Establishing dispersed operations in Mexico for an automotive systems supplier - A diagnostic approach

Contents

Abbreviations

Figures

Tables

0. Preface

1. The understanding of dispersed operations

2. The automotive supply industry: Status quo and global developments
2.1 The German automotive supply industry – Facts and figures
2.2 Abstract of trends in the global automotive supply industry
2.2.1 Development of the global automotive production
2.2.2 Increase of the automotive value
2.2.3 Value percentage of the automotive systems suppliers
2.3 The automotive supply industry in the flux: From components to systems supplier

3. Description and critical view on the forms of dispersed operations for an automotive systems supplier in Mexico
3.1 Export
3.2 Sales office
3.3 Production settlement – Maquiladora
3.4 Acquisition vs. formation of a company
3.5 Foreign Direct Investment
3.5.1 Wholly owned subsidiary
3.5.2 Joint Venture

4. Influencing factors for the prosperous exposure of an automotive systems supplier in Mexico
4.1 State and development of the Mexican economy and politics
4.1.1 Mexico – Facts and figures
4.1.2 The political situation in Mexico
4.2 The Mexican market for automotive systems
4.3 The choice of location
4.3.1 Sales potentials
4.3.2 Resource acquisition pool
4.3.3 Available skills pool
4.3.3.1 The personnel policy and expatriates management
4.3.3.2 Labour unions
4.3.3.3 Labour costs
4.4 Financials
4.5 Cross-cultural aspects of business activities in Mexico

5. Conclusion

Appendix

Bibliography

Abbreviations

illustration not visible in this excerpt

Figures

Fig. 1: The value chain in the automotive industry

Fig. 2: Capacity utilisation in the automotive sector

Fig. 3: Average selling price for new vehicles in the U.S. market

Fig. 4: Value added OEMs vs. suppliers

Fig. 5: Mexico physically

Fig. 6: Alternatives of external financing at international enterprises

Fig. 7: Time required to set up a business in Mexico

Fig. 8: Start-up costs in Mexico

Tables

Tab. 1: Production volume traditional and growth markets

Tab. 2: Legal minimum wages in Mexico 2007 (MXP per day)

0. Preface

Dispersing operations in foreign countries is not a development in only recent years and we can face it almost daily in the newspapers and on TV. Not only by the takeover waves among big multinational companies in the late nineties (for instance the lastly loosed merger of Daimler and Chrysler) but also by the riots in the run-up to the 33rd G8 Summit 2007 in Germany the issue of globalisation was spotlighted to the general public.

Based on the economic research this diploma thesis addresses the topic of dispersed operations and should give advice and instructions how to reach a successful access to markets in foreign countries in practice. Since the international orientation of enterprises cannot be generalised and is different (among other things) from branch to branch the establishment of dispersed operations is examined for the example of an automotive supplier starting business activities in Mexico. The automotive supply industry seams to be very applicable for such an analysis as the traditionally very internationally oriented automotive manufacturers, i.e. the customers of the suppliers, were notably influenced by the consolidation processes in the last years and decades. Considering this the question needs to be posed if this alteration of business conditions has impacts on the suppliers as well.

The United Mexican States as one of the biggest economies in Latin America are a quite popular location especially among the North American investors for a long time. Mexico connects (not only physically) the huge markets of Canada and the United States of America with the BRIC state of Brazil which is considered by many experts to be the growth market of South America in the next years. Since all well-known vehicle manufacturers run representations on the Mexican market it suggests examining the international orientation of automotive suppliers in respect of especially this market.

In the first chapter of this thesis the term of “dispersed operations” is defined and explained against the background of the present situation. Subsequently, the reader is introduced to the automotive supply industry. Here general facts and specifications of this particular sector are given and the influences of global developments on the German suppliers are presented in order to elaborate a change in demand in the automotive industry finally. The third chapter describes an outline of the different options the suppliers generally have to disperse their business operations. Thereby, the elaborations dwell on the specific Mexican determining conditions and analyses them against the background of the supply branch.

The focus of this thesis is put on the following fourth chapter. Starting from general information about the Mexican economy and the political situation this chapter looks into the local sales market and examines the sales prospects. In the course of the chapter several aspects concerning the choice of location are illustrated. However these aspects shall not serve as a guideline for a market entrance but rather give the reader a comprehension for the multifaceted risks and opportunities waiting for the supplier in the Latin American country. After the “hard facts” like sales potentials, labour costs and financials the cultural point of view plays a decisive role for the success of such an engagement in a foreign country. Thus, this criterion is thrown light on at the end of the fourth chapter. Finally the fifth chapter concludes the main results of the thesis and takes on the most important issues of the establishment of dispersed operations in Mexico for an automotive systems supplier.

