Reshoring Production From China to Mexico

DAVID MCQUEEN: Welcome to Tetakawi's webinar Manufacturing in Mexico versus China. I'm David McQueen. I'll be your host today. We're going to talk a little bit about the reasons why you might want to consider Mexico versus China for your manufacturing requirements. And we're going to move on and talk about some of the primary considerations to think about if you're going to implement a Mexican strategy. And lastly, we'll share with you some of the lessons that have been learned by our clients as they implement their Mexican business opportunities. Before I do that, I'd like to tell you a little bit about myself and a little bit about Tetakawi. My name, as I said, is David McQueen. I'm a management consultant. I've been with Tetakawi since 2012. During that time I've helped a number of clients develop and implement a Mexican manufacturing strategy. Personally, I have over 40 years of manufacturing experience. Much of it is a senior executive levels, including some years as president of a couple of different companies. During that time I planned and launched two Mexican operations. So I've been through the process of deciding whether Mexico is a viable alternative and then implementing that strategy. Tetakawi is a shelter services company. This is a unique type of company that operates in Mexico that does two principal things. First of all, they offer a legal umbrella to foreign companies operating in Mexico. Secondly, they provide a wide range of facilities and administrative services that can support companies operations in Mexico. We are the largest shelter service company. We're an American owned company with our headquarters in Tucson, Arizona. We employ a little over 24,000 people, the majority of them are in Mexico. And the majority of those are working under the direction of our clients. We own and manage more than five million square feet of industrial space. We also work with clients and third party real estate. And we are currently supporting the ongoing Mexican operations of 75 companies. These companies range from small family owned enterprises to large multinational global five Fortune 500 companies. The bottom of the screen, you'll see a few logos of some of our sister companies. These companies helped to support our operations. But they also give us a window into their sectors. ILS is a freight and logistics company. Dinisa is our property development and real estate arm. And Intugo is the group that supports companies operating in Mexico in office based environments. So while Tetakawi focuses on factories and manufacturing, Intugo focuses on office space activities like software design, software development, software help lines, engineering offices, call centers, and sales offices. So let's talk first of all about how we got to where we are with respect to China. This is a story I'm sure you're all very familiar with but I don't think it hurts to recap how things evolved. First of all, in the 1990s, China emerged as a very low cost manufacturing opportunity. The Chinese government was dismantling state enterprises. They were encouraging entrepreneurial activity. And dare we say it, they were implementing capitalist reforms to open their economy to both trade and investment. There were many challenges. Quality was poor. Technology lagged significantly behind the Western world. But companies began to find opportunities and trade started to develop. In the 2000s, performance improved dramatically, China advanced technologically. Their quality improved. Western companies learned how to deal and communicate effectively with China. And so there was rapid expansion. However, there was also increasing dependency during this time. Many companies either reduced their manufacturing footprint, or in some cases they came to rely totally on Chinese sources of manufacturing product. Move to the 2010s and problems started to emerge. First of all, there is wage inflation brought about in part by the rapid expansion of the economy but also encouraged by the Chinese government, who are looking to improve the welfare and affluence of their citizens and deliberately increase wages. There were political challenges, China to move to a more authoritarian, more combative and aggressive regime. The United States under Donald Trump was particularly aggressive in defending American rights. But it wasn't just the United States and China. Countries around the world began to push back against Chinese dominance in trade and economic matters. And so there were trade barriers. There were tariffs. There was disruption. So now we're at the 2020s. We're faced with a situation in which prices in China are relatively high. China is no longer the leading low-cost country opportunity in the world. There are other alternatives that are cheaper. Supply disruptions have taught us that that long supply chain between the United States and China can be a problem, most recently, of course, with COVID, but prior to that some natural disasters and other factors have interfered with that supply chain have caused problems for companies and consumers as well. And lastly, there are tariffs. And that regime doesn't show any sign of changing. The Biden administration is indicating that they are going to take a fairly strong stance against China. And other countries in the Western world, Australia, most recently are doing the same thing. So is Mexico an alternative? Well, Mexico has no restrictions on foreign Investment in manufacturing or foreign ownership. So that makes them an attractive opportunity for you to invest. Mexico is a member of the USMCA free trade agreement. That's the trade agreement that replaced NAFTA. So that opens the North American market-- Canada, the United States, and Mexico-- to free trade in both raw materials and finished goods. Mexico also has more free trade agreements with other countries than any other country in the world. So that makes Mexico an ideal base to access both raw material supply and finished goods shipments to a number of markets that aren't accessible otherwise to companies operating in the United States or even in China. The Mexican government does not interfere with private companies. The Mexican government's relationship with business is much like the United States. Obviously there's regulatory interaction and there is codependence. But they do not require Mexican government officials or party members to be in the board of your company or to operate in your company. And there is much less direct interference with companies operations than there is in China. Mexico has the same time zone as the United States. Now, companies have learned, and I'm sure you all have to communicate with that overnight delay and 12 hour spread in time zones between Asia and America. But it does add inefficiency. And it can add delays. And it's inconvenient. Mexico doesn't have that particular barrier. Of course, Mexico shares a border with the United States. This is an advantage over any other low cost country that you might consider. It makes, obviously, freight costs lower. But it also makes it easier for people to move back and forth between the countries and to conduct their business. And of course, most importantly, in many sectors Mexico has lower manufacturing costs than China. Now, we're going to give you some benchmark examples to compare with. Every business is different. There can be reasons like raw material where you are in a situation where Chinese costs are in fact still lower than they are in Mexico. But on a broad based brush approach, Mexico is much cheaper. So let's look at some examples. First of all, we have some fully fringed manufacturing wages. We've chosen a mid-level skilled employees, direct labor employee and made a comparison there. Fringe benefits are comparable. And you can see there's a 35% spread. If we were talking an entry level position, of course it will be less expensive in both China and Mexico. But that spread would still