Today’s Machining World Archives October 2006 Volume 02 Issue 10
Lloyd Graff: We’re with Jack Schwietert of V-S Industries to talk about manufacturing in Mexico. Jack, when was the decision made to establish an operation in Mexico?
JS: The decision was made in 1993. At that time, we were supplying a customer who had multiple plants in the states. They gave us an award for being their best supplier. One of the fellows I was dealing with asked me, “Have you ever considered putting a shaft manufacturing facility in the Southwest? When I said no, he said, “Our largest client is a motor manufacturer in Juarez, Mexico. We actually supply the shafts to this plant ourselves. We did a study recently and discovered we’re our own shaft suppliers. We’ve been working to resolve that but to no avail.”
The plants that they had here were very inflexible union plants, and probably did not like the idea of supplying to Mexico. He said they found a lot of good metal turn companies in the Southwest, but they seemed oriented around defense industries making 15 perfect parts a week. When you asked for 30,000 parts a week, they just couldn’t conceive how you would even do that. They wanted to see if we were interested in starting a facility down there.
Now when I worked for 3M, I would visit an engineer friend of mine who took me to their Maquila facilities in the Tijuana area. I met people he dealt with and always kept a file on Maquilas. We decided we would go down there. I didn’t know how to conduct business in Mexico. We decided we needed a Maquila operator who would shelter us and take care of the payroll. Our customer actually became our shelter operator, and we operated for the first year and a half of our existence down there in the plant of our customer, with him supplying our workers. We told him how many people we needed, he took care of the payroll and at the end of the month, they would give us a bill for how many hours we had used. After a year and a half we hired Carlos Castel, the fellow who ran our operation in their facilities. I hired him away from our customer with their approval. We had written into our contract that we could go out and deal with other customers, but I never felt that was appropriate as long as we were under their roof. Their business increased, and they needed the space. We wanted to do work with other customers. We moved into our own Juarez facility in January 1996. We now have four other customers down there. It’s very low volume, quick turnaround, and high value-added business, exactly what you want in Mexico. The only thing that’s really cheaper in Mexico is labor. The building in Juarez is every bit as expensive to lease or own as it is in El Paso. The power is probably more expensive. The work rules are probably more restrictive in Mexico. Juarez is part of the State of Chihuahua, which is a very conservative state. That’s where the PAN party started. We are non-union, but that’s a little unusual in Mexico. Most places in Mexico are union companies but are considered “white,” meaning friendly unions.
LG: It seems a little bit counterintuitive when you say, “High value-added, quick turnaround goes to Mexico,” where you might think that there are less skills; and therefore, the high value added part might be difficult to pull off.
JS: That’s probably very true. One of the problems when you talk about Mexico is that you have a high turn-over problem, which has been exaggerated. You hear horrendous numbers of 2% and 3%, 4% per month and think, “how would I ever run my business? I would be training all the time.” We do train all the time. We do need skilled people, and we need skilled people to stay with us. But I would also say that Mexico is not unlike the United States. That turnover is primarily with lower skilled people. Your key people stay with you here and in Mexico as well. We still have four or five of the first twelve people we ever hired in Mexico.
LG: How many people do you have?
JS: We have 180 people. We’ve been as high as 240 people. Our business is somewhat seasonal. In Mexico, there are problems hiring and firing. If you hire someone and decide you’re going to let this person go because business has dropped, you’re on the hook for three months worth of wages for that person. That’s the law.
LG: If your Juarez operation was in El Paso, do you think it would be successful?
JS: Yes, it would be successful, but I think we’re more profitable because we’re in Mexico, and labor is such a large part of the expense in this business.
LG: Tell me what wages are in Juarez vis-à-vis El Paso or McAllen.
JS: For a good machine operator, in Juarez you’re looking at $2.50 to $3.50 per hour gross plus benefits, and in El Paso you’re looking at $10 to $12 per hour. When you’re in Mexico, your benefit package is probably 80% to 90% of your wage vs. 35%, maybe 40% in the States.
LG: So what you’re really saying is $3 equals $5 with benefits. In El Paso $10 would mean $13. So you’re really talking about $5 versus $13 for machine operators. You’re value-added is coming primarily on labor.
JS: Exactly. It’s coming from labor because you’re doing set-ups all the time and pushing this product through. We are on a 5-day cycle time with one customer we’re servicing there. If we get an order on Friday, we have to deliver that product next Thursday, and we have no idea what he’s going to order. Every morning, we get a list of 35 to 40 different items, and we have to deliver that. Typically it’s a motor shaft with multiple steps on it. It usually requires features like a key way, a broach flat, always ground, sometimes heat-treated. If it requires heat treatment they do give us extra time to do it because there’s very little support in heat treating or plating. The heat treater we use is in Las Cruces, New Mexico. We cross the border, get heat treated, and then come back across the border. It’s not difficult, but it’s a day both ways. That time is written into our contracts. We deal only in dollars. We won’t take a job with pesos. I don’t want to be in international monetary speculation.
