Solid reasons remain for manufacturing in Latin America, despite new Asian competitors

Mixed economic signals in multiple countries make Latin America a region that manufacturers may find tempting to invest in, but it's also one in which investments have to be watched closely.Source: United Nations Economic Commission on Latin America and the Caribbean

By Cole Ollinger, contributing editor August 20, 2007

The outlook for Latin American manufacturing is decidedly mixed.

Pessimists see currency fluctuations, runaway inflation, excessive regulation, gray markets, stiff competition from China, and socialist-leaning governments. They point out annual per capita gross domestic product (GDP) growth has been negative since 2000.

Optimists are encouraged by a business-friendly Mexican government and bright prospects in life sciences, biofuels, and IT outsourcing. They suggest a regional economic recovery is under way. As New York-based McKinsey recently put it, “Latin America’s prospects are brighter than at any time in the past quarter century.”
“It’s true Latin America has had too much political volatility, regulation, and gray market activity to be appealing for manufacturing investment,” says Steve Hochman, a director with Boston-based AMR Research . “But one common misconception is that Latin American economies are too small to justify any sort of investment.” In fact, the region’s total GDP is $2.6 trillion—equal to China’s and three times larger than India’s, Hochman notes.

A country-by-country analysis shows plenty of sliver linings, but also grey clouds that never quite seem to dissipate.

Brazil’s growth potential and economic importance on the world stage, for example, can be seen by its membership in the “BRIC” countries—e.g., Brazil, Russia, India and China—first cited by Goldman Sachs. Beyond Brazil’s growing consumer market and rich natural resources, there is opportunity in biofuels.

McKinsey estimates Brazil could have 10 percent of the world’s ethanol market, which may reach 50-200 billion liters in a dozen years.

But to meet demand, large-scale investments in plants and infrastructure are required. There’s also risk involving U.S. tariffs and China’s rice-based ethanol industry.

What’s more, according to McKinsey, Brazil’s gray markets account for an astounding 42 percent of GDP, versus 16 percent in China. Reining in the “informal economy” could be worth an extra 1.5 percent of growth per year. Thus, McKinsey concludes, “The future of the country’s domestic manufacturing sector is still highly uncertain.”

Resourceful outlook
In Argentina, GDP was up 8.5 percent in 2006—a solid improvement, though not enough to make up for the 2001 currency crash in the region’s third-largest economy. However, given demand for Argentina’s vast natural resources, there’s been a mini-boom for makers of mining and construction equipment. Automotive production has also resumed. And with its huge corn and wheat output, Argentina could benefit from the biofuels revolution. Yet some analysts argue that the Argentine recovery is somewhat artificial given price controls, export duties, and an undervalued peso.

Mexico’s 2006 GDP growth was 4.8 percent. The World Bank ranked it—along with Guatemala and Peru—among the top 10 most reformed business environments from 2005 to 2006. On the other hand, Mexico fell from No. 34 to No. 51of 75 total nations on the World Economic Forum’s competitiveness ranking. Perhaps more than any other nation, Mexico has suffered from the China effect.

Perrysburg, Ohio-based glass maker Owens-Illinois , better known as O-I, has been doing business in Latin America for more than 60 years. Originally, the company supplied forming machines to manufacturers in the region, but since the 1960s, it has become a major manufacturing presence through joint ventures.

Today O-I operates more than a dozen facilities in Latin America—including 10 plants out of 100 worldwide—as well as sand mines; a mold shop in Manaus, Brazil; and a machine shop in Cali, Colombia. This tightly integrated network primarily serves regional markets, but also supplies some customers in South Africa and Europe.

Richard Crawford, president of global glass operations for Owens-Illinois, says production plants in Latin America are best-in-class in comparison to similar operations in other global regions.