be there. If we look at a professional employee, a manufacturing engineer, in the example, we've chosen similar you experience degreed engineer and similar fringe benefits, you can see there's a 24% spread in wages between the two countries. Electrical power is comparable with Mexico being slightly cheaper. But an important point, too, is that Mexico is competitive in a North American base in terms of the cost of industrial power. So it's not only not a disadvantage relative to China, but it is a competitive in the North American environment with costs of electrical power. Obviously, shipping is much cheaper from Mexico if you're talking about shipping to United States. We've shown the example of shipping to Chicago, but it doesn't matter where you choose. Mexico is much closer. It's going to be less costly. Perhaps even more important, though, is the size of the supply chain transit time. In Mexico, a couple of days less if you want to expedite. In China, by ocean you're looking at least 36 days. And that means additional investment in inventory and delays getting to market and potential for disruption. So looks good. You want to know if you can transfer your contract manufacturing from China to Mexico. If you're like me, contract manufacturing in China, develop some partnerships, work pretty well, you didn't need to directly invest. Is that possible in Mexico? The answer to that is maybe. First of all, you need to understand that the industrial infrastructure and industrial landscape developed differently. In Mexico, the development is primarily led by foreign investment and the initial investors particularly were large. Finished goods manufacturers, who were vertically integrated and provided essentially their own supply chain. In China, on the other hand, you had the dismantling of state enterprises, the encouragement of entrepreneurial activity that created a lot of potential suppliers, and manufacturers of a variety of goods from a vertically integrated economy. So what you're looking at here just brings that into focus. This is a number of industries. It shows you in blue what the internal supply level is in Mexico for that particular commodity or process. And when you look at the dark gray or band, that shows you the market opportunity in Mexico. So you can see from this, a number of processes and commodities where the supply in Mexico cannot meet even the demand from the manufacturers already operating in Mexico. So what this means is there's a shortage of suppliers and a necessity to import a number of these items. So aside from a smaller base of contract manufacturing relative to the economy in Mexico, you also have the fact that Mexican manufacturers have less need for marketing and distribution help. Most of them are perfectly capable of approaching the US market on their own if they wish to do so. So the benefits of a partnership aren't the same. When I was dealing with companies in China, particularly small and medium sized enterprises, they very much needed my assistance to sell their product in North America, to support their product in North America, and to provide engineering and technical assistance. Not the case so much in Mexico. It may be in some industries. But in most part, it's not. What this leads to then is higher costs. Because a lot of the Mexican manufacturers who could do the work you're looking for are well aware of the fact that there's a smaller, base more competition for their services, and because they have less need for your resistance in order to access the market in North America, they're able to charge higher prices for their services, even if their costs are lower. Another barrier that occurs frequently is financing. In Mexico, especially for small and medium sized enterprises, financing is expensive and access is difficult. Consequently, it's not uncommon for small and medium sized enterprises to look for accelerated credit terms to help with their financing, and to look to their customers for financing of both equipment and machinery and tooling. So that eliminates, of course, one of the big benefits of contract manufacturing. You're not getting extensive credit terms, and you still have to invest in machinery and equipment. Finally, because of the level of foreign ownership, in many cases, the company you're dealing with may in fact be owned by a much larger diversified company. And you can find yourself dealing with someone who may potentially also be your competitor. And that further diminishes the number of potential partners. So you can subtract contract in Mexico. Many people do it. And in certain industries, it's quite easy to do. There are many players and many people able to fill your needs. And others, there may be, in fact, no one. So first question is-- does a subcontracting manufacturer exist in your industry? A second question is-- do they have the technical ability to manufacture your product? And again, this is a function of the restriction of the market. There's not quite as much diversity. Third thing is-- are they price competitive? Even if they exist, they may have such a dominance in their market that they really don't need to provide you with a competitive price relative to what you're paying in China. You have to be willing to finance machinery and tooling if that comes up. It won't with every subcontract manufacturer, but it might. And lastly, you need to make sure there's no risk that your supplier could become a competitor. No, I'm not talking about intellectual property here. Mexico has very good enforcement of intellectual property rights. That's not a risk. But the risk that your supplier could take over your market can exist in a number of cases. And you need to be careful of that. So let's say a contract manufacturing doesn't work out for you. What are your other options? Well, you could form a joint venture or you could acquire a company. Good news is there's no restrictions on foreign ownership or partnership. So you can form any kind of type of company you want and any kind of joint venture. You gain an immediate base of knowledge and experience. And you also gain some market share. But much like contract manufacturers, targets for acquisition or joint venture are more limited and less easy to find. Assuming you can find one, you have to deal with due diligence, and that may be challenging. Now due diligence was small to medium sized companies is often challenging in any market. They may not be as careful about their record keeping and documentation, they may not be following all the conventions that we expect in terms of their accounting. So it can be difficult anywhere. But in Mexico, you have the added dimension that remedies may be much harder to exercise. So if you go into a due diligence situation, which is not ideal, and you rely on some reps and warranties, you may find them hard to exercise later on. Consequently, that's a challenge. Not about the case in every case. You may find the companies really well documented, and due diligence is easy and possible. But in other cases, it may not be. And lastly, there could be union risk. And I want to talk a little bit more about unions. First of all, unionization in Mexico is very prevalent. Virtually, all foreign firms are unionized in most Mexican firms. So the expectation going into Mexico is that you will be unionized. The right to unionization exists for any company in which there are 20 or more employees. So the employees have that right and will exercise it whether you want a union or not. There are red and white units. Now you probably heard about this. A red union is a union which is very politically active, very aggressive, and probably anti business, likely to strike difficult to negotiate with. A white union is a business union that is pro-business. Now they're still going to be pro employee because they are representing the employees, but they are known to be pro-business cooperative and to look for the entire enterprise, both employees and