LG: Does your product go to plants in Mexico?
JS: Yes. The idea for us going to Mexico never was to go down and do something because it was less expensive and then import it and sell to a customer up here. Right now, there’s a number of people in the industry who are doing that in China, actually importing product from China because there’s an economic advantage. We never found that to be the case with Mexico. We moved down there because our customers were looking for short cycle time.
LG: So then the rationale is 1) proximity and 2) cost. Proximity concomitant with faster turnaround time.
JS: Exactly. We’re an export company, really. 70% to 75% of our sales for the last 10 years actually exit the country, even out of Wheeling, IL. We supply Brazil, Portugal, China and Korea. But Mexico, certainly far and away is our biggest ship-to point, partly because we have developed relationships with companies in Mexico, but also because customers we had here eventually moved to Mexico and asked us to come to Mexico to support them.
LG: That’s interesting. So you see the big opportunity has been in developing customers in Mexico who find it difficult to find suppliers in Mexico.
JS: Exactly correct. And that’s why we started McAllen, Texas. We ship about $14 million worth of product out of Wheeling every year to the areas of Monterrey, Saltillo, Reynosa, which are all within 2 hours of McAllen. Our decision to go on the McAllen side of the border instead of the Reynosa side was because it’s an automated product. The proportion of labor we’ve got when you look at the total cost is not that great, and there was no real advantage to being in Mexico.
LG: Tell me about what it’s like going back and forth between El Paso and Juarez.
JS: It’s become more and more difficult because of the problems we’re having now. In Juarez, Carlos has a pass that allows him to cross the border without stopping. But he has to be alone in the car to do it; he can’t be carrying passengers. So typically when I go down, he will drop me on the Mexican side and I’ll walk over the bridge. I will pass customs on foot, and he will pick me up. If they search your car it can be up to 40 minutes crossing the border.
LG: Can you fly to El Paso direct, or is it through Houston?
JS: American has 2 flights a day non-stop to El Paso from O’Hare. One of the flights is 7:30 at night, so I can spend the entire day here, hop on the airplane, and I’m there at 9:30 at night. I get up in the morning and have a full day down there.
LG: Tell me about the financial arrangements of owning a company in Mexico. Can an American company own a Mexican firm like yours?
JS: Yes. We’re a subchapter S corporation; when we first started the facility in Juarez, there was a rule that sub chapter S corporations couldn’t own more than 79% of the foreign entity. We would have had to change our facility to a C Corp, which I didn’t want to do. I made our manager a partner, so he has part ownership in that facility. That’s no longer the rule today. The arrangement in Mexico is a typical Maquila arrangement. From a tax standpoint, when we do our distributions, this is what we have: We have an office in El Paso. That office is called V-S Precision USA. We have a plant in Juarez. That plant is called V-S Precision SRL. SRL is a legal form similar to a partnership in Mexico. V-S Precision USA has the relationship with our customers. Our customers order from V-S Precision USA, which is a two-person office in El Paso. All the orders and payments are in dollars, made to V-S Precision USA. Virtually all of our steel comes from the United States, so we order from V-S Precision USA. The only thing that V-S Precision SRL does for us is add value to the product. So we have a transfer price agreement between V-S Precision USA and V-S Precision SRL to supply product at a certain price. We say, “Our transfer price is going to be the cost that we spend in Mexico, V-S Precision SRL, every month plus 6%.” At the end of the month V-S Precision SRL adds up all of the expenses they had for that month. They add 6% to the bottom and they send the bill to V-S Precision USA. That way you show a 6% profit in Mexico on expenses in Mexico. The Mexican IRS, which is called Hacienda, looks at transfer prices very closely, and if you show that you’re making at least 6% there, they typically will leave you alone on your transfer price agreement. You’re showing 6% of the profit on SRL expenses in Mexico, so you pay Mexican tax on that. But all of the Mexican tax that you pay is 100%; the IRS views it as foreign tax credit to the tune of 100%. So you’re not paying any more tax by being in Mexico. It makes filing more difficult, but it’s not costing you Mexican tax on top of U.S. tax. Whatever you pay in Mexico the IRS gives you credit for in the United States. And the Mexican government has tried to keep business taxes very close to what the U.S. tax is, around 35%.
LG: Have you found the Mexican authorities easy or difficult to deal with?
