Learning from Mexico
During the 2000s, Audi doubled the number of models and variations to roughly 60, adding to overall sales. Meanwhile, global markets grew. As a result, they needed to add assembly capacity. But where? Similarly, where should suppliers locate their engineering operations? At headquarters in their founding location, or in Detroit and Shanghai? This set of issues—where assembly should locate relative to markets, where parts production should be located relative to assembly, and where the engineering services should be based that support both of these—is closely tied to evolving technologies, which range from the costs of transportation to the development of digital engineering.
Back to the Audi example. At the end of the day, the location was obvious. As a producer of upscale vehicles, locating in the United States would leave them facing 10 percent tariffs on exports to Europe, while a location in Europe would likewise incur tariffs on exports to many developing countries and to the United States, albeit at a modest 2.5 percent level. The benefit of Mexico is its network of trade agreements, including both the EU and the U.S. as well as many countries in South America and Asia. That matters because wherever Audi located their new plant, most output—in this case the Q5—will be exported. BMW’s plant in Spartansburg, South Carolina, is similar: it is the only location that makes the X-series, a full 70 percent of which are exported, but it was chosen before Mexico had its current array of trade agreements in place. Likewise VW continued to make the classic “Beetle” in Puebla after its production ceased in Europe, because it provided better logistics for exports back to Germany and to Central and South America, where the “classic” model remained popular.
Second, Audi is owned by Volkswagen, and thanks to the sharing of platforms and the newer modular architectures, they share many components. So within Mexico, the obvious location was Puebla, where VW has had a factory for over 50 years. Audi can thereby tap a mature base of suppliers geared toward their needs. Third, logistics were favorable. Audi eventually located their facility 30 km from VW’s plant in Puebla. It has good rail connections into the United States and to deep harbor ports near Acapulco on the Pacific and Veracruz on the Atlantic. Shipping to markets in Europe, Asia, North America, and South America is straightforward, and can be combined with those of VW.
There are additional considerations. Labor in Mexico is less expensive than in the United States or Europe, and no more expensive than in China, even though by local standards car companies pay premium wages. A job at Audi or Nissan, another firm with a half-century of local history, is highly coveted. As important, these firms offer on-the-job training and promotion opportunities. VW and Audi, for example, run apprentice programs for skilled trades, and local managers and engineers are Mexican. They can thus recruit good workers, and retain them. Overall, however, wages are a minor consideration, because direct labor costs are less than 10 percent of the cost of assembly.
Finally, a location outside Europe allows Audi to hedge against fluctuations in foreign exchange rates. These need not be trivial. Much of the profitability of Toyota stems from the sales of their Lexus brand, almost all production of which is still located in Japan. Rates fluctuate. For example, during 2011 the yen averaged ¥80 per dollar, at which level exports from Japan were no longer profitable. They are only modestly profitable at the ¥100 level of August 2016. Similarly, the yen–euro rate has varied from ¥100 per euro to ¥140 per euro. Locating production outside the home market offers insurance against these sorts of swings, though this applies primarily to local costs such as labor and not to commodities, prices of which are set by global markets.
The Changing Logic of Location
How has this logic evolved over time? First, we present the centralization of production in the United States and Europe around an “auto alley” or “auto corridor,” drawing on the work of James Rubenstein and Thomas Klier. This is a function of changing economies of scale, the proliferation of models that lower volumes, and the growth of truck transport.
Second, we trace the history of the locus of production with the growth of output inside NAFTA and Europe of firms that initially entered these markets through international trade. This was pointed out over a half-century ago by Wilkins and Hill (1964). That dynamic reflects a variety of considerations, including tariffs and trade restrictions such as the VER imposed on Japan, referenced in Chapter 2. But it also reflects other considerations firms face to “make where you sell.” This will be explored further in Chapter 5, which examines the case of China and other developing country markets.