employers, to succeed for mutual benefit. And in many cases, the white unions are far easier to deal with than any union in the United States or any other Western country, and can be in fact be very beneficial partners in your business. Now one of the things you, of course, going to look for-- you're going to look for a company with a white union. But one thing you need to be worried about is hostile takeover. Hostile takeovers are permitted. So even if you find a company with a white union, if the employer or the union haven't really been looking after the employees as well as they should have been, and there are grievances and issues festering there, you could find yourself the subject of a hostile takeover. To defend against that, first of all, make sure that the relationships are good. But secondly, you want a union that is large enough and strong enough to effectively fight a hostile takeover if one occurs. Now a caution government support for unions is high. And in general, actually with respect to labor legislation, governments and courts tend to come down on the side of the employee rather than the employer. So you don't want to get into a conflict situation or to find yourself in violation of a law. It generally won't go well for you. So you want to work positively to defend yourself by having a good union and a good relationship with the union. So last thing, that is your employer can initiate unionization. Now this can only occur when you're starting an operation and hiring your first employees, you can invite a union in to be the union before you have any employees on board. You might be able to do that in a joint venture situation, depending on how your joint venture is structured and where your facility is and if it's a new one and so on. But you may not. You certainly can't do it in the case of an acquisition. In the case of an acquisition, they will either already have a union or the employees already have the right to choose their own union. So those are the cautions if you go into a situation for acquisition or joint venture. Where there's a red union or where there's a weak union situation and you're vulnerable to hostile takeover, you could be adding significantly to your risk. On the other hand, if you have the opportunity to establish a union, you can select one carefully, work positively with them, and end up with a long term partnership that can benefit all parties. So can you do a joint venture and acquisition? Certainly can. You just need to find a partner or target. And you need to make sure you can do due diligence effectively and not rely on remedies after the sale. And you need to make sure there's no significant union risk. If all three conditions are met, you've got yourself a joint venture and for acquisition opportunity that can succeed. OK, say none of those work, what's left? Well, you can start your own Greenfield operation. And it could be you or it could be your current supplier in Asia. Perhaps you can work in partnership with them, and it works out to mutual benefit for them to move manufacturing into Mexico and continue to supply you. 100% ownership and joint ventures and partnerships in any structure you want or allowed, as we've mentioned before. So that's wide open. You of course, gain full control over the structure of your organization, the timing of the way that your staff is assembled and organized. And you're entering a foreign investor friendly business environment. Mexico is a very positive friendly environment, interested in foreign investment and interested in foreign corporations entering the market. Foreign corporations generally have a high profile with Mexican employees. They like working for foreign corporations. So it's a very positive environment. There is always a but, of course. First and foremost, you may need to build or rebuild manufacturing confidence. Now that could be a big hurdle. It's one reason why I suggested that, perhaps, your current supplier who is otherwise going to lose the business might be interested in partnering or in fact investing themselves in Mexico to provide supply to you. But also, it is possible, because Mexico is a very industrialized technically sophisticated country for manufacturing, it's possible to hire people in almost every industry who have the necessary experience to run a factory. So even if you don't have very much or you need to rebuild manufacturing competence, you are probably going to be able to assemble a competent staff. And then of course, there are also consultants available throughout North America who can help support you. So it doesn't necessarily need to be a barrier, but you need to be conscious about it. Of course, you need to invest in machinery and equipment. But as we pointed out earlier, that may also be necessary with the subcontractor. And then you have the risk of operating in a foreign country. And then of course, this happens with the joint venture or acquisition as well. You're not familiar with the laws and business practices, business culture of that country. So there's always a risk. It's one of the reasons subcontracting is attractive. You don't deal with any of that. But as I'm going to show you, there are some options to mitigate that risk as well. There's two ways to manufacture in Mexico. One is to incorporate your own company, and the other is to operate a shelter. And as we mentioned earlier, the shelter provides a unique legal umbrella. This is established under Mexican federal law. And it was put in place probably 30 years ago to help foreign companies shield themselves from needing to understand all of the business culture and legal requirements in Mexico. So, key difference-- a corporation has permanent establishment and direct responsibility in Mexico, a shelter does not. So your shelter operation does not have that permanent establishment. The shelter provider is the one that has it. You aren't the employer record, you aren't the importer of records, you don't have direct liability. The shelter provider has all of those things. In the case of a corporation, of course, you do have. You both pay corporate tax. And the mechanisms and amounts are similar. So, little difference there. In the case of a shelter, because you don't have a legal presence in Mexico, you can't, within that entity, own property. So that the solution, of course, is you can also have a corporation. As I said before, you're allowed to incorporate as much as you want. So you can have a separate corporation for the purpose of owning property in Mexico. Or the alternative is you, of course, can own property outside of Mexico that you can sign to your shelter operation. That's generally how it's done. In the case of a corporation, you can, of course, own property, or you can also form another corporation for the purpose of say owning real estate and leasing it back to your operation. In both cases, you have complete control. You operate the shelter just like you would your own corporation. You have some services that are outsourced to the shelter provider, but you operate it in the same way. Both companies can be IMMEX. And in fact, shelter needs to be IMMEX. IMMEX is the government program that allows exporters to avoid value added tax. So very desirable program. But the limitations of the IMMEX program mean that a corporation that is IMMEX and exporting cannot do other activities. And that limitation requires, in the case of a shelter, that you have a separate company to do non IMMEX operations. And in the case of a corporation, if you have an IMMEX corporation, you may also need a non IMMEX corporation to do non IMMEX activities. You can't have a non IMMEX shelter. Finally, legal and structure incorporation for any of the corporations you decide to form, much like the United States or any Western nation. In the case of contract for a shelter, it's a legal contract, which may be an American contract if your shelter provider is an American company. It may be a Mexican legal contract if your shelter provider is a Mexican company. So let's look a little more detail of incorporation. 