“From a manufacturing efficiency standpoint, it’s our top region,” says Rich Crawford, president of global glass operations, who formerly led O-I’s Latin American region. “We’ve benchmarked our plants globally, and Latin American plants rank best-in-class in terms of throughput, or glass melted and glass shipped.”
Crawford credits O-I’s success largely to the loyalty and dedication of O-I’s people. “They are very receptive to new ideas and there’s pride in regional performance as a whole, as opposed to country rivalries,” he says.
Currently, Latin America accounts for about 10 percent of O-I’s $7.4 billion annual sales, but it’s growing faster than other regions. The company is building a second plant in Peru—its first overseas construction in more than 25 years. The new $34-million glass container manufacturing facility will be in Lurin, south of Lima.
O-I’s operations in Latin America are more than a mid-cost alternative to manufacturing elsewhere. Executives and engineers participate in R&D programs led from headquarters to help drive innovation. In South America, O-I developed new packaging solutions jointly with customers, including glass bottles and jars with easy-open plastic caps and closures, and pre-labeled containers.
O-I enabled one Peruvian client to develop a glass jar to show off its high-quality asparagus. Another client, a provider of corn and peas, saw its market share jump from 4 percent to 9 percent when it switched from cans to glass jars. “Everything from beer to vegetables is seen as premium when packaged in glass,” notes Crawford.
Use of recycled glass, which has a strong history in South America, also stands to benefit O-I. In Venezuela, for example, conversions from returnable to non-returnable glass equates to 20 percent of market share. By using recycled glass in manufacturing, O-I cuts down on the amount of raw materials needed, and decreases energy usage and emissions.
Maquiladoras move up the value chain
Think about Latin American manufacturing, and the first thing that comes to mind are maquiladoras, the largely foreign-owned factories located near the U.S.-Mexico border that assemble products for shipments to the U.S.
Global electronics and technology companies— Hewlett-Packard , IBM, and Bose among them—rely on maquiladoras to make advanced hard drives, for instance, while cheaper parts now come mainly from China.
Mexico faces big challenges as it competes with China. Investments in education and physical and telecommunications infrastructure are long overdue. Chinese workers make 80 percent less than their counterparts in Mexico, according to the Inter-American Development Bank. And the government has been reluctant to offer inducements to foreign investors
Competition from China has nearly wiped out the tire, toy, and shoe industries in Mexico, though the garment industry first flourished under the North American Free Trade Agreement (NAFTA), it too has taken a major hit.
This is not to say Mexico doesn’t have advantages over China. “Shorter transport times and lower shipping costs to the U.S. and European markets are especially important given the need for rapid replenishment in lean retail environments and shrinking product life cycles,” notes AMR’s Hochman.
Mexico also offers proficiency in design and easier design collaboration, and relative strength in build-to-order environments. This means maquiladoras are well positioned for products with lots of design experimentation—e.g., automotive electronics—as well as for home appliances and other products with large weight-to-value ratios.
Friend or foe?
Overall, Latin America’s contribution to world trade is down almost 2 percent since the early 1990s—a dip attributable to competition from China. And there’s little doubt that China draws foreign investment that otherwise would go to Latin America.
Of course, China is a two-way street. According to the Inter-American Development Bank , Latin America accounts for nearly 4 percent of Chinese imports, but more than 13 percent of imports of raw materials. Chinese demand drives up prices for raw materials, and Latin American exports to China are growing nearly 50 percent annually, which could help the region diversify beyond heavy reliance on the U.S.
It’s not a “one or the other” proposition, according to Hochman. “Many manufacturers hedge their bets between lowest-labor-cost Asian options and mid-cost choices in places like Mexico, the Caribbean, and Brazil,” he says. “As companies mature in their analyses of manufacturing choices, we expect to see gradual moves toward truly global supply networks that blend several regions.”
In a 2006 AMR Research survey of 455 supply chain executives from $1 billion-plus U.S. companies, 23 percent of respondents indicated they source and manufacture in at least five geographic regions. The same survey showed 40 percent of smaller American companies source and manufacture in two to four geographies.
Advanced Technology Services (ATS), Peoria, Ill., provides plant maintenance and related services that make factories run better. ATS supports three plants in Mexico for two U.S. manufacturers.
Jeff Owens, president of ATS, believes top priorities for plants in Mexico are the same as elsewhere. “Driving up productivity, getting leaner, improving Six Sigma performance, and enhancing safety—that’s what matters wherever plants are located,” he says.
While Mexico is only a small part of ATS’ business today, Owens expects good growth the next few years. “Our business there is off to a very positive start, and we only expect it to get better,” he concludes. “Our clients tell us there is a real need for our services.”
Of the 100 ATS employees in Mexico, only three are U.S. citizens. “We found great people with fantastic attitudes and solid educational backgrounds,” says Owen, yet recruitment is not a challenge to be underestimated—especially in maintenance and support, which is far from glamorous—Owens concedes. “In the U.S., most engineers don’t want to be in maintenance, but in Mexico, our engineers view it as a good career opportunity.”

Manufacturing in Latin America by the numbers
$532 billion: Total value of Latin American exports, 2006 (Inter-American Development Bank)

$47 billion: Latin American foreign direct investment in China (Inter-American Development Bank)

$2.56 billion: Chinese foreign direct investment in Latin America (Inter-American Development Bank)

$18 billon: Chinese exports to Mexico (AMR Research)

$400 million: Mexican exports to China (A.T. Kearney)

188 million: Population of Brazil (CIA World Factbook)

90.4 million: Population of Brazil, age 15-39 (CIA World Factbook)

&3%: Annual GDP growth in Latin America, 1980-2004 (Center for Economic and Policy Research)

& 0%: Annual GDP growth in Latin America, 2000-2004 (Center for Economic and Policy Research)

42%: Size of gray market relative to GDP in Brazil, versus 16 percent in China (McKinsey)

44 million: Combined population of six signatory nations to Central American-Dominican Republic Free Trade Agreement (Manufacturer’s Alliance/MAPI)

40 million: Spanish-speaking U.S. population, the second-largest Spanish-speaking population in the Americas (The Wall Street Journal)

$9,000: Average entry-level salary for IT workers in Brazil, compared to $5,500 in India (Alsbridge Europe)

#5: Brazil’s rank as an outsourcing location (A.T. Kearney)

#9: Mexico’s rank in attracting foreign direct investment (A.T. Kearney)

152, 112: The number of days it takes to open a business in Brazil and Mexico, respectively, versus one day in Canada, and five days in the U.S. (World Bank)