Third, there is the development of global suppliers that began in the late 1980s documented in Tables 4.1 and 4.2. Local assembly was accompanied by local parts procurement, beginning with bulky items such as seats, radiators, and instrument panels. The growth of global platforms and the convergence of emissions, fuel efficiency, and safety standards, however, meant that car companies sought to purchase identical components everywhere they assemble vehicles. Firms divide the globe in different ways, but often have operations in South Africa, Mercosur, NAFTA, the EU, South Asia, Southeast Asia, China, and often Japan. In 2000, only 18 suppliers had sales over US$5 billion; in 2015, at least 50 suppliers had that level of operations, and the top six suppliers are larger in scale than the car manufacturing operations of midsized producers such as Suzuki and Subaru; Bosch, the largest, is bigger than Ford.
Table 4.1 Top Ten Suppliers, Select Years
Table 4.2 Aggregate Sales, Top Suppliers
Finally, will research and engineering become similarly dispersed? Certainly, firms need an engineering presence in all major markets to support production. However, the growth of global platforms and high-tech content means that vehicle engineering is less dispersed than manufacturing, and suppliers require the ability to co-engineer future products with their customers. The emerging pattern is one of dispersed “centers of excellence” tied to a major production facility for related components or a legacy regional center, paired with sales engineering centers in Michigan, core Europe (France and Germany), and Shanghai in China. The engineering needs of the global industry are simply too great to recruit and retain engineers in a single location, while geographic dispersion helps reinforce the need for autonomy for product lines within a single firm, be they wire harnesses and power control modules at Delphi or gaskets and pistons at Federal Mogul. We expect this to continue, with a consequent lessening of the role of engineering operations in Japan and Korea. Above all, we see Greater Detroit—Ohio, Michigan, and Ontario Canada—remaining the center of the evolving high-tech industry of automobiles.
Branch Plants: Domestic and International
Into the 1970s a combination of economies of scale and model-specific volumes led to the implementation of the branch plant system. With few models, most of which sold in large numbers, production volumes eclipsed the capacity of a single plant, particularly in an era where welding and painting remained hand operations. As Jim Rubenstein (2014) argues, autos are an exemplar of a weight-gaining product, where locating assembly close to market saves costs and shortens delivery times. Ford, for example, constructed a five-story assembly plant in Seattle in 1913, with identical “sister” plants in New York City, Buffalo, Portland, and Dallas. This compact architecture reflected the reliance on steam power conveyed throughout the building shafts and pulleys. Model-specific production volumes subsequently fell, while the advent of machinery driven by smaller electric motors changed plant architecture. In 1935, the Seattle plant was sold to a paint manufacturer, and a new and larger single-story plant was built further out, though it was soon shuttered under the impact of the Great Depression. The same thing happened in Detroit, where urban growth meant there was no spare land, so when old, multi-story plants closed, new plants located elsewhere, to the long-term detriment of the city’s economy.
By the 1990s, the proliferation of models meant that production no longer required more than one assembly plant. Placing a plant on the West Coast and shipping across the United States no longer made sense. Instead, new factories located in the center of the United States, in a band between I-65 and I-75, two major north-south expressways, that stretches roughly 700 miles from north to south. This region accounted for the single largest block of automotive sales, while economizing on shipping to the two coasts.
Over time, suppliers likewise consolidated their operations in the region—Figure 4.1 provides a visual sense of the current configuration. Modern production management accentuated that process; suppliers are expected to ship on a “just-in-time” basis to minimize system-wide inventories. For seats, the process is more extreme, as they are delivered, truck by truck, in assembly sequence. Furthermore, the order of production by color and trim level is generally scheduled no more than a day in advance. Such plants benefit from only modest scale economies, and so are small in size. They thus tend to locate within 2 hours of a customer’s assembly plant, with seats made in the morning in a car on its way to dealers by the end of the day.
Figure 4.1 North American automotive plants, 2013.
Source: Presentation to Smitka’s students by Thomas Klier, April 2016.
Adding to this locational advantage was the deregulation of trucking that began in the late 1970s under President Carter, with similar changes in Japan and the EU. While shipping steel or finished vehicles by rail remained advantageous, highway access became critical. Furthermore, this allowed suppliers to locate in more rural areas, as long as a highway emained nearby. The Canadian firm Magna thus has three seating plants in Mexico, four in Canada, and 11 in the United States. But key is that they are located within the United States auto alley, with the plants in Mexico near to the assembly plants of GM, Mercedes, and Chrysler, and those in Ontario near Canadian assembly plants but also on highways that extend into the United States through Niagara Falls and Detroit.