100% foreign owned, mentioned that a number of times, multiple companies permitted with a few restricted areas of the Mexican economy, manufacturing in one of them. But energy and a few others are restricted. But generally speaking, you can do whatever you want and own whatever you want. The corporation proceedings are similar to the US, and the options are similar like an LLC incorporated company shareholder public companies and so on. However, in Mexico, certain activities need certain types of companies. We've just talked about that with respect to IMMEX or-- you may be an IMMEX company and a non IMMEX company. In the case of a shelter, you may need a real estate company if you want to own the property. And your shelter operation which has no permanent establishment would act as your IMMEX company. So there are other restrictions. Obviously, shelter providers are a type of company. And this can lead to more incorporations than you would have elsewhere. But again, incorporation is easy, 100% foreign ownership is allowed in as many companies as you want or allowed. So not a big complication, but something to be aware of. So how do you incorporate? Well first of all, you need a permit to incorporate from the secretary of the exterior. And you have to specify your activities to make sure that you're setting up the right types of companies. And then you're not engaging in one of the few restricted activities, like energy, that's not permitted to. The incorporation proceedings typically take three weeks. You need to apply to the secretary of the economy if you want to be a Maquiladora or an IMMEX. And that takes a couple of weeks. In the case of a shelter, there are already an IMMEX or Maquiladora. So it's not a step you need to take. You need to complete some other registrations. If you start opening company, you need to register with the social services, you need to register with the municipality, you need to register with the state. Typically takes four to five weeks to get these all in place. And you need an IMMEX certification if you are going to be an IMMEX company. Now then you should become an IMMEX company, you're allowed to recover value added tax. But there's an option to avoid paying value added tax through the certification process. Of course, this is attractive from a cash flow point of view. But that certification is time based. Certain time hurdles have to be met in terms of your company operating for a certain period of time. And so six months to a year to get full certification. At shelters, again, of course, we're already certified. And lastly, the cost of incorporation is between $5 and $10,000 US typically. It can of course be much more complex and more expensive. But you can find many reliable accountants and lawyers who are capable of incorporating a company in that $5 to $10,000 range and doing it in the time frames we've mentioned here. Now let's move to the shelter company and see how it works there. So you have the non Mexican corporations not permitted to be a Mexican corporation to be a shelter. That's you, the foreign company. For sake of argument, we've said that's an American company. You have the shelter company. And I mentioned that we're actually a US company. But if it was a Mexican company, then they would be a Mexican entity. And between those two parties, you establish a contract. And the contract stipulates what the shelter company will provide, the legal entity they're going to provide, the legal umbrella, the services that are being provided, and the fact that they need to work under the direction of the foreign corporation, except when that's either impossible or illegal. In return, of course, it also specifies what the foreign corporation will pay for those shelter services. The shelter company then uses its entity in Mexico, which is it is recognized by the Mexican government as a registered entity to provide shelter services, to provide that legal umbrella. It's also IMMEX. And they'll use that entity to provide their services. We mentioned the Mexican government will look to the shelter company as the legal entity, and hold them accountable for compliance with laws and regulations. This is all in place, and the Mexican company, the contracting foreign company, can set up their Mexican manufacturing unit. It's going to look just like a subsidiary anywhere else in the world or an incorporated company in Mexico that they might set up. Their signage, their policies, their procedures, whatever practices they want with their employees, they want everyone to wear pink earmuffs, well then that's what they're going to do. So it's very much their entity. That Mexican unit will then look to the shelter company for whatever services its contracted for and those services it requires because it doesn't have a legal presence. So an example is wanting to hire someone. The Mexican unit will identify someone they want to hire, they may or may not use the shelter company to help them search for an employee. But once they've selected someone, then they will tell the shelter company who that person is, what they're paid. The shelter company will complete the registrations with the government, will establish a payroll account for that person, will pay them or withhold taxes and so on-- all of the legal side associated with that employee. The Mexican manufacturing unit wants to terminate them, they'll direct the shelter company to do so. And the shelter company will complete the legal termination of that employee. What else does a shelter do? Well, they provide a range of services. And in the administration area, they are typically capable of being the entire human resource department. So everything from recruiting through payroll, benefits, and conflict resolution can be provided by most shelter companies. You don't need a human resource department in Mexico. They can be your full import export department in Mexico, handling all the transactions that allow you to comply with the IMMEX, recovering all of the duties and value added tax that you're entitled to, and making sure your goods are properly documented moving back and forth. They can be your local purchasing department because you don't have an entity to purchase anything. So they can purchase goods in Mexico and then transfer that ownership to you in your home country. They can be your accounts payable department, paying the vendors in Mexico that you do business with. And they can ensure legal compliance. Under the regulatory category, they act as an advisor in terms of informing you of the regulations, auditing your facility, and ensuring that the regulations are in place, and dealing with any conflict or government complaints that arise inspections. On the other hand, because you are controlling your operation and directing it, it becomes your responsibility to ensure that your employer are in fact following the regulations. So it's a bit of a shared responsibility there. Some shelters provide facilities. In our case, we do have industrial parks where we provide buildings, we provide building maintenance. We also provide a range of shared services as do many other shelters. And these can include things like common bussing system where all of the client companies share a single bus system to get their employees to work. And therefore, it can be done in a much lower cost. It can include medical services, training facilities. And it typically does include shared security. Now those services that I mentioned incidentally can be provided whether or not a company is actually using the shelter legal umbrella. Sheltered companies can and do provide the range of administrative services to incorporated companies as well, and that's a permitted activity. However, in that case, the legal umbrella doesn't apply, the core incorporated company has to assume that. So what are the advantages? Well first and foremost, there's no