’t have a specific region in mind yet, your best bet is to begin by speaking with the largest shelter service providers to get a better idea of their options. The first things you should find out from a potential provider is how big they are, where they provide services and what kinds of services are available. Most organizations want to operate within an area which is already prepared to cater to their specific expertise. You will also want to be sure a service provider has the proper talent in place to aid your operations. Next, David speaks to the costs of using Mexican shelter service providers. While shelter providers can often help identify providers, they are not directly involved in your business or familiar with your raw material costs. Costs, credit and payment terms will vary from shelter to shelter, so it’s important to discuss costs with your chosen provider. Transition contracts will typically end on the day stated on the initial contract. In other cases, a shelter provider may want to match the contract terms to the term of the real estate, typically 5-7 years. However, shorter term contracts are also available.
Thank you for joining us on Manufacturing in Mexico!
Speaker 1: Welcome to Tetakawi's Manufacturing in Mexico podcast, where we talk to internal and external experts to provide you with news, insights and best practices about doing business in Mexico. Whether you're thinking about expanding into Mexico or already there, this podcast will provide you with the information and advice you need to launch, operate, and thrive.
Ricardo Rascon: Hello and welcome to another episode of our Manufacturing in Mexico podcast. My name is Ricardo Rascon and with me here again today is David McQueen. David, how you doing today?
David McQueen: I'm great, thanks Ricardo and glad to be back here.
Ricardo Rascon: Great, I'm glad to hear that and I'm really excited about today's episode because it was inspired by one of our listeners who listened to one of our previous podcasts where we talked about modes of entry for expanding into Mexico and asked us to expand a little bit more on the shelter program. Specifically they said, if I've kind of decided that the shelter program is the right way for me to expand into Mexico, how should I go about finding the right shelter service provider? So having David here with us today is going to be really phenomenal because before he worked with us, he was the president of two Canadian companies that expanded into Mexico, used shelter service providers, so he did a lot of due diligence. He's been in the shoes of a C level executive thinking about expanding into Mexico, looking at different modes of entry, interviewing different providers. So he's going to be able to provide us with a lot of insight here today. So Dave, in order to kind of kick things off, can you give us a recap of what the shelter model is in the context of manufacturing in Mexico?
David McQueen: Sure. It's a program set up by the Mexican government. It was set up more than 30 years ago, and the idea was to provide foreign manufacturers with an easy way to operate in Mexico, and essentially what it does is it allows a foreign company to do most of the things they would do if they were operating independently, but they don't have to have permanent establishment. So that means no direct liability in Mexico, no regulatory liability in Mexico for the foreign company. Instead, the shelter provider assumes that role. The shelter also participates in the IMMEX program, which is the program the Mexican government is set up for exporters that allows them to avoid value added tax and also to participate in some duty relief programs. Shelters are part of IMMEX, just like you could be an IMMEX standalone company.
Ricardo Rascon: Great. And then so how does the shelter program work?
David McQueen: Well, it's relatively simple. It starts with a contract. A foreign company signs a contract with a shelter provider who has in Mexico a shelter operations that are recognized by the Mexican government, and then that shelter provider simply uses that contract to advise the Mexican government that this company will be coming in and operating. And that's about all there is to it.
Ricardo Rascon: Great, and when you were kind of talking about the benefits of the shelter program, you talked about direct liability. Can you elaborate a little more on that? And are shelter clients protected from liability in Mexico?
David McQueen: Yes, they are. The client company is protected from liability to the Mexican authorities, so there's no direct liability to the Mexican government. The foreign company's not exposed to Mexican legislation directly, none of those things, but as you might expect, there's some compliance issues that will be under the company's control. So the way a shelter operates, the foreign corporation, they are permitted to direct the employees in their facility and to run their operation. That's essentially the key feature of the shelter. They're not subcontracting their whole operation, they're only taking advantage of the shelter provider's legal umbrella and subcontracting to the shelter provider, the things that the shelter provider has to do for them.
So because the foreign companies in control of those things, there are some risks to the shelter provider that are not under the control. So contracts will typically include some provisions for the provider to be compensated if the client's actions or omissions cause some kind of a problem. And an example would be a health and safety regulation where the shelter company had told the foreign operation to do a certain thing and the foreign operation hadn't complied and then there was a fine. There's going to be some language in the contract that allows the shelter provider to recover compensation for that, but there's no direct liability. It's all in the contract.
Ricardo Rascon: Right. So then the shelter service providers, the manufacturer of record, employer of record in Mexico as well. So these foreign companies are operating under the auspice of this shelter service provider. So does the foreign company have to pay taxes in Mexico since they're operating essentially as a division of the shelter service provider?