Klier and Rubenstein document a similar trend in Europe. With the growth of the European Union, firms with a Europe-wide presence such as Ford no longer had to locate production in multiple countries. Meanwhile, the presence of a good highway system and the ability to ship across borders by truck without needing to stop likewise made locating on a railroad less important. Within the region, supplier plants could be dispersed, even as assembly plants were centralized. Despite the enlargement of the European Union with the addition of Poland and central Europe, auto assembly became more geographically concentrated. Indeed, the spread of assembly plants in the EU and the United States is very similar, as illustrated in Figure 4.2.
The product-plant alignment in fact reinforces this story. Small cars are made in Mexico and Eastern Europe because that is where the markets are, and not, or not solely, because of labor costs. In the case of Mexico, 65 percent of these are still exported. However, the export share is much smaller than if these plants made midsized cars or light trucks. In contrast, GM does have a pickup truck in Mexico; 97 percent of its output is exported. A final example is Nissan, the market leader in Mexico. Their output is of smaller cars, and they sell over 40 percent of those inside Mexico, while under half of sales are in the United States and Canada. Locating in Mexico means Nissan makes most of their smaller cars near to where they are sold. Similarly, Klier and Rubenstein document that as the market in Europe for smaller cars expanded eastward, so did the production of small cars. As in NAFTA, the production and sales footprints of the auto industry align more closely than they did a quarter century ago.
Figure 4.2 Core automotive manufacturing locations, Europe and NAFTA.
Note: Source as above. These maps have identical scale, including the size of the rectangles.
Figure 4.3 Development of the European Auto Corridor
Multinational Business
An auto company that wants to expand outside their home country has three options. First, it can export. However, tariffs generally made that unattractive, at least until the GATT process lowered automotive tariffs among developed countries. Licensing designs was not practical for such complicated assembled products. So a firm could either set up a branch plant and ship parts from home, as Ford did around the world in the 1910s and 1920s, and the Japanese in the 1980s, or it could ship old tooling to make an old model, with suppliers continuing the production of parts for such models after home country assembly ceased, or themselves shipping old equipment and tooling. VW and Fiat did this in a number of countries.
Of course, when there were existing car factories, a company could simply buy one, as GM did around the world. Acquisitions, however, resulted in local operations that had no integration with the parent company. Over time a company could invest to create common accounting systems, similar production layouts, and use engines and transmissions in common. Branch plants moved in the opposite direction: pressures to make where you sold led to greater use of local suppliers, which might or might not be branch plants of existing suppliers. Different suppliers and local material availability would mandate adapting slightly different locations of connectors, and that would cascade to affect additional parts. While they were at it, it was natural to adapt designs to local driving conditions and consumer tastes. While perhaps apocryphal, this meant that the European and North American versions of the Ford Mondeo, intended to be a “world” car, ended up quite different. While individual parts may have remained almost identical, in the end only a door hinge could be safely interchanged among the two regional versions of the “same” vehicle.
Over time, then, branch plants tended to diverge to become operations with some measure of autonomy from the “mother” plant of the parent company. Acquisitions would generally achieve some measure of coordination with the parent. In this case, foreign operations could contribute modestly to achieving economies of scale, and might be able to share in engineering. However, in the 1970s the characteristics that helped make a car sell well in Europe or Japan were often different from those in other markets—Americans in general did not want small cars, and the rest of the world did not want or could not afford large ones. Tastes also varied, so styling diverged even for vehicles in the same segment. Driving conditions—lower speeds, narrow and winding roads—might also lead drivers to expect a different “feel” when behind the wheel.