learning curve. It's much faster because these shelter company, of course, already has all the people and facilities and infrastructure in place to do all of the activities necessary to administer your business. Secondly, there's expert assistance from experienced professionals who are also already all in place. So you don't have any need to hire expert professionals to manage the activities the shelter is conducting. You've outsourced your Mexican administration. So that means that's an area you don't need to manage, and you don't need to finance and provide facilities for. It's completely done by a third party. No Mexican legal or regulatory exposure. That is a significant benefit in terms of the early stage, particularly with respect to errors and omissions. You might be able to avoid doing anything illegal and probably would try very hard to do that. But the possibility of an error or an omission when you're new to a particular country or legal system is high, and there can be penalties for that and costs associated with that. These become the responsibility of the shelter. Lower investment and operating costs. You don't need infrastructure to support a bunch of functions that the shelter provider is going to do. Operating costs is lower because it's being spread over a large number of clients and a large number of people rather than the number of people in your facility. And lastly, critical mass is more easily achieved because you're outsourcing all of these services to a shelter provider who has a much larger critical mass at a very low headcount. You can achieve the economics associated with those larger scale operations, makes it much easier to launch and grow. And that, of course, is why even Fortune 500 companies with global reach consider using a shelter if their facility is either going to start at a much smaller headcount or is, in fact, going to be a small headcount operation for a longer term. It's economically favorable to outsource the activities to the shelter rather than having to create and pay for that infrastructure in-house. Let's go back to IMMEX for a minute. So IMMEX allows exporters to avoid or recover the value added tax. And the value added tax applies throughout Mexico on most goods and services. It's an attractive point, both from a cash flow perspective and from a cost perspective. The exports can be physical or virtual. Now physical export is obvious, you're going to ship something outside of Mexico or you're going to import something into Mexico from somewhere else. But they can also be virtual. And virtual means between IMMEX companies within Mexico. So goods can be moved between IMMEX companies on a supply or finished goods basis under the IMMEX program and not a value added tax. It requires an IMMEX legal entity. There is, in fact, IMMEX legal entities for Mexican companies as well. Everybody has to use the correct entity and comply with a bunch of criteria. And as I mentioned earlier, that means that non IMMEX activities typically to be done by a non IMMEX company. But there are requirements that need to be followed in order to maintain IMMEX status. And one of those requirements for foreign companies operating in IMMEX corporation or in a shelter is that their invoicing must be from a foreign entity. And this is how the government ensures that it's an export transaction. I'm going to explain how that works. So you have your corporation-- we'll say is either the customer or the supplier corporation in the United States-- both corporations have an entity in Mexico that is an IMMEX entity. So customer corporation issues the purchase order to the supplier corporation, and that's done outside Mexico. The supplier corporation sends a work order or some other communication that directs their Mexican manufacturing unit to produce the goods and ship them either directly to the customer corporation. Now we have an export transaction very clear. Or they can ship them within Mexico to the customer's Mexican entity. But in both cases, the invoice and payment must follow the same path as the purchase order and occurs outside Mexico. So only the physical transaction, in this case, occurs within Mexico. Now what if you do need to sell directly in Mexico? Either end user or somebody that needs a Mexican invoice for one reason or other. How do you do that? Well, let's take an example. ABC Corporation is a foreign company. They've set up an operation in Mexico which they own. It's an IMMEX operation. That's how they're going to manufacture in Mexico. And it could be a shelter or it could be incorporated, doesn't matter. But that's what they have operating. They have a customer in Mexico. Turns out to be an end user and requires a Mexican invoice. So they set up a trading company. It's owned by them. It is an incorporated company. It does have permanent establishment in Mexico. But it does not have to have any staff. It's used for transactions. And it can have staff. It doesn't have to. So ABC Mexico makes some things, they sell those goods to ABC Corporation in a foreign country. They ship those goods to the Mexican customer who's the end user. ABC Corporation, the parent, the foreign company, does a definitive importation through their trading company. So now the goods have been definitively imported back into Mexico. And the trading company executes the sale and invoice with the Mexican customer. This is a very common structure. Many companies in Mexico use it. Many of our clients use it. And so it's a very common way to deal with this particular issue. Now let's talk about location a bit. Mexico is a big country, and there are many options in terms of locations and many reasons why you might, for your company, choose one or the other. I can't cover them all. But let me say just generally that it is the North of Mexico where most of the industrialization is. And let's talk about a couple of areas to give you a flavor for some of the differences. First of all, the border area obviously has a big advantage. That is that it's adjacent to the United States. That allows staff to live on the US side of the border, if that's a benefit. But it also makes transportation in the United States very, very easy, and movement of people back and forth very easy. The border area has been industrialized for a pretty long time. We're talking places like Tijuana, Mexicali, Ciudad Acuna, Juarez, and so on. And these cities have a large-- most of them have a large industrial structure, many skilled people, many services available, often a lot of services just over the border on the US side as well. So they're attracted from that point of view. They typically have skilled employees available. On the negative side, there's higher wages, higher benefits, and consequently there's higher costs. And they're materially higher in the border zone. Secondly, turnover tends to be higher. There's a lot of transients. And in Tijuana, for example, turnover typically ranges between 12% and 16% per month. So that's a significant burden on recruiting and training. A third problem with border cities is the crime level or security level. Crime tends to be much higher in the border cities. And so security is correspondingly lower than elsewhere in Mexico. There's also another offset that you can consider, and we'll talk a little bit more about it. But within the border zone, there is an incentive provided by the government in some specific communities and subject to certain criteria that allows you to, in the case of value added tax, access a lower value added tax. But if you're IMMEX that doesn't matter. But it allows you to access a lower corporate tax rate as well. So there are some offsets that might apply. And we'll talk more about that when we get to taxation. Next option might be Sonora. Again, an industrialized area close to the United States. The Hermosillo for instance is four to five hours from the Arizona border by truck along good highways. Access to the Pacific Ocean in terms of incoming