Maquila Program Overview

Table of Contents:

Executive Summary
What is a MAQUILA?
Ownership of Real Estate
What Companies use Maquilas?
Where are they?
Alternatives
Location Decision
Labor
Labor Laws
Taxes
The Future

Executive Summary
This is a brief overview of the opportunities available in Mexico to firms contemplating overseas production sharing in the form of Mexico’s Maquiladora or “in-bond” program.  Important factors which make Maquiladoras attractive include:

•  Low cost labor: Wages range from 15% to 25% of comparable rates in the U.S.  Normal work week is 48 hours.  Productivity often exceeds the U.S. rates.(U.S. Bureau of Labor)

• Favorable duty/tax treatment: Southbound, the Mexican government allows duty-free imports of all materials and machinery needed for the plant.  Northbound, many North American sourced products are now duty free under NAFTA.

• 100% Ownership of subsidiary: Leaves total control for all operations in the hands of the parent.  There are professional services available to handle such matters as personnel, accounting and import/export management.

• Proximity to U.S.: Lower turnaround times compared to other low labor rate countries, lower transportation costs, and the ability for managers or skilled technicians to commute on a daily basis to the Mexican facilities is possible in the border areas.

• Access to the Mexican Market: Maquilas may currently sell up to 55% of their previous years export output in Mexico’s  90 Million person consumer market.

What is a Maquila?
A Maquiladora or Maquila (used interchangeably) is a plant in Mexico that retains a Maquiladora Permit from the Mexican government to import raw materials duty free into Mexico for manufacturing, assembly, repair or other processing.  The foreign company must agree to re-export a majority of its production.

Originally known as the Border Industrialization Program, the Maquiladora or “in bond” industry was designed to reduce unemployment in the border regions.  Mexico gains over $3 billion in hard currency each year for its foreign exchange balance, as much as from tourism.  Mexico hopes to also benefit from the technology transfer and training provided by foreign companies as they integrate with the local economy.  Each Mexican administration has supported the industry with new laws and decrees designed to streamline the process and increase foreign investment.  Maquilas may now easily sell to other Maquiladoras.

Job creation south of the border reduces immigration pressure and helps strengthen and stabilize the Mexican economy.  There are many jobs created in the U.S. to support and supply the industry, since over 95% of Maquiladoras’ raw materials and machinery are sourced in the U.S.

Mexico’s currency was overvalued before the December 1994 financial crisis. The subsequent free-fall in the value of the peso is now spurring Maquila growth.  NAFTA is also forcing third country (mostly Asian) manufacturers to establish North American facilities to gain duty free access to the Mexican Market.

Proximity to the world’s largest consumer market, favorable tariff treatment in both directions, and relative political stability has made Mexico an especially attractive site for off-shore production and assembly. The Mexican government allows 100% foreign owned subsidiaries to operate in Mexico.

The Mexican government sees the Maquiladora as a tool for the diversification of Mexican industry—  the first step to economic self-sufficiency.  This is an opportunity that cannot be ignored by any manufacturer with processes that include a significant labor content.

Ownership of Real Estate
Article 27, Section 1 of the Mexican constitution disallows the foreign ownership of land in the “forbidden zone” — that area of land within 100 kilometers of the borders or 50 kilometers from the coasts.  Leases were allowed for a maximum period of ten years.  This applied to any company that did not specifically exclude foreign shareholders.

A 1971 law allowed foreigners to purchase land through a trust called a Fideicomiso with a Mexican bank.  The bank holds the title, while all benefits of ownership are retained by the foreign owner.  The latest Foreign Investment Law passed in December of 1993, has continued the gradual loosening of restrictions to foreign ownership.  Foreign owned Mexican corporations — even 100% foreign owned corporations — can now directly purchase commercial and industrial (non-residential) real estate without requiring a trust.  Foreigners may now directly purchase residential land in the forbiden zone through a Fideicomiso, with an initial term of 50 years.  Under most conditions the Fideicomiso can be extended for a new 50 year term.

Typical costs for finished industrial pads range from $3.00 to $9.50 per square foot along the U.S. border.  Prices are usually higher than what most foreign companies expect due to the few sellers and limited land with industrial infrastructure.  Many land lords will only lease, prefering to keep the property as a patrimony to their decendents.

What Companies use Maquilas?
Almost all of Americas largest and best known companies have some sort of manufacturing operation or subsidiary in Mexico.  These include the auto industry giants like GM, Ford and Chrysler, and most of their suppliers, like Champion Sparkplugs and Cooper Tire.  Rockwell International, Baxter Healthcare, IBM, Hughes Aircraft and Black & Decker also manufacture in Mexico.  There are over two thousand U.S. manufacturers directly operating Maquilas.

