What is the outlook for the auto parts industry in Mexico one year after the lockdown decreed by health authorities?
The behavior of the Mexican auto parts industry is closely linked to the manufacturing and consumption of automobiles in North America. As a regional bloc, we produce around 18 million units per year and 80% of the auto parts production in Mexico ends up in an auto assembly plant in the United States.
After the initial onslaught of the pandemic, the automotive industry in the region began its rebound in mid-2020. In response to the better performance of the US market, assemblers gradually recovered their production rhythm and ended the year with a very acceptable level of activity. However, at the beginning of 2021 and due to the global shortage of semiconductors, particularly in the months of January, February and March, some plants around the world were forced to carry out technical stoppages. This disrupted full recovery, but automakers are slowly getting close to pre-pandemic levels of activity.
In the specific case of the auto parts industry in Mexico, its behavior in 2020 can be divided into three large blocks. The first one, and where the most vigorous recovery is observed, is plants that export auto parts to the United States, a market to which—as I have already pointed out—80% of our production is directed. The general outlook for this segment is very encouraging and its current level of operation already resembles that of 2019.
Then comes the segment of auto parts factories that mainly supply new car assemblers based in the country. In the United States, vans and SUVs have practically displaced sedans from the market. So plants that manufacture sedans, which are around half of those established in Mexico, face an adverse situation and—for now—their only option to resume their usual rhythm of activity is to replace their line of production. In the particular case of our industry, the auto parts producers that supply sedan assemblers are producing 60% of what they originally planned; but their plants are open, operating and waiting for a new growth opportunity. The van and SUV factories established in the country, and their supply network, have a different outlook. The upturn in their level of activity is pushing them very close to pre-pandemic levels.
Then comes a third block, made up of auto parts manufacturers that supply the aftermarket—the repair of automobiles in circulation segment. Throughout 2020, they faced an adverse situation because many vehicles were not being used and the demand for spare parts—shock absorbers, tires, brakes, filters, and oil—suffered a significant fall. Fortunately, since the start of 2021, there is greater movement in the streets and there is economic reactivation. Everyone is starting to use their cars and we are confident that this segment will also pick up its pace.
When do you think the auto parts industry as a whole will go back to pre-crisis levels?
Practically this year. If the usual supply of semiconductors is restored, factories will likely be working overtime in the second half to make up for lost time. What is happening now is that there are more exits than entries in the industry inventory. The only thing that has held us back from achieving full recovery is the shortage of electronic devices and not the dynamics of the market. That’s encouraging.
Do you think the usual supply of semiconductors will be restored?
You have to understand where the problem arises. Cell phones, computers, automobiles, and other modern gadgets have been reduced in size while incorporating more features. We can see this by comparing a modern phone with one made ten years ago. To a large extent, semiconductors that have become increasingly sophisticated are responsible for these technological advances. However, the technological capacities to produce cutting-edge semiconductors tend to be concentrated in a few factories and a handful of brands. Suddenly, without realizing it, 70% of the manufacturing of this type of component is carried out in a single country and in one factory.
The pandemic created a spike in world demand for semiconductors. All households substantially increased their consumption of computers, telephones, monitors, video cameras, and other devices necessary to communicate and work remotely. The electronics industry and semiconductor manufacturers, in particular, increased production to meet demand, but eventually began to streamline deliveries to be in a position to supply their most important customers. Although the automotive industry annually manufactures between 90 and 96 million vehicles in the world, it represents only 5% of the semiconductor business. We are literally at the end of the line and in extreme cases, shortages force us to stop some of our operations.
Due to the shortage of semiconductors, it is estimated that around 1.4 million less vehicles will be manufactured in the first half of 2021. But we had planned to build 95 million, which presents a problem, but not a crisis. Nobody likes to lose part of their production, but no more than 2% is lost.
What measures should be taken to avoid situations like the one currently experienced by the shortage of semiconductors?
The pandemic made the risk of limiting the supply of semiconductors to a few countries and a handful of companies visible. Important governments in the world have spoken out to review this issue that not only affects the automotive industry, but also other more sensitive ones such as national defense and telecommunications. Recently, President of the United States Joe Biden opened a series of enquiries to analyze the operation of the supply chains of industrial inputs and components, and semiconductors. Several European governments are also analyzing different alternatives to tackle this problem.
We believe that in the coming years the semiconductor industry will have three major production poles: Asia, Europe, and America, the latter based in the United States. Why in that country? The production of semiconductors can be divided into two main phases. The first one is the actual manufacturing of the component. It is a highly capital-intensive, high-volume phase, requiring between three and four billion dollars; the machines are highly specialized, require extreme tolerances, and demand high electricity consumption. Of the three North American countries, Mexico is the one with the least resources to develop this phase.
Then comes the second phase, the programming phase. Let’s say that in the first one you get a generic product that needs to be configured before being installed on a telephone, a console, a telescope or a car. This second phase involves smaller volumes and is relatively more labor intensive. This is where Mexico can successfully be part of the semiconductor manufacturing chain and be a complement to its USMCA partners.
Raising the value that is added internally to exports is one of the pending issues of the Mexican export model. What concrete steps would you recommend to move up to more sophisticated and higher value-added phases?