The diploma thesis in hand would like to provide suggestions and encourage the reader to give some thought to an investment on the Mexican market. If it succeeds to point out the future potentials and challenges of this market to some readers and to motivate to reflect on the future of the automotive supply industry a major concern of the author will already be satisfied.

1. The understanding of dispersed operations

The term “dispersed operations” allows various interpretations and should be understood as a collective term for a multitude of processes and activities. From the enterprise’s point of view dispersed operations in the context of internationalisation can be grasped as sustainable and significant foreign activities. For instance, an enterprise indeed runs settlements in a foreign country but those transactions are - compared to the total business volume – not significant so it is still not an international enterprise in the sense of the definition. The comprehensive description already indicates that there are differing characteristics of dispersed operations, starting from a high export proportion of the total turnover to the point of foreign direct investments with subsidiaries, production plants and joint ventures in all parts of the world. In this last-mentioned, most extensive case you can talk about globalization tendencies.^[1]

The level of dispersed operations can be measured on the basis of many different indicators, e.g. the revenues achieved in the foreign country, the number of employees in the foreign country, the number of foreign subsidiaries, etc. However the numerous approaches discussed in the literature are strongly varying and could not lead to a standardised explanation. In general the quantification of the individual characteristics can detract from the fact that the dispersed operations trans-sectorally affect the whole enterprise so you have to consider it critically. By dispersing business operations in a foreign country the corporate culture, objectives, strategies and mindsets and behaviours of the management as well as the employees will change to a great extent. So you can draw the conclusion that the level of dispersed operations is rather reflected in the last-mentioned changes than in export quotas or the number of foreign subsidiaries.^[2]

Beside the aspect of internationalisation dispersing operations can be considered in the context of a market entry strategy, too. That means that the enterprise has to examine explicitly several alternatives of how to gain access to a foreign market. Accordingly, the reduction of dispersed operations to questions of distribution or marketing and their challenges is too narrow because other operational tasks like financials, purchasing or research and development can cross borders as well. Dispersed operations are processes and transactions that comprise (at least conceptually) the enterprise as a whole. Thus, a solely function-specific view on the cross-border expansion does not seem to be appropriate.

The same applies for the limitation of the term to the first start of foreign businesses. Consequently when the enterprise is about to establish dispersed operations in a foreign country it has to face several completely differing (i.e. different from country to country) circumstances influencing the whole value chain.^[3] In addition to the legal, political, environmental and last but not least cultural conditions, a great effort is allotted to the acquisition of information and the planning process. In some countries this is very difficult since governmental forces hinder foreign investments for reasons of protectionism. If protectionism is also a problem for the automotive supplier intending to enter the Mexican automotive system market will be examined in the course of this diploma thesis.

To sum it up and making the point, in the context of the further considerations dispersed operations will be interpreted as a bundle of procedures and alternatives to achieve a successful entry in a foreign (selling or purchasing) market. These activities will especially be discussed against the background of a German manufacturing enterprise in the field of the automotive supply industry.

2. The automotive supply industry: Status quo and global developments

Having explained the relevant aspects of the comprehension of dispersed operations in the first chapter the description of the automotive supply industry is now proceeded. After the illustration of general facts and figures with regard to the automotive supply industry the growth prospects respectively trends are to be determined. Furthermore the reader is given an outline of the change in this branch which brings the supplier companies to an adaptation to the altered requirements. This change is essentially characterised by the increasing request for completely assembled modules and systems instead of single automotive parts or rather components on the part of the OEMs.

Excursus: Tiers and Mega-suppliers

The structure of the automotive supply industry can be divided into several levels of production with the automobile makers on top. Thereunder you find the suppliers which are sub-divided into the several production stages (i.e. tiers). At this point, you distinguish between tier 1, tier 2 up to tier n suppliers whereas the term tier 1 stands for the direct suppliers for the OEMs as the suppliers of all the other tiers are not directly supplying the automobile manufacturers. Thus each supplier can be assigned to a production stage along the value chain (see fig. 1). Sometimes, the OEMs are also labelled by their production stage so that they are called tier 0.

Fig. 1: The value chain in the automotive industry^[4]

illustration not visible in this excerpt

As an exception, the so-called tier 0.5 suppliers are not only characterised by their direct connection with the manufacturers; they also act as an “automaker without brand”. That means they are responsible for a complete model range (containing R&D and production) of the manufacturer.^[5]

Mega-suppliers are large internationally-active suppliers with a strong connection to the OEMs. They are typically accessed to the production stages tier 0.5 and tier 1. However, an exact differentiation from other tiers is not always possible so that sometimes tier 2 suppliers can belong to the group of mega-suppliers, too.^[6]

2.1 The German automotive supply industry – Facts and figures

In the German automotive industry, about 80 % of the companies are industrial medium-sized businesses which generate half of the total German business volume. Nearly 70 % of all employees are working in this business sector.