Japanese companies like JVC, Sharp, Sony, Sanyo, Casio, Kyocera, Pioneer and Cannon have plants in Tijuana.  Taiwanese and Korean manufacturers like Ichia Rubber, Samsung and Hyundai are also setting up plants in Mexico.  The motivations of these companies are not only the labor rates but also low tariff access to the U.S. market.

The Maquila is now an open system, whereby companies can buy raw materials, components or packaging materials from other Maquilas or Mexican companies.  As more companies enter the Maquilamarket, the diversity of materials, services and sub-assemblies available in Mexico increases, facilitating component sourcing.  PC board assemblers, printers, packaging, safety and industrial parts suppliers, and plastic, metal, and foam fabricators and molders supply maquilas on a Just-In-Time basis from nearby contract shops. This will be a major source of cost improvements in the future for those companies that take advantage of it.

Where are they?
Most maquilas are located in the Mexican border states of Baja California and Chihuahua.  The cities which have attracted the overwhelming majority of maquilas are Ciudad Juarez across the Rio Grande from El Paso and Tijuana, San Diego’s southerly neighbor.  The larger maquilas are typically found in the Juarez area, whereas there is a large number of small Maquilas in Baja California.  The intensity of Union activity decreases as one heads West along the border — Tamaulipas unions, on the Eastern seaboard, boasts over 90% control of the maquilas located there, and only 5% of Tijuana’s maquilas are unionized.  Some of the other states with significant Maquila activity include:

Alternatives
The profit associated with moving production to Mexico depends on the balance between labor cost reduction, tariff and transportation costs and the fixed cost of the move.  There is a continuum of alternatives available depending on the size and time frame of the operation needed in Mexico and the specific skills required of the labor  force.  The general terminology used for these alternatives is: 1) sub-contract– when the assembler bills on a per unit basis– 2) shelter – for administrative services with a labor hour billing scheme, and 3) Wholly owned and operated subsidiary.  There are a continuum of options depending on negotiated contracts.  Some wholly owned subsidiaries contract for certain services such as import/export and accounting support with traditional “shelter” companies.  Some shelters pass through many costs .

Under the traditional shelter, the U.S. company supplies capital equipment, raw materials and technology.  The shelter handles start-up permits, basic facilities, labor, customs, accounting, legal, and transportation on the Mexican side of the border.  Different firms handle these aspects differently.  Some will provide a menu of services including personnel, import/export management, freight forwarding, general administrative, accounting services or initial permit processing from which to chose; others will provide only a complete turnkey approach.

The cost of these services are burdened to direct labor hours and charged to the U.S. firm.  These charges are typically between $3.00 and $10.00 per direct labor hour, depending on the number of workers and the contractual obligations of the shelter.

The shelter can be a fast method of entry into Maquila production because a manufacturer can focus on establishing the production process, and can let the shelter handle administrative  and start-up issues.  After a few months or sometimes years, the administrative, personnel, import/export and accounting systems are established and the shelter is no longer needed.

Wholly Owned Subsidiary
This alternative takes the most time, energy and capital to start-up, but if the commitment is long term or the number of direct line workers exceeds 100, it is usually the most cost effective.  Fully burdened labor costs in Tijuana range from $1.00 to $3.50 depending on skills required.

Different industries and shelter operators will experience different cost structures, but it is generally agreed that it is not worth setting up a shelter or subsidiary for less than 15 direct laborers — the start-up costs and overheads associated with management, import/export and transportation in Mexico are not worth the savings attained with such a small direct labor force.

As the size of the operation grows, the wholly owned subsidiary becomes the most economically attractive way to enter into Mexico.  The difficulty  of starting a subsidiary has been steadily decreasing as the Mexican government and institutions have matured.  There is now a Maquila window at SECOFI (Secretary of Commerce and industry) where many of initial permits can be applied for with just one stop.

Location Decision
The location decision for industrial facilities takes on a special significance in Mexico.  In a macro sense, cities on the border offer different rewards and problems than interior cities.  The border offers easy access and greater infrastructure but higher labor and land costs.  The interior can be a real bargain for labor and land but at the price of difficult transportation, infrastructure and communications.  The right choice depends on U.S. market locations, personnel skills requirements, freight volume, and U.S. based management intensity.

In the micro sense, location within a Mexican market can be even more critical.  Proper location can reduce labor costs as much as 25% and, more importantly, reduce labor turnover by as much as 75%.  The key variables are proximity to worker housing and industrial density.   Workers who can walk to work will accept lower wages to avoid a commute.  They also exhibit greater loyalty to a job that allows them more time with families.