David McQueen: Well, yes, unfortunately they do. That's the one thing that they can't escape. It used to be that that was allowed under the shelter program, but it no longer is. A shelter client does have to pay taxes. They're going to pay exactly the same taxes at exactly the same rate that they would've paid if they were a standalone corporation, that the rules are the same. As you can imagine there's no way for them to directly pay their taxes. So the government has set up a process whereby the shelter provider can collect those taxes and then pay them on behalf of the client to the Mexican government.
Ricardo Rascon: Say it's a US or a Canadian company, could there be opportunities for double taxation there or would they get some sort of tax credit? Can you expand a bit on that too?
David McQueen: Yeah, no, there's no opportunity with most countries for double taxation. Mexico has tax treaties with most countries, like all tax treaties they allow for a foreign company that pays taxes in one country to deduct those from their tax owing in their home country, and that will apply certainly for US or Canadian companies operating in Mexico. They'll be able to do that. The other thing that people might want to be aware of is that it's because it's a non arms length transaction that you'll be having with your Mexican subsidiary.
There's a safe harbor rule that is applied to the taxation to calculate in lieu of a transfer price, and that rule is six and a half percent of your assets in Mexico or 6.9% of your expenses in Mexico, whichever is greater that becomes a proxy for your taxable income and you pay the tax rate of 30% on that income, and that would apply exactly the same way if you were a standalone IMMEX corporation. It's exactly the same rule that safe harbor calculation is recognized by the US and Canadian tax authorities, and you can deduct those taxes against the taxes that you owe in your home country.
Ricardo Rascon: Perfect. Thank you, Dave. Say, I've decided on the shelter model for my expansion strategy. Are there any qualifications that I need to become a client of a shelter service provider?
David McQueen: Yes, there are. There's a few criteria you have to meet in order to be a shelter client. First of all, foreign ownership, the program's not open to Mexican companies, so you must access through a foreign corporation. Secondly, you have to invest minimum assets in Mexico, that's usually not a problem because foreign corporations are going to transfer machinery and equipment, raw materials, inventory, things like that to their operation in Mexico. So it's usually very easy to meet those hurdles, but they're there and they need to be complied with. And this is important, you need to manufacture. If you are not doing a substantial transformation of the product, you don't qualify as a manufacturing shelter and by substantial transformation it's not a terribly onerous requirement, but simply repacking goods wouldn't qualify. You need to be doing some kind of transformation to the product itself in order to qualify, and that's an important one.
You also have to meet the IMMEX standards, which essentially requirements around exporting your product either externally outside of Mexico or internally between IMMEX companies, one or the other. So those standards need to be met. Because of that, you need to use foreign invoicing. So the way the Mexican government determines that it's an export sale is that they require foreign invoicing. So your invoice has to come from your home country, but the goods can ship either internally in Mexico, between New Mexico companies or they can physically be exported outside of Mexico to a customer who of course would be in some other country. I should also mention that if you can't qualify for those requirements, you still have the opportunity to use the shelter provider services. Shelter providers have evolved into essentially service providers who can provide a whole range of administrative and facility services. So you still have an opportunity to use their services, but in that case, have permanent establishment and you will have some direct liability, so it's not the same. They usually provide that through a separate arm of their company, but the service is available.
Ricardo Rascon: Great. So let's say I meet most of the criteria that you listed there, Dave, but I do need to sell some of my products in Mexico to a domestic market on a Mexican invoice. Could I still use a shelter service provider services?
David McQueen: Yeah, you can still be an IMMEX provider and you can still be a shelter. It's a fairly common situation actually, and essentially the workaround is that most companies will set up a trading company, which is a Mexican company, does have permanent establishment and therefore does have the ability to collect and pay value added tax. And then they use that company to definitively import the product that they're going to sell in Mexico and then invoice it to Mexican customers. It's a relatively simple process to go through and fairly common as I say.
Ricardo Rascon: So now we've defined the shelter program. We've talked about some of the benefits, we talked about the qualifications. Now how should companies go about finding a shelter service provider?
David McQueen: Well, of course, search engines, we all like search engines, Google or other search engines, whatever your favorite is, the tags that are probably going to turn up the most hits are things like Mexican shelter or Mexican manufacturing. Those will generally turn up a whole raft of shelter companies. So that's one way. The second way, there's an organization of industrial parks in Mexico called Index, I-N-D-E-X. And Index has a group within it that is a group of shelter companies, so they can provide lists of shelter companies that you might want to contact and contact information. I'd use your network too.
