Publish in Perspectives - Wednesday, July 5, 2017
Audi’s plant in Puebla – the first dedicated luxury automotive plant in the country – opened in late 2016 and is producing the Q5 SUV. (Photo: Audi)
Mexico eclipsed Brazil in 2014 to become the largest vehicle producer in Latin America. Source: Euromonitor International.
Despite a cold shoulder from Trump, manufacturing cars in Mexico makes sense.
BY ERIC TOTARO
As Donald Trump tries to revive an American manufacturing base, automotive production in Mexico has come under scrutiny. Many global automakers already operate plants in Mexico, attracted by its strong economy and stable government, but uncertainty surrounding trade deals such as NAFTA – the North American Free Trade Agreement – have called into question the long-term value of these investments. Given uncertainty surrounding NAFTA and its current reliance on the United States as an export destination, Mexico’s future lies in becoming a global export hub for premium automakers’ entry-level vehicles and as a regional base for automakers expecting strong growth in Latin America, particularly Chinese brands. These two areas will allow Mexico to diversify its export base and hedge against uncertainty in the United States.
Mexico’s steady GDP growth and government make it an attractive base for capital-heavy investments like automotive manufacturing. Among Latin American countries, Mexico’s economy ranks second in size only to Brazil. Mexico eclipsed Brazil in 2014 to become the largest producer of vehicles in Latin America, a trend that is expected to continue for the foreseeable future. Mexico’s position as the number one manufacturer in the region signals to automakers that the country has the capacity to produce vehicles that can be distributed beyond just Latin America.
HUB FOR PREMIUM AUTOMAKERS
One of the biggest pieces of automotive-related news to circulate about Mexico in recent months has been the cancellation of Ford’s plant in San Luis Potosí. The cancellation appeared to be an apparent boon to American industry as Ford announced that the production of its Focus sedan would remain in Michigan rather than moving to Mexico. However, in June 2017, Ford announced that Focus production would be shifted to China instead as demand for small sedans wanes in the Americas.
While Ford’s decision to shift Focus production from Mexico to China will relieve cost pressures for a slow selling vehicle, it does not mean that Mexico cannot offer advantages to vehicles with healthier margins or automakers with different distribution models. The Ford Focus is made in several plants around the world, and the Mexican plant would serve as a manufacturing base for only the Americas. Meanwhile, Audi and BMW have affirmed their commitment to Mexico and plan to distribute the vehicles they manufacture there globally. Audi’s plant in Puebla – the first dedicated luxury automotive plant in the country – opened in late 2016 and has an annual production capacity of 150,000 vehicles, all Q5 SUVs. BMW’s plant in San Luis Potosí will open in 2019 and will follow a similar model of exporting vehicles globally.
Audi and BMW have strong brand equity, which makes it easier for them to produce accessibly-priced vehicles like the Q5 SUV in Mexico without diluting their premium image. Production of flagship vehicles like the Audi A8 and BMW 7-Series will likely remain in Germany; however, high-volume entry-level and mid-range vehicles produced in locations with cheap labor pads the bottom line. Global consumers, while likely to view Mexico as an inferior production location compared to Germany or the United States, will react better to buying a Mexican-made Audi or BMW than one made in China.
Premium automakers’ shift to low-cost production centers parallels the shift that has happened in recent decades among premium apparel brands, which now manufacture substantial portions of their product lines in places like Eastern Europe and Southeast Asia with a few ultra-premium lines still manufactured in their country of origin. Consumers have accepted inexpensive manufacturing locations as a cost of doing business as long as brand image and quality do not suffer.
The opening of Audi’s and BMW’s plants in Mexico also raises long-term questions about the sustainability of manufacturing hubs like the BMW plant in Spartanburg, South Carolina. The South Carolina BMW plant opened in 1992 and produces SUVs including the X3 and X5 that are exported around the world. If Audi is able to undercut BMW in profit margin by producing similarly sized and priced vehicles in Mexico, BMW may be tempted to respond by shifting a significant portion of its production from the United States to its Mexico plant for vehicles destined for global markets.
MANUFACTURING BASE FOR CHINESE BRANDS
A plant in Mexico enables Chinese automakers to grow their brand presence in the region without taking away production capacity in the still-booming Chinese market and appeal to consumers who may negatively view a product made in China. Chinese-designed cars also tend to include emerging technologies quicker and more affordably – albeit with poorer quality – than Western brands, which will enable them to target price-sensitive Latin American consumers more effectively than their Western counterparts.
According to JATO Dynamics and Euromonitor International, the total brand share of Chinese automotive brands in Latin American countries is under one percent. However, the Chinese manufacturer JAC Motors announced a partnership with Mexican billionaire Carlos Slim Helú in early 2017 to produce two Chinese-designed SUVs at a plant in Mexico, with the goal of distributing the vehicles throughout Latin America. This trend will likely continue as demand for vehicles like SUVs is expected to grow in the region. Other Latin American countries that have made commitments to curbing greenhouse gas emissions (e.g., Costa Rica) can fuel demand for cheap Chinese-designed electric vehicles that American- or European-based brands cannot compete with due to price constraints.
Additionally, because many Latin American countries have less stringent safety regulations than the United States or Western Europe, Chinese companies can manufacture high-margin vehicles like SUVs in Latin America without facing research and development costs from homologation.
ABUNDANT OPPORTUNITIES, BUT RISKS REMAIN
Despite the potential for premium marques to export products globally from Mexico and for Chinese companies to use Mexico as an entry point to grow their presence in Latin America, Mexico’s automotive sector faces risks stemming from its dependence on the United States as an export destination and changes in macroeconomic conditions that would affect the attractiveness of Mexico for premium or Chinese automakers. To lessen Mexico’s dependence on the United States, now is the time for it to leverage its strong economy and stable government to attract even more automotive companies looking to export vehicles beyond just the United States. Mexico must also balance a highly-qualified yet affordable labor force to avoid companies outsourcing vehicle production from Mexico to a place like China in the event of an economic downturn.
Chinese automotive companies, although currently enjoying high levels of growth at home, may aggressively try to export vehicles globally if their domestic economy faces a downturn. Cheap Chinese exports have the potential to undermine even Mexican-made vehicles, but the threat can be mitigated if Mexico insists upon equitable trade terms and does not allow China to dump underpriced vehicles in its market.
Eric Totaro is Automotive Industry Analyst at Euromonitor International. This article was written for Latinvex.
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