materials and outgoing materials and goods which might be a benefit. And good access to the West Coast of the United States. Sonora has been industrialized for a shorter period of time and has a lower level of industrialization. Consequently, wage rates tend to be lower. Turnover is a little better. But the skill sets and services are not quite as comprehensive as they are elsewhere. Now nonetheless, there are some pretty sophisticated industries operating there. Ford has quite a large assembly complex in Hermosillo. And Sonora is the center of the aircraft engine manufacturing cluster in Mexico with the greatest number of people in that industry operating there. So Sonora might be a West Coast option. The Northeast is the area of Mexico that has been industrialized for the longest. It includes cities like Monterrey, Saltillo, Chihuahua, Torreon. It's a highly industrialized area with high skill levels, lots of services, multigenerational manufacturing employees, excellent training. So an ideal area for manufacturing operations. It's further from the border and so in-- but not far. Monterrey, for example, two to three hours to Texas by truck. But that distance to the border helps to reduce turnover. Typically 3% to 4% per month, this is common in Monterrey. And so, much lower is the general rule. Wages are a bit higher than Sonora. But still, significantly lower than the border zone. And security is generally better than the border area. If you don't need to be close to the US border, then the Bajio is pretty attractive area. The Bajio includes the states of Queretaro, San Luis Potosi, Guanajuato and Aguascalientes. There are many cities in there that are possible locations-- Queretaro itself, Celaya, Leon, Guanajuato, Irapuato, and so on. Bajio has been more recently industrialized, but has seen considerable expansion primarily due to its location. It's in the center of the population of Mexico, and pretty much in the center, geographically, of Mexico. So it's an ideal area to supply the Mexican market, including supplying Mexican factories that are producing goods throughout Mexico for other industries. So in terms of supplying anyone who's located in Mexico, the Bajio is ideal. And the result of this expansion is that services and skill levels have been rising dramatically, and are generally competitive with other areas in Mexico-- not going to be as comprehensive as Monterrey-Saltillo area, for example, but certainly good for most industries and very viable. Another feature of this area is-- particularly in Queretaro, there has been inward migration. So not every city is the same here. But in the case of Queretaro, there has been inward migration. And inward migration of lower income people is uncommon in Mexico, but it does occur in Queretaro. And as a result of that, they have very attractive turnover. In fact, one of our clients in Queretaro has turnover in the range of 1 and 1/2% per month, which is good in any market in the world in terms of direct labor. So people are available, the wage rates are comparable to the Northeast, and the turnover is lower. The biggest drawback is the distance to the US border. There are, of course, other options. I'm not going to be able to cover everyone here. Each company that's listening will have their own reasons for looking at one area or another. For example, if you're in the electronics or software development field, then Guadalajara has got to be on your list. And if you're servicing Volkswagen, well then you're going to think of Puebla as an option, and so on. Let's talk about real estate a bit. You can see-- first of all, let me say that these are average lease rates in US dollars per square foot per month. It's common for Mexican landlords to look for US dollars in order to give them currency stability. But it's not necessarily the case. Some landlords will look for pesos. And some landlords will denominate the rates in US dollars per meter as opposed to US dollars per foot. Typically, rates are quoted triple net as they are in the United States and elsewhere. So you're going to have to add the taxes, maintenance and insurance on top of the base rate. Now you can see from looking at this particular graphic that along the border area, Tijuana, I'd say, is more expensive just as it is for wages in that region. And if you get down to include Manzanillo on this, which is a port city with a very big ocean port facility but relatively little manufacturing, and so manufacturing building prices there and, in fact, wages are much lower. So like any market, of course location, location, location. Those variations of building quality and so there's a wide range around these averages. But just, it gives you a flavor of what the rates are. And generally, they are competitive. Also another thing to consider, you can buy a building or buy property and build a building if you like in Mexico. But in many markets, the real estate is relatively closely held. And most of the landlords prefer the income rather than realizing the asset value. Consequently, availability might be low and prices might be high for purchasing as opposed to leasing, which is the more common choice. And in most markets, there's a good volume of leased facilities available, and plenty of developers willing to do, build the suit lease construction as well. One thing to be aware of even with leasing is if you are entering into a contract where the property is not serviced, it can be very expensive to service the property. This is also something to be aware of if property is offered to you on an incentive basis. Often that property is completely unserviced. It may not have sufficient power running to it. It probably doesn't even have a water or sewer line going by it. So costs can be expensive and a free property cannot be nearly as free as it seems. Just something to be aware of. Let's talk a bit about hiring in Mexico. First of all, qualified candidates are plentiful. Mexico has an excellent education system that graduates large numbers of managerial and engineering and technical people capable of fulfilling professional jobs. There's also strong emphasis on manufacturing, both in education and in the general economy. And manufacturing is still viewed as a favorable career choice in Mexico. At the direct labor level, as I mentioned earlier, there are plenty of people that have experience with foreign corporations, have experience in manufacturing. So in most markets, it's possible to find plenty of people with the skills that you need. The one caveat is skilled trades. Mexico doesn't have a certification and apprenticeship program as exists in many other countries. They are starting to implement that kind of a strategy. But for the most part, when you're hiring tradesmen, you'll need to verify that they have the knowledge and experience you're looking for. They do exist, but most of them have learned on the job. And consequently, the verification that you're getting exactly what you need isn't as easy as just looking up their certificate. Strong English language skills are readily available in the professional and managerial groups. It's an expectation. So you can easily find people with excellent skills there. There's no premium for having those skills in executive and professional class positions. If you're talking about clerical positions, then there is a premium. But again in terms of receptionists and clerical staff, there are plenty of people available. Just, you will pay a small premium over someone who doesn't have English. Direct labor, supervision, trades, people are going to have very limited English or none at all. They're going to speak Spanish and you need to be aware of that. Point to keep in mind is at technical and managerial staff have a reduced pay gap on a percentage basis to US pay scales compared to direct labor and even trades. As you move up the skill level, the gap lessens. If you're talking about general managers, these people are, of course, global commodities