Flying high: Further investment is expected in the burgeoning aerospace industry

Over much of the past decade, Mexico has been one of the most attractive targets for foreign direct investment (FDI) in aerospace. Since 2006 the industry has grown at an average annual rate of 18%, and exports have tripled from $2bn to an estimated $6.1bn in 2013. FDI has focused on the traditional northern industrial giants, including Baja California, which hosts 58 aerospace firms, and, to an even greater extent, on the central state of Querétaro.

According to foreign investment tracker FDI Markets, Querétaro led Mexican states with 24 greenfield aerospace investments between 2003 and the end of 2013. These amounted to a total capital expenditure (capex) of $2bn. Following were the states of Chihuahua, Baja California and Sonora. Chihuahua attracted the second-biggest number of greenfield investments with 20, involving total capex of $830m. Baja California and Sonora each received eight greenfield investments over the same period with capex of $435m and $282m, respectively.

Continued investment can be expected in Mexico and elsewhere as aerospace original equipment manufacturers (OEMs) ramp up production capacity to tackle a record backlog. As of the first quarter of 2014, the Boeing and Airbus backlogs at list price stood at $441bn and $809bn, respectively. Mexican aerospace companies integrated into Boeing and Airbus supply chains will have the opportunity to grow to meet demand from these OEMs and others.

History

Mexico has a long history in aerospace. Hughes Aircraft, an aviation firm founded by Howard Hughes, and Rockwell Collins, a manufacturer of avionics and communication equipment, built plants in Mexicali, in Baja California, in the late 1960s and early 1970s. Gulfstream followed, opening a plant in 1988 that still operates today. Safran, a French manufacturer, has operated in Mexico for 20 years.

However, the rapid growth of the sector began in 2006, when Canada’s Bombardier, the world’s third-biggest aircraft manufacturer, picked Querétaro as the site of its newest manufacturing base. The decision was made after a search for a country that could serve as a lower-cost alternative to the US, Japan and Northern Ireland, from which Bombardier planned to transfer some production capacity. The company invested $200m in a new plant, which made clear its commitment to the area, and suppliers soon followed. The same year, Cessna opened a plant in Chihuahua and a rush of investment in the area ensued. Between 2007 and 2012, 36 aerospace plants opened in Chihuahua City alone.

Arrivals

In the same period, many of the world’s leading aerospace companies also arrived in Mexico. Goodrich Corporation (now UTC Aerospace Systems) opened a factory in Baja California in 2008. The Spanish group Aernnova arrived in Querétaro in 2009 and now operates two plants, one producing wings and fuselages, and the other components. Meanwhile, Safran expanded its Mexican operations with a new plant in Querétaro in 2012 and another in Chihuahua in 2013. Eurocopter, a helicopter manufacturer and subsidiary of Airbus Group, opened a factory in Querétaro in 2013.

Low-cost manufacturing and proximity to the US and Canada played a big part in attracting these firms. According to KPMG’s “2013 Competitive Alternatives” report, aerospace manufacturing costs in Mexico are almost 30% lower than in the US. Most of the savings come from lower labour costs, which are less than a third of those in the aerospace industry north of the border. Overall aerospace manufacturing cost savings compared to Canada, Japan and France are similar at about 25%.

Among low-cost manufacturing countries, Mexico stands out also for the North American Free Trade Agreement (NAFTA). Free access to the US and Canadian markets has facilitated the integration of manufacturing facilities in Mexico with North American supply chains. This was one of the primary factors that, in 2006, led Bombardier to locate its new plant in Mexico rather than Eastern Europe, North Africa or India, other regions with burgeoning low-cost aerospace industries. Today, Bombardier’s operations in Mexico are integrated with its North American supply chain, which includes assembly plants.

Added Benefits

The maturation of the aerospace industry has brought other benefits besides location and cost. Since 2007 Mexico has had a bilateral aviation safety agreement with the US, which enables components to be certified and safety-checked on-site in Mexican plants. More recently, in 2012 the country joined the Wassenaar Arrangement, an arms export control regime. Mexico’s membership has given the industry greater freedom to expand into military aerospace work. Furthermore, some low-cost manufacturing countries that compete with Mexico for aerospace FDI, such as China, Brazil, Singapore and India, are not parties to the Wassenaar Arrangement, which could discourage those companies with military contracts from investing there.