There's so many people operating in Mexico that suppliers, customers, advisors, there could be any number of people that you already know who have worked with a shelter and can recommend them, and of course if they've worked with them, then that's going to be a pretty good recommendation. Then of course there's events, podcasts, webinars, videos, things like we're doing right now. Lots of shelters host or promote or attend events, so that's a great way to get information about them or even in some cases meet them face to face.
Ricardo Rascon: As you mentioned Dave, there's a host of shelter service providers. The last time we did the research there was a little over 25 registered shelter service providers in Mexico. So obviously that's a lot of companies that foreign investors have to potentially interact with, but what are some of the signals or things that they should look for before reaching out to all 25? How do you narrow that list down and what are some of the things they should be looking for?
David McQueen: I mean, there's a number of ways you could go about it, but I think if you have some idea what region you want to locate in, I'd start there. You don't necessarily need to know this city or even just one region, but if you've got some kind of idea, that's a place to start. Smaller shelter companies often only serve one very specific area or region. So compare your options. And even the largest ones don't have facilities everywhere, so having an idea of location will start to limit the list. I wouldn't be too restrictive. It's probably too early to focus on just one city for example, and that might quickly narrow you down to one shelter company. If you know a general area, I want to be in the Northeast, I want to be in the border area, I want to be in the Bajio, that's going to help you to narrow the group of potential shelter companies.
Ricardo Rascon: What if I'm pretty location neutral, I don't really know quite where I want to manufacture in Mexico, or maybe I'm not too sure about the different geographical clusters. I know I need to be in Mexico. How should I start my search for a shelter service provider in that case?
David McQueen: Well, in that case I would talk to the largest shelters first, the multi-location people, Tetakawi's one, but there were others. Because the large shelters are going to be able to give you a perspective on a number of different regions, give you some recommendation of where your business might be best suited. You can always drill down later and talk to a local shelter company or two once you've sorted that out, but the bigger companies are going to have more of a perspective on the whole manufacturing scenario in Mexico and be able to guide you on the options that you might have available.
Ricardo Rascon: Perfect. So I could obviously narrow down the field of shelter service providers by geography, by size, but how else can I narrow down my selection to maybe five or six companies that might be able to support me?
David McQueen: Well, I think the next thing to think about is what your service needs are. If you're planning a Mexican facility that's going to have 300 employees or less, it almost certainly benefits from having a full service shelter and not every shelter's a full service shelter. Large corporations going to be greater than a thousand people say within the first year. They're probably more suited to a soft landing situation. They're going to very quickly have the ability internally to do a lot of the things that the shelter company doesn't. That doesn't mean they don't still want to be with a shelter to avoid permanent establishment, but in contrast to a smaller company that may always need the resource benefits of a shelter, they may not, a large company may not. Companies of any size that are looking for a comprehensive solution. If that's what you want, that kind of full service, I want to do the least amount of administration in Mexico that I can, I want somebody to look after as much as possible.
Then you should be thinking about a manufacturing community, and these are dedicated industrial parks where everybody in the park is a client of whatever shelter company owns the park and it has the significant benefit that the shelter company can provide a bunch of shared services. So there's an economic benefit to that, but there's also a more comprehensive service offering available and that may be attractive either as a way to start or a long term way to operate. If you require specialized real estate, on the other hand, you're probably better off to look outside the manufacturing community. If your process demands a very specialized building, then probably you're going to look for a build to suit third party option that can be specific to your needs and that that's probably the direction you should go.
Ricardo Rascon: Thanks for that recap there, Dave. So it sounds like there's a lot of different ways that a shelter service provider can help you depending on your need. Do all shelter service providers provide each of these options?
David McQueen: No, not all of them do. Some like Tetakawi do provide all these options, but not in every region, and there are others that do. Most companies actually focus on only one type of service offering or one particular location offering one or two services, especially if the company's smaller, it doesn't have the means to offer as wider range of solutions.
Ricardo Rascon: So you mentioned a lot of solutions. You talked about full service shelter, you talked about soft landing manufacturing communities, shelter and more kind of specialized real estate as well. How do I decide what I need not just now, but in the future?
David McQueen: If you don't know based on limited guidance that I've just given or perhaps your conversations with other people, then I'd start with one of the larger shelters that offers more solutions because they can talk about the options and then once you've directed yourself to one option or the other, then you can always talk to some other companies that specialize in that option. So much like location, if you're not sure, then you might as well start with somebody that has a lot of different options to offer and can give you a perspective on what the benefits might be. And then perhaps move on to a more specialized company as a potential alternative.