Let’s start by reviewing the parts that make up a car and the raw material with which they are made. In the basic part, steel is essential. This metal is produced nationally, although not necessarily with the appropriate specifications for the automotive industry. Additional antioxidant coating processes are required. Fortunately, these processes have been developed in the country, particularly in Monterrey by the company Ternium and a Japanese firm that deals with coatings. There is also a Korean company established in Tamaulipas. The important thing is that the steel that a car needs is finally made in Mexico.
A second component of the basic part of the car is plastic resin with its different types: polypropylenes, polycarbonates, nylon, and PVC. This raw material is produced by very large transnational companies, established in strategic locations to meet global demand. There are large German, American, and Japanese factories—in smaller numbers. We don’t produce high-tech plastic resins in Mexico. There are some very old factories in Coatzacoalcos that produce polypropylenes to make kitchen utensils, cups, and disposable spoons, among others; but not the resins required by the automotive industry. The production of this raw material in the country is in the past, there is no investment, there is no investment promotion, and in the world, there is enough production to supply the current requirements of the automotive industry.
Then comes aluminum, a material that is increasingly used in the automotive industry because it is extremely light and contributes to mitigating the emission of pollutants. It is also a good substitute for steel, although at a higher price. There are no aluminum factories or bauxite production in Mexico. This sedimentary rock, which is the main source of aluminum in the world, is extracted mainly from mines in South America. Today, the largest aluminum manufacturer in North America is Canada, a country that has abundant and cheap sources of electricity, an essential input for the production of aluminum. China also has an important aluminum production and, unlike Canada, it does have bauxite mines within its territory.
So we make aluminum auto parts, but we use imported raw materials. We produce auto parts with plastic resins, but mostly with imported material. Then there is copper, and we do have something to do with it. All the wires and practically all the copper components in cars come from Mexican mines. We also boast—and have done for many years—an outstanding production of cable wires. I believe that, out of all automobile components, the ones with the most vertical integration are wires.
Mexico is the fifth largest producer of auto parts worldwide. Is the industry prepared to face the challenges posed by the transition to electromobility?
It is definitely an important change, but not as radical as you might think. Gasoline, hybrid, and electric cars have many elements in common. What essentially changes is the powertrain which, while important, is only one part of the car. So all the stamping systems for seats, dashboards, steering wheels, wheels, brakes, suspension, security systems, lighting, all of this is exactly the same. The industry will not disappear to make way for a new one, it will only transform.
Honestly, it is easier to build an electric engine than an internal combustion one. The latter is made up of around 250 components, while the electric drive system has only 20. The size is bigger and the controls are more demanding in a gasoline engine factory than in an electric motor factory—it’s incomparable. And the network of suppliers that is needed to make a gasoline engine is more diverse and technical. So it’s a pleasant leap, because it’s always better to drive an electric car than a gasoline one, but technologically it’s not a major challenge for manufacturing. Except in the case of batteries where you need a lot to increase the autonomy of the car and reduce recharging time.
What measures should be taken so that global companies established in Mexico become more decisively involved in the development of national supply and in the building of more complex production and technological capacities with greater added value?
A paramount aspect today is certainty, respect for the rule of law. We see it with the electrical industry, where a significant change was promoted in the regulatory framework for renewable energies. Certainty is a very sensitive element for foreign companies, and one that all countries interested in attracting foreign investment should guarantee. If there isn’t any, we don’t need the rest because there won’t be any investment coming. We have good engineers in Mexico—some of the best, I would say.
Multinational companies came to Mexico to strengthen their production and improve their cost structure. Currently, auto parts factories in Mexico generate more jobs than their counterparts in the United States. More value is produced in the latter, that’s for sure, but we are responsible for labor-intensive manufacturing, and we are slowly incorporating more capital and technology-intensive phases. Originally, all we made were harnesses and today we manufacture 100% of the harnesses, seats, brakes, seat belts, and airbags required by the automotive industry in the region.
Are there important foreign direct investment projects on the horizon in the sector?
Very few. The investments that come to the country are mainly directed to the expansion of facilities. I don’t know of projects that focus on the building of new car or truck factories. As I mentioned before, the demand in North America is around 16 million units per year and together we have a regional production of 18 million units—and we must consider production from Europe and Asia. Nobody in their right mind is going to invest in an additional factory. In current market conditions we have plenty of installed capacity.
What scenarios are emerging for the Mexican auto parts industry in coming years? Generally speaking, are you optimistic or pessimistic about its future performance?
Optimistic, very optimistic. We believe that US President Joe Biden’s strategy to relaunch the economy of that country will generate many jobs and a lot of purchasing power in our main destination market. We must not lose sight of the fact that 80% of auto parts production in Mexico ends up in an auto assembly plant in the United States. So the general outlook is encouraging.
As for the national market, the situation is not so great. Sales fell for the fourth year in a row. So, that’s something endemic that has to be resolved with different types of support: Nafin, with the intermediation of commercial banks, can channel resources for the acquisition of new cars, offering loans at competitive rates to reactivate demand as has been done in the past.
The domestic market also needs to put an end to car smuggling, which only distorts market prices and increases the circulation of cars that don’t pass physical-mechanical tests in the United States. There are two ways of getting rid of an old car in the United States: you send it to a junkyard and pay around 500 dollars for the service, or you send it to the Mexican border to sell it.