Human Resources

One of Mexico’s weaknesses in aerospace, even compared to some low-cost manufacturing countries, is a lack of qualified engineers. In 2013 David Cote, chairman and CEO of Honeywell, told reporters that the pool of skilled engineers in Mexico was smaller than in areas with which it is competing, such as Eastern Europe. Mexico also suffers from a brain drain of talent to the US, as PwC México observed in a 2012 report on the talent gap in the emerging world, and has suffered in its attempts to attract talent from abroad because of the perception of the country as unsafe.

The federal government, which has aggressively courted the aerospace industry, has made efforts to improve the talent pool. When Bombardier was considering an investment in Mexico, the government made it more attractive by offering to build a specialised aerospace university near its plant. This school, the Universidad Aeronáutica de Querétaro, opened in 2006, and has worked closely with Bombardier and other aerospace firms to design courses based on companies’ specific labour force needs.

Specialised education institutions have also been established in Baja California. In 2013, the Colegio Nacional de Educación Profesional Técnica, a public technical college, and the Baja California Aerospace Cluster, an industry association, opened the Centre for Specialised Aerospace Technical Development, a training school for technicians. The Centre joins Tijuana Technical University’s engineering school and Baja California’s public university graduate school on the list of the region’s higher education institutions focused on the aerospace industry.

Skilled graduates of these schools are in high demand, especially since design and engineering are increasingly part of aerospace operations in Mexico. In 2013 General Electric announced a $20m investment in its existing research and development centre in Querétaro. The investment will expand the facility’s staff to 1800 engineers focused on designing and testing jet engines, among other activities.

Honeywell, whose operations in Mexico include a turbine components plant in Chihuahua, has been developing its Mexicali Research and Training Centre in Baja California since 2006. The 350 engineers working there design, engineer and test aircraft components. Honeywell intends to expand the centre’s capabilities. Ricardo García, site leader at the centre, told OBG, “One problem is that the designers are far away from where the products are made. We are aiming for all manufacturing in Mexico to be designed and engineered by our group in Mexicali.”

After a decade of rapid development, aerospace manufacturing in Mexico has achieved a high level of sophistication. At Bombardier’s first plant in the country, it produced primarily electrical harnesses. Today, at a plant opened in 2010, it makes parts of its Learjet 85’s composite fuselage. Safran and Spain’s Industria de Turborreactores, which has a plant in Querétaro, produce jet engines. GKN Aerospace in Baja California makes parts for Black Hawk helicopters. Aernnova Aerospace manufactures wings.

Finishing Processes

However, as Mexico’s manufacturing and design capabilities have advanced, some of the more mundane parts of the supply chain have been neglected. One of the most important deficits relates to finishing processes, such as nondestructive testing, priming and shock painting. Too few Mexican companies have all of the certifications they need to provide these specialised services. As a result, many tier two and tier three suppliers are unable to carry out the entire manufacturing process, from order to delivery, within the country.

Alaxia Aerosystems in Querétaro, for example, which makes landing gear and parts for Bombardier, Airbus and Boeing, among others, has to send 90% of its components to the US and Canada for finishing processes. Outsourcing these processes to more expensive labour markets comes with significant expense, but as of early 2014 there was no alternative. Raul Cuevas Campillo, programme manager at Alaxia, told OBG that there are companies in Queré- taro and other industrial regions of Mexico that have the technical capabilities to provide these services, but lack some necessary certifications.

NADCAP

This problem is largely the result of the aerospace industry’s fragmented certification regime. Despite the existence of the National Aerospace and Defence Contractors Accreditation Programme ( NADCAP), a standardised engineering and manufacturing certification, many OEMs require that all firms in their supply chain also carry their own proprietary certifications or approvals.