Ricardo Rascon: Perfect. So let's say I've kind of worked my list down to two or three companies that I want to explore working with a little further, what are some of the early questions that I should be asking each of these shelter service providers to make sure that I'm making the right decision?
David McQueen: Well, I think one of the key things you're looking for is the fit with the company. So to me, like a job interview, I'd start off with who they are, how big are they in terms of headcount, how big is their client base, where do they provide services in Mexico and what kind of services are available in each of those locations, where's their headquarters and where are their operational centers. Some companies will offer to serve you in any area in Mexico, but that doesn't mean they have an operation center there and in fact might be very far away. That might be okay or it might not be okay with you. So it's important to know where are their operations center, how many people are going to be nearby, where do you go to solve problems? I'd want to know how long they've been in business and I'd want to know whether they're a Mexican company or a US company.
Ricardo Rascon: Why is that last point there important, Dave?
David McQueen: Well, it has implications for the contract. If it's a US company, then the contract's going to be a US contract governed by US law. If it's a Mexican company, the contract's going to be a Mexican contract governed by Mexican law. That may not be important to you or it may be important to you, it certainly guides you in terms of how you have to proceed when you're negotiating with that company. The Mexican legal system is not a common law system like the United States or Canada or Great Britain. It's a codified system. So there's a significant difference in how things are done. The end result's often very similar, but there's a significant difference. So if you decide that you're going to deal with a Mexican company, one of the things that should be on your list is getting some Mexican legal advice from some Spanish-speaking lawyers who can advise you on the contract, and if they're a US company, well, then it's going to be a US contract.
Ricardo Rascon: Okay, so assuming I've had all of these questions answered and I'm ready to continue to the next step in my journey to finding a shelter service provider, what's the next step from here?
David McQueen: I'd drill deeper on whether that fit works. One of the first things is are there similar companies, yours either in the shelter itself or in the immediate area, so is that kind of industry represented in that area or not. Some people want to avoid an area where their industry is represented, but most don't. Most want an area where there's going to be services and suppliers and so on that are serving the industry that they're operating in. Are the people and skills that you need available? The shelter should be able to advise you on that in terms of the availability, the difficulty of recruiting specific skills, difficulty of retaining specific skills. In fact, turnover in general is a question to ask, what is the turnover? What practices do the shelter put in place to help manage the turnover in that particular area?
What do they recommend you do to manage turnover and retain employees? You want to know if they have experience recruiting the skills that you require, and if they don't, because some people have of course very specialized requirements that may never have been recruited by anybody, what do they do when they encounter that? I'd ask them both questions. How do you recruit the skills of mine that you're familiar with? And then what do you do when you encounter some kind of a unique position, how do you recruit that person? How do you find them for me? You probably want to ask if local support services and suppliers are available or how close they are. There'll be critical things for your business that you have to have in the area. You may not be looking for raw material suppliers, but you need someone nearby the can fixture machine or sell tool bits or something like that.
The utilities is an important question, not only for your shelter provider but for whoever the real estate provider is going to be. If it's not the shelter company, if it's a third party, if you need gas or processed water, is it available in the quantities you require? Will you have to pay any fees to have it connected or to have the capacity improved? That can happen. It's important to explore that. And then a related question, what kinds of buildings are available in the area where you're looking at locating? Will it work for your operation? How difficult will it be to find a facility that suits you? It may be more difficult or less difficult depending on what you do and where you want to do it. Mexican real estate by the way right now is very hot, absorption's very high. It consequently it's difficult in most markets to find buildings and to secure buildings, so something to be aware of that you need to... When you're ready to look at buildings, be prepared to act. And then finally discuss logistics and accessibility with them.
How do you get to the location of your facility in terms of flights and local transportation? What's the logistics like in terms of getting goods in and out? The shelter company should have answers for all of those things and be able to guide you. And of course your priorities may differ from one company to the next, but if for example, port access is critical to you because you're bringing in tons of containers and shipping them out, well then that's going to be a topic of conversation. If you want to be closer to the US border, if you want to be closer to particular companies in Mexico, so the shelter companies should be able to advise you on all of those things and provide information on them so you can help determine whether you fit with that particular shelter in that location.
Ricardo Rascon: Great. So assuming conversation with the shelter service providers going great and I've determined that they could be a good fit and it seems like they would be able to help me realize my expansion plans into Mexico. What's next at this stage in the journey?