In 2005 the number of employees in the automotive supply industry remained at 329,000 people which is corresponding to the level of 2004. Meanwhile the OEMs cut about 7,000 jobs so that nearly 43 % of the total number of jobs in this branch was employed in the supply sector.^[7] As a result of large overcapacities (see fig. 2) the manufacturers will be triggered to reduce more jobs which will probably cover negative employment effects for the suppliers as well.^[8]

Fig. 2: Capacity utilisation in the automotive sector

illustration not visible in this excerpt

In 2005 the German automotive supply industry caused revenues of 68.2 bn Euros which was a plus of 4 % compared to 2004. The inland turnover gained a plus of 3 % to 39 bn Euros and the overseas revenues grew by 6 % to 29 bn Euros compared to the preceding year.^[9] In contrast to the automobile manufacturers (32.7 %)^[10] the suppliers did the bigger part of their turnovers within Germany (57.4 %).^[11] One of the key factors of success is the creation of technological innovations. That is why the automotive branch spent 16 bn Euros for research and development activities in 2005 which is about one third of the total German industrial R&D expenditures.^[12] These efforts can certainly be explained with promising return expectations that will be analysed subsequently.

2.2 Abstract of trends in the global automotive supply industry

Despite of currently stagnating revenues, the automotive supply industry still covers significant growth potentials. This assumption mainly derives from three fundamental developments: The development of the global automotive demand,^[13] the increase of the automotive value and finally the rising value percentage of the automotive systems suppliers. In the following these three developments will be described.

2.2.1 Development of the global automotive production

The automotive industry faces a strong increase in its production outcome till 2015. This assumption is documented by the survey “Future Automotive Industry Structure (FAST) 2015” which was published by Mercer Management Consulting and the Institute Fraunhofer in 2003.^[14] At first the survey differentiates two groups of markets: The traditional and the growth markets. The NAFTA states, Western Europe and Japan form the traditional markets whereas Eastern Europe, China, South America, Asia, India, South Korea and ROW outline the growth markets. Table 1 shows the number of production units for the traditional and the growth markets in the years 2002 and 2015.

illustration not visible in this excerpt

According to table 1, the number of vehicles in the growths markets will double in the considered period of time so that an enormous dynamic is expected in these regions. This development offers great growth opportunities for the automotive supply industry as well provided that the enterprises are able to cope with the new functions assigned to them by the OEMs.

2.2.2 Increase of the automotive value

In addition to the growth of the global automotive production the development of the car prices has proved to be very dynamic. Regarding the U.S. automotive market as “the largest automotive market in the world”^[15] the average retail selling price of a new vehicle was 20,450 US$ in 1995 whereas it was 28,400 US$ ten years later (see fig. 3).

Fig. 3: Average selling price for new vehicles in the U.S. market

illustration not visible in this excerpt

As McAlinden and Andrea found out in their 2002 study on the “New Automotive Value Chain” these rising sales prices are basically due to an enhancement in value of the electrics and electronics in the vehicles. Nowadays the value percentage of electrics and electronics installed in the cars is around 25 % whereas it might be up to 40 % in the year 2010. In consideration of the fact that nearly each new vehicle is equipped with airbag systems (i.e. driver-side, passenger, side-impact airbags), ABS and electric centralised door locking this is not very remarkable. Furthermore the equipment components quota of power window lifts, air-conditioning systems and ESP has been mounting extensively. Even more elaborate interiors like cruise control or route guidance systems more and more belong to the standard equipment in new cars.^[16]

These and other systems are developed nearly completely by the automotive supply industry and therefore they result in an increase of the value added of the supply sector. The success of electric and electronic devices in the vehicle can be traced back to the willingness of the customer to spend money on vehicle safety and comfort. In consequence the automotive suppliers operating in those segments will be facing the largest growth potentials.

2.2.3 Value percentage of the automotive systems suppliers

Corresponding to FAST 2015 (see above) the automobile manufacturers will more and more focus on branding and marketing activities. Accordingly the suppliers are more and more adopting the non-brand-forming functions in the manufacturing process. Besides the survey predicts a growth for the automotive supply sector of more than 70 % till 2015 because of an increasing value added from 417 bn Euros in 2002 to 700 bn Euros in 2015 (see fig. 4). In order to be able to cope with this huge growth the suppliers need to create 3.3 m new qualified jobs worldwide.