and they're mobile. And consequently, you may be paying a pay package very similar at that level to which you might pay comparably in the United States similar benefits and similar expense. Career path alignment is important at all levels in Mexico. I mention this because it can help to make you an employer of choice. And it can help to attract and retain people from direct labor up, people in Mexico like to know that they're going to receive training and development in their employment, and that there is some kind of a career path available. For those it doesn't necessarily mean that they need to know if they start as a mechanic on the line that they're going to be president of the company. But the fact that there is advancement opportunities and that those advancement opportunities are knowledge based is very attractive, and is something to give consideration and to ensure that you do implement at some level in your company. And lastly, references, of course, important in any economy. But in Mexico, there is a statutory severance law and it comes into effect the minute you hire someone. So there's a cost of termination immediately after you hire someone. You can deal with them on a contract basis for a short period of time without that obligation. But then once you hire them, that's it. So you want to be very careful. You want to make sure your references are done properly and completely. It's a good area to get some help-- first of all, because sometimes, getting information in Mexico can be challenging. And so knowing how to get that information and verify it is important. But also because it's an area you need to be diligent with. Not just from the point of view of somebody with fraud, but lack of qualifications or other issues related to employment can be a factor. Now, Mexico has relatively few restrictions on what can be asked of new hires and what can be used as a hiring criteria. That's good news, because when you do the reference checks and if you do them properly, you'll know whether that's an employee that you're going to have difficulty with or not. So hire carefully. Do reference checks, and you'll be quite successful. Let's talk a bit about taxes. I mentioned value added tax applies to most goods and services. It's called IVA in Mexico. And that's an abbreviation of the Spanish. Tax could be as low as 8% in particular areas along the North and South border. This is a temporary program that the current administration has put in. They have extended it to 2024. Whether it will exist beyond that is not at all clear at this point in time. And there are criteria required to access that 8% rate. Elsewhere, it's 16% throughout the rest of Mexico. Now as we mentioned earlier, this is not a factor for IMMEX transactions, but it is a factor for non IMMEX transactions. Corporate tax, similarly, there's a 20% rate in those specific municipalities where the incentive applies. There's a 30% rate elsewhere. In both cases, there is a safe harbor provision for companies that are operating in a non arm's length relationship, which, of course, most of you will be. In that case, you can use 6.5% of your assets or 6.9% of your expenditures in Mexico as a proxy for your taxable income and apply the tax rate to that and be done with it. Easy to do that calculation and decide whether you like it or not. If you don't, then it's also possible to do a transfer pricing agreement and to complete your tax return on that basis. In either case, Mexico has a tax treaty with the United States in effect with most other countries. So any tax paid in Mexico is able to be offset against tax paid in the home country. The predial or real estate tax is a primary source of income for municipalities. It ranges from 0.1 to 0.5% of assessed value. In the case of leased property, of course, the landlord's going to let you know what that component of the TMI is. In the case of property that you purchase or own on your own, this will apply. Usually not a big number. But it's important to know that it's there. And the state payroll tax is the principal source of revenue for the states in Mexico. It's applied on the gross payroll. It ranges from 1.8% to 2.9% depending on the state. And it's paid at the time that the payroll is paid to the employees. Now as we said earlier, IMMEX avoids the value added tax. And the predial and estate tax might be able to be delayed or deferred as part of an incentive package. At this point in time with COVID going on, incentives are really up in the air. But prior to COVID, Mexico was moving away from an aggressive incentive environment. They weren't seeing a need to incentivize strongly in order to attract companies. There were still some programs available that were useful in terms of training and development costs and in some states in terms of startup costs. But the bottom line is that the incentives were typically not of sufficient magnitude to sway a decision either in terms of where to locate in Mexico or whether to locate in Mexico or not. They just simply weren't of a magnitude where that was a big factor. On the other hand, of course, always pays to ask because it doesn't hurt the bottom line to have some assistance. Now I'd like to share with you some of the best practices for standalone manufacturing, and we're talking about new standalone manufacturing here. These have been gleaned from our client base and from other companies that we've done consulting work with, and I'd like to share them with you right now. So first of all, I highly recommend you start with a shelter. Of course, I'd like you to start with us. But if you don't, still consider a shelter. The reason for that is very simple. A shelter is something that you can move out of at any time. And if you start with a shelter, you're going to be able to go faster, you're going to have a whole lot more in place from day one than you would otherwise have. And you significantly reduce your risk. At the time when you feel competent to handle your own operation, you can move to a corporation very easily and stop your shelter relationship. Now we have companies that do that quickly, we have companies that do that never. So we have had companies stay with us for 30 years. It's your choice. But launching with a shelter, any shelter, is going to help you to reduce risk and increase your chances of success. No matter what you do, whether it's a shelter or whether you're incorporating on your own, choose some experienced partners. I can't emphasize enough. You want somebody who's done a lot of launching in Mexico, who worked with a lot of people and seen a lot of the problems that can arise and knows how to resolve those. A lot of companies rely on their receptionist's cousins, sisters, uncle who happened to have started a plan in Mexico five years ago. That person may be very good member of your team, but starting one plan or just knowing Mexico is not enough. You really want someone who's done this many times. And there are people out there. There are lawyers, there are accountants, there are consultants and there are shelter companies who've done this many, many times and can help remove a lot of barriers and reduce a lot of costs. Maintain tight financial controls. This is advice that comes out of our client base. And it may seem obvious in a way, but what they're really saying is in the early stages particularly, it's important to be paying very close attention to all of the financial transactions. And there are a multitude of reasons. Obviously, one is fraud. But more importantly than that, because there's a lack of history and because there are some differences in the economies and cultures, it's a process of education on both sides in terms of where money should be spent and where money shouldn't be spent. And it can work both ways. I had examples where my maintenance people thought they were doing a wonderful job for me not buying parts for my machinery. And by having tight financial controls, I became aware that that was