David McQueen: I'd say the next thing is it's time to start talking about the solutions themselves or are you going to go into a manufacturing community, is that what you're discussing or is it third party real estate? In either case, what services will be available to you? How are they going to be provided? Are these services internal? In other words, is the shelter company using their own staff to provide that service or are they subcontracting to a third company in part or entirely? Some shelter companies essentially contract everything they do, so they're really almost like brokers. Other shelter companies will do almost everything internally and you may have a preference based on the urgency of your needs or the way that the services are going to be provided. So I'd start exploring that. Good idea to find out what services can be shared with other clients. Services that are shared with other clients are going to reduce costs.
So if you for example, share a busing system in a manufacturing community with all the clients in that manufacturing community, your unit busing costs to get your employees to work, it's going to be much lower and the quality of the service is going to be higher because there's going to be a larger volume. What that means is more pickup points closer to where employees live, which for the employees is a priority, so better retention. So all those things kind of are interrelated. Medical services. Does the shelter company provide medical services and are those shared with other clients? If so, they're going to be more economical than if they're not. So I start talking that through and determining what you need. In some cases, of course you have third party real estate and there's nobody else immediately around you. Well, no matter whether the shelter wants to or not, they can't provide shared services and that could be an issue that drives you in terms of how you set up your operation.
But it's important to recognize that some things just can't be done in certain circumstances. The shelter should help guide you with all of these things. If you're going to plan to transition at an early time, you might as well discuss, in fact, transition's a good idea to discuss anyway because at some point down the road you might decide you want to transition to an independent company. So good idea to talk that through at the shelter. How will it be handled? Most shelters will put in a gradual plan of transferring individual responsibility areas one at a time as you get it up to speed, but some it's you're in or you're out. If you want to leave, you leave, that might not be very attractive to you because you don't have a time period to transition. I'd go through that. You certainly want to know what your responsibilities are going to be, and this is an important point because what can look like the same services between two shelters may in fact have layers of responsibility that differ.
One example might be human resources. Some cases, shelter companies will require you to hire someone on your payroll as your HR generalist in your plan, and that'll be right in their contract. So that person's on your payroll, they're your responsibility, but the shelter service company is directing them and providing the services. In a transition model that works pretty well. In a long-term service model or a manufacturing community that might not be very attractive to you, but either way, you need to know that, what are you going to be responsible for. There are other cases where security, for example, some shelter companies are going to make security your responsibility, others are going to offer it either through the shared service or they'll take care of it. So what are you responsible for and what's that going to add to your costs or your management burden? And I think another question is, we talked about this earlier, where are the service going to be supplied from?
We talked about operational centers earlier. Where are they coming from? Is somebody that's going to serve you or solve a problem hours away or are they nearby? Another question to ask, is there a cross dock consolidation service? Not every shelter provides that, but it can be very beneficial for you. A cross dock is usually a situation in which you consolidated LTL shipments, less than truckload shipments, to benefit your organization, both in terms of timing and cost. Also, usually offers faster border transit times. So it might be of interest to you to have a cross dock consolidation service. And a related question to that, which is kind of the flip side of it, can you enter an exit from any port in Mexico? Can they serve you on import export anywhere in Mexico or are they limited to just a few border crossing locations? Those are the questions I would be asking about service provision.
Ricardo Rascon: Great, Dave, that's some excellent insight there. But now the most important question, what does it cost to manufacture in Mexico using a shelter service provider? How do I figure out what it's going to cost me to pursue expanding into Mexico this route?
David McQueen: Well, shelter of course is going to be able to estimate their fee and tell you how they're going to calculate it, but they should also be able to provide an estimate of your operating costs. Shelter companies, because of their role, have a lot of data on operating costs in Mexico. They're not going to be privy to your revenue or your raw material costs, but they see all the costs of manpower. They see all the expenses, not just for you but all their clients, so they see it across a variety of companies, a variety of industries, and they see it in real time. Some of them have very sophisticated cost models that are backed up by that database that they create. Others have more simplified versions, but nonetheless, they still are familiar with it and can answer specific questions. In any case, you should be able to use the shelter corporation's expertise to estimate your actual operating costs in addition to whatever they're going to charge you for their service.
Ricardo Rascon: What are the different operating costs that would be included in a cost model? Assuming that you're working with a company that has more of a sophisticated cost model, what are the different operating cost elements that they would be able to help you estimate?