Other significant issues of plant location are permit status, zoning, and infrastructure availability.  Not every property marketed in Mexico for industrial use has industrial zoning and not every property can be approved for a Maquila permit by SECOFI and SEDESOL.*

Reliable infrastructure availability is location sensitive as well.  Most facilities in Mexico are constructed on a build to suit basis due to the lack of bank financing for real estate development.  Construction time is generally 4-7 months depending on the season.  The construction period allows time for the permit process and infrastructure hook-up.  Construction costs for a typical 30,000 square foot shell warehouse range around $15 dollars per foot.  Rents in Tijuana range from $0.30-$0.40 per foot on a shell basis.

The quality of construction has improved dramatically in Mexico in recent years.  U.S. style concrete tilt-up buildings are now available in the major Mexican markets.  Prices remain reasonable at levels slightly below comparable U.S. space.

Maquila Properties, Inc  keeps abreast of all available commercial real estate and can find the best alternatives based on your site selection criteria.  Once the best sites are selected, Maquila Properties will negotiate the most favorable terms and lowest total occupancy cost and flexibility.

Labor
This is the reason companies come to Mexico.  Wages are low in dollar terms.  The regular work week is 48 hours. Productivity is high if management learns how to effectively deal with the Mexican laborer.

It must be recognized that Mexicans come from a very different cultural background, the types of incentives used in the U.S. may not be motivating to the typical Mexican laborer.  Mexican family life continues until a relatively advanced age.  Many households include members from three or four generations.  Respect for elders carries to the workplace.

Stratification of the different classes of society is still strong.  Titles and position are more important in Mexican society than in the U.S.  Subordinates are not used to being delegated authority. The use of qualified, experienced Mexican management is of great help in learning the proper management tools for effective management of our very different neighbors.  There are proffessional recruiting companies that can help you find just the right management.

Labor Laws
Mexican Law establishes the minimum wage as well as fringe benefits.  Wage scales are adjusted periodically and vary by region. The rate is based on a 48 hour work week.  In addition to the seven legal holidays, the worker is entitled to a week vacation paid at a vacation pay rate of 25% more than his normal pay.  After each of the first five years of service, an additional 2 days paid vacation must be granted for each year.  A Christmas bonus of 15 days pay must be paid on or before December 20.

Overtime pay is twice the regular rate, and cannot be more than 9 hours per week.  Work on Sundays or holidays are paid at a rate at least 25% higher than the normal wage.  A profit sharing program amounting to at least 10% of pretax profits must accrue to all employees of 1 year or more.

Payroll taxes include INFONAVIT, a housing tax and mandatory employer contribution to a retirement plan equal to 5% of the payroll, education tax of 1%, and Social Security tax that varies between occupations.  The Social Security tax averages around 15% and covers hospitalization, medical care, surgery, unemployment and old age compensation.  There is also a Baja California state tax on incomes.  The total burden is approximately 35% but call your Mexican accountant for the latest rates in this dynamic system.

Taxes
Mexican tax is constantly changing.  The latest changes are associated with the 1994 tax treaty between the US and Mexico  Periods of hyper-inflation have strained the governments ability to formulate equitable rules.  A recent method of accelerated cost recovery allows a company to depreciate 51% of the value of an asset in its first year of use.  This asset can no longer be depreciated after the use of this deduction.  This, along with a five year carry forward of losses allows companies to shield profits very effectively.  Careful tax planning with a top-notch Mexican accountant will pay for itself many times in the course of your Mexican investment.  Here are some of the most important Mexican tax considerations:

Asset Tax. The latest in a series of taxes designed to reduce tax evasion is the 1989 2% Asset tax.  This is a minimum alternative tax that comes into play when a company  pays less than 2% of its asset value in income tax.  This tax does not apply in the first two years of operation and is not currently creditable under the U.S. foreign tax credit.  The value of assets includes the liabilities associated with the assets.

Income Tax. Corporate income tax is progressive up to a maximum of 34%.

I.V.A. (Value Added Tax). A value added tax is imposed on all sales and imports in Mexico.  This tax amounts to 10% of normal sales or imports.  Exports are not taxed.  A Maquila can be credited with the IVA that they have paid to Mexican suppliers when they export.  An important aspect of the Maquila Program is that this allows the Foreign owned company to avoid the IVA tax upon importation of raw materials and machinery imported temporarily.

The Future
The positive factors of the NAFTA for the Maquiladora industry include a lowering of costs of Mexican sourced products, reduction in transportation costs, a broader range of financial and insurance options, and easier access to the Mexican consumer markets.

The negatives in the long run are that the Mexican wages are likely to increase, environmental regulation may increase and Asian and European components of production may be excluded through the use of local content rules.  Overall, the effects should be positive for the manufacturers in Mexico, whether they are called Maquilas in the future or not.

© 1998-2014 By Jean-Paul de Kervor, Maquila Properties, Inc.