Fig. 4: Value added OEMs vs. suppliers

illustration not visible in this excerpt

With regard to the different types of automotive components you can state that all modules will benefit from this development with a special emphasis on the electronic parts. Corresponding to FAST 2015 today’s average car is equipped with electronics of about 2,220 Euros whereas the value of on-board electronics will be 4,150 Euros in the year 2015. Because of a simultaneous increase of the production volume (see 2.1.1) the value added of electronics will rise from 127 bn Euros to 316 bn Euros (global view). Concerning the employment situation this development means more than 600,000 new jobs (especially for the car electric suppliers) in Europe because premium brands like Audi or BMW with comparatively high functional claims and value added will expand above average.^[17] In contrast the job count at the car manufacturers will slightly decline; Japan and the NAFTA states will chiefly be affected by that.

Beside the electronic components the drive chain modules will register a strong plus in the supplier value added of 5.9 % from 2002 to 2015 which means an absolute growth of 38 bn Euros.^[18]

To sum it up you should point out that the growth potentials mentioned above can only be utilised by those suppliers who invest efforts to prepare themselves for the challenges of the future. That means that they will only benefit from this outsourcing effect of the OEMs if they can enlarge their skills (especially on the electronic sector). Moreover the development of the global vehicle production (see chapter 2.2.1) gives reason to set on the internationalisation endeavours of the suppliers. This aspect will be specified in chapter 3. Finally it should not be left unsaid that the optimistic forecast of a 70 % growth is a one-sided perspective. Beside increasing turnovers the supply industry has to look forward to better profits. So the branch has to suffer from low return on assets and the increasing cost pressure.^[19] The resulting structural changes will be considered in the next chapter.

[...]

---

^[1] Comp. Casson, M., Mol, M. J., Strategic alliances – A survey of issues from entrepreneurial perspective, in: Shenkar, O., Reuer, J. J. (eds.), Handbook of strategic alliances, 2006, p. 19.

^[2] Comp. Beaumont, P. B., Human Resource Management: Key concepts and skills, 1993, p. 47f.

^[3] Comp. Caves, R. E., International differences in industrial organization, in: Schmalensee, R., Willig, R., Handbook of industrial organization volume 2, 2003, p. 1227f.

^[4] Comp. Gogolin, M., Electronic market places in the automotive industry, p. 27, [www.wi.uni-muenster.de/wi/studieren/izi/ss05/IOS_05_07_emp-automotive.pdf], 2007-03-21.

^[5] Comp. Maurer, A., Dietz, F., Lang, N., Beyond cost reduction – Reinventing the automotive OEM-supplier interface, p. 13, [www.bcg.com/publications/files/Beyond_Cost_Reduction_Mar_04.pdf], 2007-03-25.

^[6] Ibidem, p. 12.

^[7] Comp. Verband der Automobilindustrie (eds.), Auto Jahresbericht 2006, 2006, p. 183f.

^[8] Comp. PricewaterhouseCoopers (eds.), Supplier Survival – Survival in the modern supply chain, w/o author, p. 3, [www.pwc.com/extweb/pwcpublications.nsf/docid/4EFBA3D2E36509CC85256B

DE006BEC7B], 2007-03-22.

^[9] Comp. Verband der Automobilindustrie (eds.), l.c., p. 46.

^[10] Ibidem, p. 183.

^[11] Ibidem, p. 46.

^[12] Comp. Verband der Automobilindustrie (eds.), Competitiveness of the German automotive industry in Europe - Challenges and need for action, w/o author, p. 3, [ec.europa.eu/enterprise/automotive/

pagesbackground/competitiveness/stakeholder_consultation/vda.pdf], 2007-03-22.

^[13] Comp. Benko, C., Global automaker growth strategies, [www.pwcautomotiveinstitute.com/

rating.asp?sub=in], 2007-03-22.

^[14] Comp. Hertel, G., FAST 2015, [www.mercermc.de/veroeffentlichungen/studien/branchenkompetenz/

automobil/layout_automobil/browse/2/article/studie_von_mercer_und_fraunhofer_institut-1.html], 2007-03-23.

^[15] See McAlinden, S., Andrea, D., Estimating, the new automotive value chain – A study prepared for Accenture, p. 15, [www.cargroup.org/pdfs/CAR2002_7.pdf], 2007-03-30.

^[16] Ibidem, p. 20ff.

^[17] Comp. Hertel, G., l.c.

^[18] Comp. Hertel, G., l.c.

^[19] Comp. McAlinden, S., Andrea, D., l.c., p. 37.