happening and could intervene and say, I really wanted the machines to have the new parts, and I wanted spare parts on end. Appreciated their effort to try and help me financially, but that wasn't a good choice. Simple examples like that. As you grow and become comfortable with each other and understand what's expected, you can loosen those controls perhaps and give more responsibility to your Mexican stuff. But initially, it's a key thing to be reviewing all of those financial transactions. Our clients also recommend that you communicate clearly. Now again, this seems pretty obvious. But what they're saying-- and then some of you, if you have dealt with Chinese suppliers who have been through some of the same kinds of issues-- but what they're really saying is two things. First of all, remember, a lot of people speak Spanish. If English as a second language for them, even if they seem to speak English really well, there may be gaps. And those gaps can translate into misunderstandings. And that kind of goes hand in hand with the second thing, which is that culturally, in Mexico, Mexicans tend to be very polite, courteous, to try to avoid conflict, and they want to be-- they want to help people. They want to be perceived as helping. And that translates into a culture where it's better to encourage or agree to something than disagree. And that can be misunderstood particularly by Americans who are from a culture where we expect clear speaking, we expect people to say no when they mean no and to say yes when they mean yes. But that's not necessarily the case in Mexico. Sometimes what you might think is a yes is, to a Mexican, a maybe. And you may have seen some of that in China as well. There's differences there too as, I guess, there are with any culture. So I point that out because many of our clients talk about that and about how you have to start to learn to really be sure that, on both sides, that what's a yes is understood as yes, what's a no is understood is a no, that everything needs to be on the table is on the table and dealt with, and that the messages have been clearly understood on both sides. And if you do, if you take time for that, eventually, it's not an issue and companies move smoothly forward. Another thing our clients have learned is to provide for comfortable travel. In the first year, most clients will say that face time is critically important with as many employees on both sides as possible. And obviously, that's difficult right now with COVID. But in a non COVID environment, that face-to-face interchange-- and this, by the way, applies even if you're dealing with a contract manufacturer. Face time in the early part of the business relationship goes a long way towards making sure understanding is there and making sure things go smoothly and a business relationship that's effective for both parties is established. Now many of you may have had that experience in China or elsewhere in the world. So I'm speaking to the-- preaching to the choir. But I think it's worth mentioning. Our clients have used all kinds of mechanisms here. Mexico has a lot of options for, in most venues, for service departments and furnish departments and other kinds of long term stay accommodation. Some clients have purchased houses or rented apartments. Same with vehicle travel-- some companies buy vehicles, some companies negotiate with driving services, some do just rely on taxis and shared rides and so on. But thinking it through can help for your cost significantly. And for the employees that are going back and forth, they can make travel more comfortable and more attractive. And that, for the long term, can be beneficial to your operation. And perhaps the most important word is to train aggressively. And this again applies whether you're dealing with a subcontractor or whether you're actually dealing with your own operation. It's important to know that there's no native knowledge in place and many of the companies that our clients of ours entered into their Mexican operation, not having done a new relationship of that type for quite some time. And it's easy, even in a well documented company with great training materials already in place, to forget that that native knowledge, it takes a while to establish, and it's very difficult to make sure that that's transmitted. So attention on training, providing lots of material, providing materials in Spanish-- you reach the five year horizon, it probably won't be necessary because the native knowledge will be in place. But initially, that's a very effective way of ensuring that operations go smoothly and that information gets transmitted. What do you do next? All this looks good. You need to move forward, you like the Mexican option. What do you do? Well, first of all, think about what gateway works for you and investigate the gateways that you think you're interested in. You may need some help with that. So talk to some experienced advisors. People like shelters can help for sure. But there are plenty of others-- lawyers, accountants, consultants, all kinds of advisors out there that have experience and can help you decide what gateway to use and provide you with more information about Mexico. Select a support team. And I think the earlier you develop a project team that includes your advisors and the people in your organization who are going to implement the plan, the better. Have that group develop your manufacturing plan. And as always, good plans make for good results. It's not that they don't change, but the exercise of planning helps you anticipate and develop strategies for dealing with whatever is going to come down the pipe. And doing that at an early stage, I think, is quite helpful and our clients would say the same. And then estimate your costs to find out if it's viable. Now this is something that you're probably going to need help on. It's difficult to get cost information that's reliable in Mexico. It's not as easy as it is in the United States to get costs and determine if they're reliable in many cases. So get some help on this. Certainly, shelter companies should be able to help. They have data from a lot of client operations. We certainly do. We have a very detailed cost model as well that you can access to help you to determine what your manufacturing costs are going to be. But there are other people that can help with this. And so find someone that can help you estimate those costs. And as if all of this falls in place, you've got a way to move forward is very likely to succeed. I'd like to ask if we can help. A couple of areas we can deal with. First of all, if you need help deciding which manufacturing options to pursue, we can guide you further than we have in this presentation. We can also direct you to other people who can guide you for particular requirements if we're not able to assist you. If you need help finding a supplier or contract manufacturer, once again, we might be able to help. If not, we know competent consultants who can help and operate in particular sectors. And we can probably direct you to them. If you need more information on doing business in Mexico, I've covered a lot of ground here. I'm sure you haven't been able to get enough information on every point that is of interest to you. So please, don't hesitate to call us. We can, once again, either provide the information or, if necessary, direct you to someone else who can. And if you need help estimating of those manufacturing costs, as I mentioned, we have a comprehensive estimating system. We'd be glad to help you work through that and determine what your costs are going to be with high level of accuracy. So contact us. We'll help you find the answers to your questions, or we'll recommend a reliable professional who can help you. That's everything for today. Thank you very much for listening to our presentation. Our contact information is here. Please reach out to us if we can be of any more assistance. And good luck with your strategy for Mexico.