David McQueen: Well, they should definitely be able to provide very accurate data on the fully fringe payroll costs. For any employees you're going to hire in Mexico, that's kind of a given. That's the core of their operation. They're recruiting those people, they're paying those people. They should be able to identify very accurately what manpower is going to cost. They should be able to tell you about utilities because they're paying those bills. So electricity, telecommunications, gas, if you require it, water, they should have costs for all of those. Rent of course is another one they should be able to provide. Because you don't have a presence in Mexico, the shelter corporation will generally be processing your local maintenance and miscellaneous expense purchases. Anything you buy in Mexico, they need to pay the invoice, so they're going to have a window on that cost. So they should be able to tell you a lot about what local maintenance and miscellaneous expense is going to cost you provided you can give them the date on what you're going to need.
Severance cost, that's a fact of life in Mexico. It should be included in the cost model. Severance applies any time you terminated an employee without cause and cause is very limited. It does not include performance. So inevitably you are going to end up probably terminating some employees and paying some severance costs and the shelter company should be able to help you estimate what that will add. Employee transportation costs, what's going to cost to bus your people to and from work. And most shelters could help with logistics costs. That may be something you don't need their assistance on because perhaps you have a logistics provider that's that's able to do that. But nonetheless, it's certainly a question shelter providers should be able to answer.
Ricardo Rascon: Thanks, Dave. And assuming I'm looking to localize most of my supply chain in Mexico, or at least a portion of it, would they be able to help me estimate the cost of raw material as well?
David McQueen: Not really. Shelter companies can often help identify suppliers and local raw material sources. They can be quite helpful there. Their expertise isn't in that area, they're not directly involved in your business. Actually, one of the attributes of the shelter program is they're not involved in your business. They don't know what your revenue is, they don't see your raw material costs, so they're not experts in that area and are unlikely to be able to provide a lot of data on raw material costs. So one area they probably can't help very much except perhaps to help you identify sources.
Ricardo Rascon: Right. So aside from operating costs and raw materials, obviously the shelter service provider is going to charge a fee for the suite of services that they're providing. How do different shelter service providers charge and what are some things that companies thinking about using a shelter service provider should keep in mind when getting to the point of the conversation where they're talking about fees?
David McQueen: Just let me back up for a minute and just clarify that the operational costs that we talked about, the shelter company should present those in a manner in which they are exactly the same as what you would pay as a standalone company. If a certain employee is going to be paid X, then that's what they should tell you, the cost of that employee is X. So the operational cost should have no fee for the shelter company included in. They should be the cost of those operational activities. The shelter themselves are going to then have a fee, and that's a separate item. It should be a separate item in the cost estimate, and that covers their costs, including the people that work for them providing the services. The ones that are on their payroll and their profit. Shelters charge in various ways. So it's important when you're comparing to drill down and identify those differences.
Most full service shelters will either charge per head or per payroll hour, and typically they'll use a sliding scale so that the larger your organization is, the lower the per head head rate or the lower the per hour rate that they apply. That information should of course be in the contract and it should be provided to you upfront. Now, some shelters, as I mentioned earlier, include heads on your payroll that they require you to have. So shelter X might say you have to have this employee on your payroll. We require it as part of our contract. That employee will probably be included in the headcount or payroll hour calculation. Their shelter fee might be a little lower, but it'll be on a higher base. Whereas shelter Y may say no, those people are on our payroll, so their shelter rate per hour might be a little higher, but the base they use for calculation is a little lower.
So you need to be very careful about those comparisons. The other thing to watch for is that some shelters will add transaction fees while others won't. Many shelters, us included, just pass through the operational cost. We don't mark them up. Our fee is a single item, but some shelter companies spread that out and they'll apply, say a percentage to every purchase that you make or every payroll that you run, that kind of thing. There is a difference in soft landing models. In soft landing models or transition models, then transactional costs make a lot more sense because the base is changing. The tasks for the shelter company is changing rapidly and so therefore charging everything per transaction can be a common scenario. Certain shelters will offer that as an option to their standard rate system or they'll only apply it in a transition. Either case is possible. But it's certainly for transitional activities that does make sense to go by transaction. A lot more work, but it makes sense in terms of the changing services.
Ricardo Rascon: Thanks, Dave. And do shelter service providers commonly charge startup or cancellation fees?
David McQueen: Yeah, most shelters will charge some kind of a startup fee to cover the cost of setting your organization up and doing the initial recruiting. As you can imagine, the initial recruiting is a lot more onerous than maintaining your organization. So usually there'll be some kind of an initial fee. These can vary widely from shelter to shelter. They're usually higher for third party real estate and soft landing services. In the case of the soft landing services because of the early transition and in the case of the third party real estate, as you can imagine, that might be more difficult for the recruiting depending on where the real estate is. So they can vary. Early cancellation fees are included in most contracts. Obviously the shelter company will have some interest in providing a penalty if you cancel your contract earlier and recovering some costs. So those are a normal part of contracts.
