October 30, 2023
Nearshoring: Hype or reality? Takeaways from our trip to Monterrey
Global trade is a theme that we have been excited about at QED Investors. Among the many opportunities in this multi-trillion-dollar space, the one that has caught our attention the most lately has been nearshoring. Nearshoring is the practice of moving operations to a nearby country. While it’s not a new concept, it has grown exponentially as a trend, with North America pushing more companies to move away from China and relocate operations closer to home. With that, Mexico, particularly, has emerged as the number one place to be given its proximity to the United States and competitive labor and logistics costs.
To understand how much nearshoring is being hyped or not, and uncover the opportunities and challenges it brings, Mike Packer, Fernando Gonzalez and I decided to travel to Monterrey in Nuevo Leon, the state with the highest share of foreign direct investments in Mexico. It was my first time in the region, and I was absolutely blown away by the pace of development there. We met with many experts in the field, such as Prodensa, U.S. Mexico Foundation and Gobierno de Nuevo Leon, and the takeaway can be summarized as follows: Nearshoring is far from hyped. It is real and already happening.
We often suggest to founders to align themselves to a major trend or a growing, large market, and nearshoring is the combination of both. We believe a number of massive companies will emerge in this space and, as QED, we’re excited to join the opportunities.
Why is this happening?
We all felt the effects of supply chain disruption during the pandemic, but COVID-19 was just one of many disruptions that have been impacting the industry in the past few years. Disruptions have become more severe and more frequent, from climate change-related disruptions like the drought of the Panama Canal to conflict related disruptions like the war in Ukraine. These disruptions have led to a very important paradigm change in the field of supply chain: It is no longer just about efficiency, but also about resiliency.
Re-shoring, nearshoring, friend-shoring, offshoring…
There are way too many “shorings”, but the reality is that more companies are moving their operations closer to the market they serve to safeguard themselves against disruptions and cater to the higher consumer expectations who want their products fast. Mexico is uniquely positioned to serve North America given its proximity (which equals speed to market) and prime young demographics that are capable and willing to work in manufacturing jobs as older generations retire (average age in Mexico is 29 years old, while in the U.S. is 38 years old). On top of that, the transition from free trade agreements between the United States, Canada and Mexico like NAFTA to USMCA will keep pushing for more incentives.
With a manufacturing powerhouse that exports $578 billion a year, Mexico surpassed China as the largest exporter to the U.S. in July 2023 and is now its top trading partner. And with China losing foreign direct investment (FDI) and Mexico gaining share, Mexico’s FDI is expected to grow 60 percent a year, according to a McKinsey study. Just in the past 12 months, more than 150 companies announced investment in Mexico totaling $33 billion, including large global players like Tesla ($5 billion investment), Ternium ($2.2 billion investment) and Constellation Brands ($1 billion investment).
But changing decades of supply chain is far from trivial.
Although trade agreements and tax incentives help build the business case to nearshoring, Mexico has many structural challenges to overcome.
- Energy: According to a McKinsey study, more than $80 billion needs to be invested in energy infrastructure to satisfy the growth of energy consumption. The issue is not only energy production (and clean energy), but its transmission and distribution. Energy is under federal mandate and private grids are not permitted, even though many companies have offered to build their own energy facility to serve themselves.
- Water: If you ever visit Monterrey, you’ll understand why water is a constraint. The region is dry and although there is a functioning water supply, water permits are capped for environmental reasons.
- Industrial space: There is virtually no vacancy of industrial space (currently it’s at its lowest level of 2.1 percent). Arrival of companies could demand an additional 50 to 70 million m2 of surface area in parks and an investment of $50 billion by 2032.
- Logistics: Mexico has a good infrastructure linking it to the U.S., but significant investment ($120-185 billion) in logistics infrastructure (road, railway, port) and border crossing will be needed to sustain economic growth. For instance, Laredo and Otay Mesa (the first and fourth largest crossings), could reach +85 percent saturation of crossing volume by 2032.