Its simplicity allowed the Model T to be a “world car” with global sales around the world helping support engineering in Dearborn. In the 1950s and 1960s VW was similarly successful with the Beetle, which for 20 years sold well outside Germany. Outside their home market most cars failed to gain acceptance except among a small slice of purchasers, who could however be charged a premium price. That sufficed for higher-end vehicles, which in any case sold in low volume everywhere. Such cars also had long product cycles, so exports were viable and could help spread fixed costs. Models in volume segments might sell enough to cover the costs of local marketing operations, but tended to contributed little to overall sales. Mass market producers had to rely on domestic sales to achieve economies of scale. In sum, firms might be multinational, but they were not global in the sense of taking into account multiple markets when designing vehicles, and running their operations in other countries in an integrated manner.
Market Integration, Product Integration: Globalization
As incomes rose in Europe and Japan to roughly North American levels a luxury car such as a Volvo or a Mercedes might sell anywhere. Indeed, such cars dominated the high end of the Japanese market. From a German perspective, the Japanese market was not closed. While less pronounced, growth in Mexico and South America, in Eastern Europe, and in East and Southeast Asia increased the overall automotive market for high-end automobiles. These evolved into global status symbols, defined by German styling. At the national level the midmarket remained more idiosyncratic.
German styling was one element that helped make automotive design global. Similar changes were occurring in an array of other fashion products, with the growth of global clothing and accessory brands and the advertising images used to market them. Movies and TV likewise crossed national boundaries, both part and parcel of the growth of a common design ethos. Lines, color palettes, and even brand names ceased to be purely national. By the 2000s mid-market cars could tap this growing global design ethos. To focus their process, Ford for example picked a hypothetical 30-something Italian woman in the suburbs of a regional city as the target purchaser of a Fiesta, and could expect that a car designed and engineered to “her” tastes would, with a few tweaks, find a reception in markets around the world. As a result it was less and less necessary to style separate versions of a car for Europe, the US and Asia in order to have it sell well.
At the same time international trade grew. Through the various GATT and WTO tariff reductions, exports to the developed markets of Europe, Japan, and the United States became easier. This was amplified by the implementation of trade agreements, with the growth of a common European market for automobiles by the early 1960s. Transoceanic trade benefitted too from the development of roll-on, roll-off ships designed specifically for transporting cars, the first of which was launched in 1973. For a long time, Euro Zone consumers were not free to purchase cars outside their home market, due to a Block Exemption on the retail side, which was eliminated only from 2010. Until that time price differentials in neighboring markets for the identical car could easily be 20 percent. But car companies and parts manufacturers themselves faced few or no barriers to operating across the EU, and the implementation of the Euro currency zone eliminated foreign exchange risk among the core members.
The evolution of NAFTA reflected different dynamics. Trade integration between the United States and Canada was low, reflecting policies that dated back to the 1800s. While there had been 30-plus domestic car manufacturers in Canada in the late 1890s and early 1900s, the Detroit Three set up branch plants and eventually acquired the Canadian local producers that operated them. But in 1965, Canada’s population was only 20 million, whereas that of the United States was 200 million. Production remained high in cost and the model choice more limited than across the border, while Canadian parts producers also suffered from low production volumes. As described by Dimitri Anastakis in Auto Pact (2005), the industry pushed for the Canada–United States Automotive Products Agreement, which was signed in 1965. This paved the way for integration of the North American market, including the realignment of geography traced in the early section of this chapter. It was also the first step toward the formation of a broader trade agreement between the United States and Canada in 1987, which was in turn combined into NAFTA in 1994. A similar dynamic can be seen in Mexico, where NAFTA was preceded from 1962 by the “maquiladora” policies that saw labor-intensive parts production such as wire harnesses migrate to the region along the U.S. border. Those early policies had only modest impact on the efficiency of the finished vehicle production. As in the EU, however, free trade applied primarily to producers, as it remains difficult for the residents of one country to buy a vehicle from another.
Unilateral Trade Changes
In most other markets, trade barriers remained high; the impact of such policies is the topic of Chapter 5. A handful of countries, however, unilaterally lowered tariffs and removed other barriers to automotive trade. In the case of Australia, this will lead to the closing of the last two assembly plants by 2018. The market was small but had several producers, dating back to Ford’s branch plant system of the 1920s and to GM’s acquisition in 1931 of Holden, a local producer. Small scale meant both parts firms and assemblers were inefficient, accentuated when exports of commodities such as iron ore caused the Australian dollar to appreciate, making imports particularly attractive and exports prohibitively costly. As trade barriers fell, the industry collapsed.
