Detroit's Big Three automakers reportedly are moving forward with plans to produce more small cars for the North American market in Mexico, which allows them to reduce labor costs on smaller cars while using higher-paid U.S. workers to build more profitable trucks, sport utility vehicles and luxury cars.

 

Indeed, new versions of several popular U.S. compact cars are expected to be made in Mexico, people familiar with the companies’ plans say, a Reuters article reports. The cars include General Motors’ new Chevrolet Cruze hatchback, a successor to Ford’s Focus compact and a replacement for Fiat Chrysler Automobiles’ Jeep Compass compact SUV.

 

The decisions in turn prompt automotive research firms to project a big increase in Mexican output of small cars by the three companies. AutoForecast Solutions estimates that GM, Ford and Fiat Chrysler will collectively produce 45 percent of their small cars for the North American market in Mexico by 2020, up from 18 percent in 2014, the Reuters article explains. LMC Automotive researchers put the 2020 figure at 37 percent, also up 18 percent from last year. Finally, researchers at IHS Automotive project the Mexican percentage of small car production to reach 42 percent in 2020.

 

This isn’t a surprising move. A recent USA Today article points out that in 2014, automakers announced $7 billion in new projects for Mexico, according to the Center for Automotive Research. That’s in addition to the 18 automotive plants already in Mexico, and at least five more are already planned or under construction. The result is that Mexico has seen a 40 percent increase in auto jobs since 2008, USA Today reports.

 

The automakers’ strategy is based around margins and competitiveness. The production shift would primarily reduce costs in production of compact and midsize cars, which have small profit margins. Secondly, shifting production to Mexico also may enable the companies to be more competitive with foreign rivals, such as Nissan and Volkswagen AG, who have been steadily adding production capacity in Mexico.

 

Margins on small cars may fall even further if production remains in the U.S. because new labor agreements negotiated by GM, Ford and Chrysler grant the first raises in a decade to veteran workers, and give recent hires a path to earn $30 an hour after eight years on the job, the Reuters article points out. However, Mexican labor rates, which averaged about $5.50 an hour in 2014 according to the Center for Automotive Research, offer a significant cost savings.

 

“Moving car production to Mexico makes sense,” Haig Stoddard, industry analyst for WardsAuto, says in the USA Today article. “It makes sense to build less-profitable vehicles in Mexico and more-profitable ones in the U.S.”

 

There is more than low-cost labor that makes Mexico appealing for automotive production. The country’s infrastructure, supply base and productivity all have clearly improved in recent years.

 

The flip side of the coin is that shipping costs from Mexico to the U.S. remain high, and energy sources can be unreliable. Furthermore, executives at many companies still have concerns about safety and security in Mexico. In an AlixPartners survey last summer on nearshoring, only 42 percent of the North American respondents said they expect improvement in those areas in Mexico. That number is down from last year, when 55 percent of the North American respondents said they expected improvements to safety and security in Mexico.

 

Nevertheless, if the U.S. companies do shift much of their small car production to Mexico, it will be interesting to see what impact their investments—along with those of other automakers and the Mexican government itself—have on Mexico.

 

What are your thoughts on automotive production in Mexico? Do you think there will be a time when most small cars are produced there?