Outsourcing to Mexico may not improve investment returns

Outsourcing to Mexico may not improve investment returns

BY PAM SHERIDAN
Special to the Rice News

A new Rice University study shows seeking cheaper labor in Mexico by shipping materials and equipment on a duty- and tariff-free basis for assembly or manufacturing may not be as cost-effective for companies as believed.

Francisco Roman, assistant professor of management at the Jesse H. Jones Graduate School of Management, found that except for companies with poor financial performances, those that relocated to Mexico do not necessarily have more significant improvements on their investments than those who keep the jobs in the U.S.

Last year, about 80 percent of the firms that outsourced their labor to Mexican factories, called “maquiladoras,” were from the U.S. Mexico’s lower labor costs, and proximity to the U.S. explains why such manufacturing arrangements are on the rise, Roman said.

“Although there are clear benefits for having maquiladora operations in Mexico, there are also potential costs firms may or may not be taking into account before they move their operations,” he said.

In addition to transaction costs, companies have to deal with major infrastructure problems that exist in Mexico, particularly in border areas where many maquiladoras are located. Cheap labor costs can also be offset by the costs incurred from the high turnover rate, a poorly educated labor pool and Mexican laws requiring employers to provide an extensive range of employee benefits.

“The additional — sometimes hidden — costs to operate in Mexico may exceed the cost savings in cheaper labor,” Roman said.

Since 1999 Roman has conducted fieldwork and analyzed the effects of maquiladora production on the performance of 48 firms with significant labor outsourcing operations. He compared the maquiladora group with a control group consisting of firms in the same industries but operating mainly in the U.S. Both the control firms and maquiladora also had similar performances over the three years prior to the opening of the Mexican-based facilities.

The average return on investments for the maquiladora firms did show improvement or no decline between the three years prior to their move to Mexico and the three years after they opened the facility there. However, when Roman compared their performance with the industries’ overall performance, he did not find a statistical difference between the two groups.

One reason there was any improvement among the maquiladora companies, Roman said, may have been that the businesses were having financial problems before moving to Mexico.

“Their profits were decreasing and their costs were rising,” he said. “The fact they were not cost-effective is the main reason why they decided to go to Mexico.”

Roman said maquiladora firms may face fewer committed costs in Mexico as opposed to the U.S., where firms still have to pay their workers whether demand for their product is up or down. High turnover and absenteeism in Mexico may allow firms more flexibility with regard to labor costs, particularly if sales are seasonal or cyclical.

In addition to his work on the operations and strategic functioning of maquiladoras, Roman has done extensive research on incentive schemes and managerial control, cost systems and the impact of innovation and managerial practices on firm productivity.