In contrast, Thailand had the largest domestic market for pickup trucks outside the United States and Canada, and before its removal of trade barriers, it had local “kit” production of those products. While not as integrated as the EU or NAFTA, the presence of the ASEAN market and product differentiation meant that global firms increased their production of light pickup trucks, with Japanese firms ceasing production of those products elsewhere in the world. This is similar to what is happening with high-end vehicles, where a BMW or an Audi will make a particular product in only one country and export elsewhere. Over time, we may see additional cases of a local industry based on product differentiation and intraindustry trade. But Thailand remains exceptional among developing markets that are not part of a larger free-trade area.
Global Cars: Today’s Structure
This combination of the integration of markets and the convergence of styles and segments in other regions of the world provided one foundation for the development of true world cars. The second was the development of a global supplier base, with the firms producing critical components such as turbochargers, pistons, and transmissions, and more mundane items such as wire harnesses and automotive lighting, having a presence in all major markets. By 1990, Japanese suppliers set up or acquired over 300 factories in the United States, as parts companies followed their customers to North America and later to other markets. Less well known, approximately 300 factories were likewise built or acquired by European-based suppliers, whereas large U.S.-based suppliers were enhancing their European presence. New technologies had the same effect. Car companies needed outside suppliers who could provide catalytic converters, sensors, and hardened integrated circuits for the engine control modules that controlled fuel mixtures and ignition, crucial for emissions and fuel efficiency. The development of such components is costly and production specialized, and this has led to consolidation of the firms involved. In many cases, four or fewer firms now dominate global production.
What is less clear is how this will affect future engineering locations, which, as manufacturing productivity increases, will be a more important source of industry value-added. The development of the platform approach to engineering vehicles, and the current module approach such as VW’s MBQ system, facilitate localization of customer-visible vehicle attributes and result in the presence of some local engineering wherever cars are produced. This then requires a location-specific sales engineering capacity for suppliers, and production engineering and purchasing offices for their factories by both assemblers and local suppliers. As a result, global suppliers have built up a global engineering presence, and there is some movement toward making different locations the global center for one or another technology or product line. In other words, engineering is decentralizing.
At the OEM level, strategies have not—or not yet—converged. Ford and General Motors have a long history of decentralized operations in multiple markets that included stand-alone engineering operations. Even GM Holden in Australia developed its own cars. The challenge for Ford and GM has been to integrate engineering and design centers so that they can share platforms globally. That too has led to regional centers that focus on specific vehicle segments such as rear-wheel drive vehicles or small cars. Hence, within GM, their engineering centers at Opel, in Germany, Daewoo, in Korea, and Warren, Michigan, work on different global platforms, while attempting to create common production protocols for their factories, and common approaches with key suppliers of high-tech components. Ford is doing the same. For both firms this includes China, and both are in the process of building up engineering centers in India.
In contrast, European producers continue to undertake most engineering in their home market. VW had no presence in the United States, and pushed old models in developing markets. BMW, Audi, and Mercedes are relatively recent in setting up production facilities elsewhere. Japanese firms are in between in this process. In terms of production and sales, Honda is as much an American company as a Japanese one, and they currently engineer specific vehicles in Ohio and others outside Tokyo. Toyota, likewise, can now develop a vehicle in Michigan. It is not yet clear whether they will set up multiple regional centers specialized in different product segments, with the development of small diesel engines centered in Europe and large pickup trucks and related products in the United States. Finally, there are cross-national mergers: Nissan and Renault coordinate their operations between Yokohama and Paris, but with a large center in metropolitan Detroit. Fiat and Chrysler intend to do the same between Turin, Italy, and Auburn Hills, Michigan. Then there is Geely in China, which purchased the Swedish firm Volvo. So while smaller firms may not develop multipolar engineering operations, they too will be global firms no longer based solely in their home market.