- Talent development: Qualified technical labor will need to be developed across to serve the level of demand from the newly established global companies.
- Security and rule of law: World Justice Project Rule of Law Index 2022 ranks Mexico 115th out of 140 countries, due to corruption and the state of criminal justice system. Freight escorts are normal in Mexico and, according to an expert, operational cost can increase 2-5 percent in Mexico due to safety issues.
I am a big optimist and believe that challenges can lead to opportunities, which is why I am excited to see the new cohort of startups emerging to tackle these issues.
Here are some of the challenges and opportunities that we identified:
Integrate small and midsize enterprises (SMEs) to the supply chain: SMEs are not prepared to cater to the large companies investing in the space. They need capital to invest in machinery and working capital to invest in inventory. On top of that, they need the skills and certifications to serve large global players.
- Certified vendor program
- B2B marketplaces with vetted suppliers
- Trade finance to bridge the financing gap
- 21st century borders: Mexico can produce as much as they want, but there is no value created if they can’t move the goods into the United States.
- “Global Entry/ Fast Track” for cross border trucks to speed up customs
- Specialized digital freight forwarders like Nuvocargo
- Electrical vehicles: As the fifth-largest auto exporter in the world, Mexico is set to become one of the EV manufacturing hubs given its high storage capacity of lithium, a key component in EV batteries, and automaking capabilities. Multiple automakers have also recently announced moves into Mexico to produce EVs: Tesla’s gigafactory Monterrey, BMW close to $1B investment in its plan in San Luis Potosi, Ford’s plan to triple EV production in 2023, and so on. And some of these investments are already happening. During our trip, we visited GM’s manufacturing facilities and were astonished by the sophistication and size of the plant. GM produces one car per minute in its Ramon Arizpe facility!
- Opportunities: this sounds obvious, but EVs are produced very differently to regular cars. The entire supply chain around it will grow. Think batteries, charging stations, etc.
- Clean energy: With the rising demand, clean energy will be a must for the region. For instance, we barely saw any solar panels around, despite the high sun during the whole day.
- Everything logistics and infra: Freight forwarding, third-party logistics providers and carriers will grow and need investments to keep serving the higher volume in the region. And infrastructure will need to be put in place for goods to move from one side to the other. One important reminder: everything that is happening in development in Mexico has its counterpart in the U.S. The states on the other side are huge - California, Texas, Arizona and New Mexico - and will equally need logistics and infra to attend to the growing demand. Just to give a sense on how important these four states are, this region together would be the third-largest economy in the world, ahead of Japan and Germany.
- Modern industrial real estate park with nearshoring as a service: Self-sustainable industrial parks need to be developed in the region, potentially with its own energy and water supply. On top of that, we believe that a software and marketplace layer can be built on top of it to serve “nearshoring as a service” catering for customs, logistics, compliance etc. needs.
- Fintech for the nearshoring global players: As QED, we couldn’t write this post without mentioning a fintech play and this is one we are particularly excited about. The companies setting up shop in Mexico are not only from the U.S., but from all over the world. Think Asia, Europe, everywhere. Although the big players will be able to continue banking with their large banks, the mid-size supplier base that is coming along will have challenges sending money back, banking in Latin America, following complex tax and compliance requirements, and so on. We believe there are multiple opportunities in payments, insurance, lending and embedded finance to serve this growing number of mid-size global companies coming to Latin America, many of which are expanding abroad for the first time!
As you can tell, I came back from my Monterrey trip more excited about nearshoring than I already was before. The thing that I love about this major trend is that it impacts supply chain profoundly and supply chain has a beautiful characteristic: it’s a chain. When you need more manufacturing facilities, you need more machines and more materials, you also need workers, and workers need to live somewhere, which means real estate, which needs cement and so on. One thing pulls another and can transform an ecosystem entirely. It means lower costs, more durable structure, and, for disciplined investors like QED, tons of opportunities.