Does Outsourcing to Mexico Improve Investment Returns?

By Debra Thomas

For close to four decades, U.S. firms have sought to take advantage of cheaper labor in Mexico by shipping materials and equipment on a duty- and tariff-free basis for assembly or manufacturing in maquiladora facilities.

Francisco Roman

Last year, about 80 percent of the firms that outsourced their labor by way of maquiladora facilities in Mexico were from the United States. Mexico’s lower labor costs and proximity to the United States should explain why such manufacturing arrangements are on the rise.

A new Rice study shows, however, that this strategy may not be as cost effective as believed. Except for companies with poor financial performances, those that locate in Mexico don’t necessarily improve their return on investments significantly more than those who keep jobs in the United States.

“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,” says Francisco Roman, assistant professor of management at Rice’s Jesse H. Jones Graduate School of Management.

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 also can be offset by the costs incurred from Mexico’s very 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,” says Roman.

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 United States. Both the control firms and maquiladora also had similar performance averages 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 their industries’ overall performance, he did not find a statistical difference between the two groups.

One reason there was any improvement at all among the transplanted companies Roman studied may have been that they were having financial problems before moving to Mexico. “Their profits were decreasing, and their costs were rising,” he says. “The fact they were not cost effective is the main reason why they decided to go to Mexico.”

Roman also believes that maquiladora firms may face fewer committed costs in Mexico as opposed to the United States, where firms still have to pay their workers whether demand for their product is up or down. The high turnover and absenteeism in Mexico may allow firms there more flexibility with regard to labor costs, particularly if sales are seasonal or cyclical.