In some cases, Mexican companies have NADCAP certification but are delayed for years in obtaining OEMs’ in-house certifications, putting them off-limits for many supply chains. Until enough Mexican firms obtain the necessary certifications, Alaxia and other suppliers will be unable to consolidate their supply chains domestically. Cuevas told OBG: “I bring the raw materials here, machine it, then the parts go to the US or Canada for processing. They come back and I deliver them to my customers 20 minutes away from here. As soon as one of the local suppliers of finishing processes is ready, I will use them.” Cuevas estimates that using a local supplier for finishing processes would save his clients 9-12% on the price of Alaxia’s components.

At least one foreign company has moved to fill the void. In 2011 Metal Finishing Company, an American firm based in the aerospace cluster of Wichita, Kansas, opened an office in Chihuahua to provide non-destructive testing and aluminium surface finishing and plating, among other services. However, it does not offer a comprehensive suite of finishing processes and is a small operation of about 40 employees. An opportunity exists for a company with the necessary certifications and technical capabilities to provide these services to Mexico’s industry.

Components

There is also an opportunity for suppliers of components. Aernnova Aerospace Mexico imports roughly 60% of the components for its wings and fuselages from abroad, which is more expensive than sourcing domestically. Many aerospace firms likely import an even greater share of their components than Aernnova does. This is because Aernnova benefits from having its own supplier next door. Aernnova Aerospace’s Querétaro plant, where fuselages and wings are assembled, is in the same industrial park as its sister entity, Aernnova Components, from which it sources 20% of its components at a significant discount to the cost of importing.

One of Aernnova Aerospace Mexico’s objectives for 2014 is to find and develop more Mexican suppliers, general manager Javier Pérez Alcaide told OBG. By developing local suppliers, Aernnova expects to generate savings on its fuselages and wings, and free up Aernnova Components to pursue other clients. Today Aernnova Components is a “captive supplier,” as Pérez Alcaide puts it, because he needs almost 100% of its capacity to be dedicated to Aernnova Aerospace. “I’d like to be able to assign more work to other suppliers in Mexico and leverage the Aernnova Components capacity I am currently using into more strategic projects,” Pérez Alcaide told OBG. “This would also allow Aernnova Components to expand its base of clients in the US, which would be more profitable than working only for me, but they cannot pursue some of these opportunities because I don’t have enough alternatives in Mexico.”

In recent years, government and industry associations have made attempts to address the dearth of firms supplying components and finishing processes. The government of Querétaro has created the Department of Supplier Development, which, among other activities, provides financial support to local companies going through the expensive process of obtaining NADCAP and OEM certifications.

In 2012 the National Entrepreneurial Institute gave the Baja California Aerospace Cluster, an industry association, a grant of MXN6m ($466,000) to promote development of the supply chain. As of early 2014 the cluster had begun a programme called CAMPPEC, with additional funding, through which it plans to open a facility that can provide services such as precision machining and surface treatment, enabling more components produced in Baja California to be finished locally rather than sent abroad.

Raw materials are another weak link in the domestic supply chain. A small portion of the raw materials used by the aerospace industry are sourced from within Mexico – Marcelo López Sánchez, minister of sustainable development of Querétaro, has put the figure at less than 10%. This is partly due to the tight controls on aerospace OEMs’ supply chains.

Raw Materials

Just as aerospace suppliers are subject to rigorous certification requirements, they must also follow strict guidelines on the sourcing of raw materials. In many cases, aluminium, titanium and steel must not only be of a certain alloy or type, but also come from a specific mill. There are few mills in Mexico supplying metal to the aerospace industry and there is no distribution centre from which approved metals can be acquired on a large scale.

Instead, Mexican aerospace plants must import the vast majority of raw materials from abroad. Alaxia, for example, sources its aluminium, steel and titanium from ThyssenKrupp’s distribution centre near Montreal. This increases costs in freight, Customs, taxes and brokerage fees (NAFTA does not eliminate all border-crossing expenses). Cuevas estimates that the opening of a distribution centre for aerospace raw materials in Mexico would save his clients 2-3%.

The aerospace industry remains a relatively small part of the economy, accounting for 2% of manufacturing exports in 2013. Mexico is the world’s 15th-biggest manufacturer of civilian aircraft, but these figures may soon change. Growth in the industry is robust, and the country has consolidated its position as a target of aerospace FDI. The challenges – a shortage of skilled workers and supply deficiencies – are manageable and, as they are resolved, the industry should become even more competitive.