Some shelter companies will have a windup fee though, regardless of when you terminate, even if it's at the end of the term of a contract. So that's something to be aware of. And then finally, terminating a shelter contact at any time will incur a severance cost. The people that you've asked the shelter company to hire on your behalf to work in your facility, if you end your operation, they need to be paid severance. And so that obligation is yours and the shelter company's going to want to pass that on to you. So there's usually a contract language around that making you responsible for those costs.
Ricardo Rascon: Thanks, Dave. And so obviously there's a lot of different cost factors here. In terms of paying for these monthly operational costs, how does it work? Does the shelter kind of front the money, payroll pay facilities fees, kind of extend a credit to the client or do I have to deposit my anticipated monthly operating expenses into an account and they deduct from there? How does the kind of cash flow situation work and do I have to provide money up front in order to pay all these things?
David McQueen: Once again, that's going to vary with the shelter. Some shelters will require you to put money up front, some even when you're making a purchase that you deposit the money ahead of time for a purchase, but many of them will, or a number of shelters will require that payroll, like a payroll service that you deposit the payroll ahead of time and then they draw on those funds. Other shelters will give you some leeway on that. Obviously with payroll they're not going to give you a long period of credit, but it's not uncommon for some shelters to process the payroll and then look for payment from you the following week in order to compensate for that payroll.
And a lot of shelters, when they're purchasing items for you, they're not going to look for payment until the vendor's looking for payment. So if you have 30 days from a vendor, there's going to be no requirement to front that. It will be become owing when the vendor's finally paid 30 days later. That sort of thing. But it's a it once again, something you want to discuss with the shelter because it does vary and the larger shelter's going to be, of course more able to provide some kind of credit than the smaller ones are.
Ricardo Rascon: Perfect. Thanks, Dave. So now I've kind of filtered down to one or two providers that I really like work through the cost estimate. It looks viable. I could really envision myself expanding into Mexico with them. What's the next step in the process? How do I really make sure that I've done all my due diligence to make the best possible decision for my company?
David McQueen: I'd say at this point it's time to visit. The shelter provider should be able to set that up for you. And there's a bunch of things they should provide. They should arrange local transportation for you. They should tour you around to the various things you want to see, show you potential real estate options. Provide a guide that's Spanish speaking bilingual guide throughout your visit. They should organize a tour of a current client's operation. That's an ideal thing to see because that company's working with that shelter provider at the very time you visit. And so you get a chance to see and talk to them and that should be part of it.
And then of course, they should assist with hotel arrangements, provide you access to their operations center. You're going to want to see that where are the people that you're going to be working with, introduce you to those people so that you can meet them. And then if you want, they should be able to assist with the local service providers, suppliers, local accommodation options, anything else you need. The whole thing should be from your point of view and theirs, an exploration of the area you're going to locate and whether it fits, whether you have a compatible arrangement with each other, whether you're comfortable dealing with each other, that's what you're trying to determine.
Ricardo Rascon: Great. So assuming I'm looking at one specific city in Mexico or even state, how long should I budget for a typical park visit or visit of the shelter service provider's location?
David McQueen: I'd want to spend at least a day with each shelter provider, more if you need to see suppliers or other options like a number of real estate options, that kind of thing. But I'd spend at least a day with each one that you were actually seriously considering. We want to get to know them.
Ricardo Rascon: Thanks. So now I've kind of decided, there's a shelter service provider that I really like that I could really envision myself working with. I feel comfortable with the partnership. I've gone through a cost estimate. It makes business sense and I'm pretty comfortable that they can help me realize the objectives that I'm trying to achieve in Mexico. What's next in the process?
David McQueen: It's contract time. You want to see a draft contract and you want to negotiate with the shelter company the terms that you're going to work together on. Now, a couple points about that. The lease may be separate, it's third party. Obviously it's going to be a third party lease, but it may be separate anyway, and it's usually similar to us type triple net lease. But remember that in Mexico, contracts are governed by Spanish language version even if you're given a translation, so that's just a point about the lease. Commercial rents in Mexico, by the way, are often denominated in US dollars, so don't be surprised if that's what you see. And areas might be in square meters as well rather than square feet. So just a couple things you might see. Otherwise, leases tend to be very similar to a triple net lease in the US or elsewhere in the world.