JS: Probably a better question for Carlos. From afar, what I see is that the laws in Mexico are very close to what the U.S. requires. Frequently you’ll hear people say, “Welsomeone went to Mexico because they don’t have any laws relative to the environment.” That’s absolutely not true. We have a very sophisticated system for managing our cutting oils down there. We actually have a separate little facility adjacent to us that handles all our swarf. I haven’t seen an OSHA fellow, because they can only cover so many facilities. They spend their time looking at the worse case. There’s so many people working for the government of Mexico they can afford to be at a company every week. It’ not a situation where you have to pay people off. There’s plenty of corruption, certainly, but we don’t deal in payoff. But with the environmental laws down there you can bet someone is going to visit you on a very regular basis. There’s probably a lot more time spent on the enforcement aspect just because they have the people to do it.
LG: What’s been the most rewarding part of doing business in Mexico?
JS: One of the most satisfying things is being able to do something for the community down there. When we first started our facility, we built parking spaces for 50 cars, and there weren’t a dozen cars in it. Obviously our employment grew, but at this point there are probably a hundred people who drive to our facility. You kind of stop and look at that and say, “We are an employer who offers a better wage than the average person putting a wire harness together. We demand more of our employees, but we also pay a better wage.” We are part of the developing middle class in Mexico.
LG: Is there a real competition for workers down there?
JS: You asked me about the effect of China. The effect of China actually was most significant back in 1999, 2000, and 2001. At that time, Juarez had an unemployment rate of about 5%, which was unheard of because you could never get enough employees in Juarez. That has pretty much turned around now, in part because some people moved back, but I think more and more U.S. companies and foreign companies have moved to Mexico. The turn-over situation becomes more aggravated the tighter the labor market is, and the labor market is tight right now. What you see in Mexico are employees or companies competing for employees on the basis of benefits, not wages. We serve our employees 2 meals a day; we include that in the employment agreement. There will be companies that have 3 meals that have shower facilities that have bus service taking people to and from work. Nevertheless, you always have your core group of important people who get there every day.
LG: Do you have top-notch setup people who would be competitive in Chicago?
JS: We do. When we started the facility down there we took five or six people from our facility here in Wheeling, who were primarily Hispanic, and moved them down there for a period of time. Two people decided to stay down there. One is a very good grinding person and another is in charge of the cam equipment. We actually run far more CNC turning down there than up here because it’s all short runs down there. Carlos has something like 45 CNC bar turning machines, mostly Star, some Citizen equipment. The fellow who runs that is from Mexico, who started with us in the first year of our production there and stayed with us. We do have people down there who are key to our operation and would be considered good people up here in Chicago as well. But I would also say that it’s easier in Chicago to find that kind of technical expertise as it is if you were in Nashville or Memphis. You’re comparing a marketplace up here that is technically a very good marketplace compared to any place in the U.S. If we had to replace everybody down there with someone, it would be much easier to do it here in Chicago than down there.
LG: If you had a customer that came to you and said, “I want you to do what you did for me in Mexico, and I want you to do it in Shanghai” would you consider it?
JS: Yes, we have considered it because they have asked. But you’re going to have to operate your Chinese company with someone from China, and I don’t know any-body in China whom I trust. I think business in China and Mexico is similar in that regard. You have to develop a personal relationship with your key people in Mexico, not just a business relationship. If I knew someone in China like that, I would consider it. It’s also 8,000 miles away as opposed to 1,200 miles away. We’re thinking about starting another facility in central Mexico, around Mexico City. We do have relationships down there where I know I can get very good management for that company. That’s key. There’s as many people who go to Mexico, have been disappointed and come back as there are people who stay. It probably has very little to do with where they were location-wise, but who was operating it and what kind of support they got. I talk to some of the guys in PMPA about Mexico, and they look at me frankly and say, “Why in the hell would you do that?” It makes no sense to them whatsoever. And that’s fine. It’s not for the weak at heart. We’re in the business of gambling all the time in our business; that’s what we do. You mentioned to me the satisfaction of doing the magazine and doing something on your own, and I feel that with Mexico a little bit. That’s something I did.
LG: So now I follow your train of thought. Long run work, capital intensive U.S. Niche work, labor intensive Mexico. Anything else you would like to say to our readers?
JS: Everyone has to make the determination whether it makes sense for their company or not. Mexico started for us because we had one customer who really wanted us down there. I said, “I’m not going to start a facility just for you. I need three good customers down here, and I’m not going to make a move until I pretty well lock that up,” which we did. I would caution anyone about moving for one customer. You hear a lot of horror stories about that. And I think that’s one of the problems with someone making a decision to do that. The key is to have the right people down there running it, but that would be no different than if we decided to start something in Denver.