In addition to the usual boilerplate, the shelter contract should address the legal entity that will provide the shelter services. The shelter companies have a number of ways in which they can comply with the Mexican government requirement, with Mexican entities that provide shelter services. It's a good idea to know who that is and how you're going to interface with that company. What services are going to be provided, obviously should be listed. What's the shelter company going to do? Your responsibilities, what are you going to be responsible for, including, are there any employees you have to put on your payroll as something you're going want to negotiate during the contract phase? Like example I gave earlier was an HR employee that the shelter provider might insist is on your payroll, but under their direction fee calculation method and pricing, of course the price scale should be in there.
How's that fee going to work? Is there any escalation clause? That kind of thing. And then of course the length of the contract and what are the cancellation and termination or renewal privileges under that contract. Most shelter providers are happy to provide it early in the process. They're generally quite happy to do that because it starts the negotiating process and doesn't hold things up at the end. So anytime you feel ready, ask for a contract that you can redline and start the negotiating process so that when you're ready to get moving, it doesn't hold you up.
Ricardo Rascon: Thanks, Dave. So going back to your second to last point there, length of contract. Typically, what do you think is pretty reasonable for most shelter service providers in terms of average initial contract length?
David McQueen: If you're looking for a transition contract right from the outset, then of course that's going to determine the length too. I want to start on day X and I want to be fully independent by day Y. That's how long the contract's going to be. So that's one scenario where it's bounded by your initial plan to exit at some point in time. In other cases, shelter provider will probably want to match the term of the contract to the term of the real estate. Five to seven years is the kind of timeframe that you're going to see in leases. And it's not uncommon for shelter providers to look to match the shelter contract to that term. The shorter is available, people will do one year, three years, four years. Like lease contracts for property, the shorter the contract, probably the higher the rate and perhaps the higher the termination fees are.
But the options are there to negotiate what you need. Shelter companies are also usually receptive to working through launch schedules. One of the hurdles for a company launching is, well, I've got to get going with some things six months or perhaps longer ahead of when I'm actually going to be operating my facility. So how can I bridge the gap between there, the starting point and my launch point? Talk it out with the shelter company. They're usually willing to be creative about how that part of the process can work in order to facilitate what everybody has to go through in terms of getting their operation up and running.
Ricardo Rascon: Thanks, Dave. Well, we've covered quite a bit here. Any final tips on how to choose the right shelter service provider for your expansion into Mexico?
David McQueen: Well, I would say the most important thing, and I think in my own case, the most important thing was finding a good fit. In my case, I got down to three shelter companies, all of which could have and would have done a good job of serving our company. I negotiated price to the point where there was very little to choose between them. And my final decision was really based on fit, the type of support I wanted, the people I was going to be working with. That's what finally tipped the balance in favor of the shelter they dealt with. So I'd say fit is probably the most important thing. Everything else you can work on and negotiate and where you gain on one, you might lose on another. But at the end of the day, you've got to work with these people. They're an integral part of your operation for some period of time when they're providing services, critical services. So a good fit is important. Secondly, tap into their expertise. These people, all of them are supporting companies, operations across a range of industries, a range of companies.
They have a lot of activity going on. They know a lot about how to operate in Mexico. They're an excellent source of information. They can advise you on almost anything and where they can't advise you, they can almost certainly recommend qualified experts who can help you with things like legal or accounting questions that they can't deal with. So tap into their expertise. Finally, unless you have boots on the ground already or have a substantial amount of Mexican experience, I would recommend that you use a shelter at least to start. And that applies whether you're a Fortune 500 company or whether you're sub 100 mom and pop shop. It's just faster, it's cheaper, it's much lower risk, and you can transition at any time. As I say, even if you're a Fortune 500 company, it's the best way to start. You don't necessarily need to stay with it, but you should start there. If you're a smaller company, you should definitely think about staying there.
Ricardo Rascon: Thanks, Dave. I really appreciate the information insights that you shared. And to all our listeners, I hope that you really found this information to be valuable as well. If you are thinking about expanding into Mexico and considering using a shelter service provider, I would also encourage you to visit our website and download one of our eBooks titled Buyer's Guide to Choosing a Shelter Service Provider in Mexico. We'll include a link to that in the show notes, and please stay tuned for some of our upcoming episodes. We will touch on things ranging from how to reduce turnover in Mexico, some of the fiscal implications of manufacturing in Mexico, and much more. Thanks again, Dave, and thanks again to all of our listeners for joining us. Have a great day.
Speaker 1: We appreciate you joining us for this session of the Manufacturing in Mexico podcast. For more information and resources about how to succeed in Mexico, be sure to visit our website, tetakawi.com.