This Plant For Hire: Manufacturings Next Big Wave?
First it was apparel and food products, then electronics and pharmaceuticals. From Guadalajara to the Far East, contract manufacturing is booming everywhere but here. How can Puerto Rico get a piece of the action?
by Daniel R. Garza
It may not be the second industrial revolution, but more and more manufacturing companies are concentrating on developing and marketing their productsand having subcontractors make them. Contract manufacturing may be Puerto Ricos next great opportunity for creating and saving jobs.
Manufacturings next big wave?
Hewlett-Packard (HP) test engineer Antulio Acevedo carefully inspects modems fresh off the assembly line to make sure they meet the companys rigid standards. However, Acevedo isnt doing his job at HPs plant in Aguadilla, but up the road in Aguada at SMART Modular Technologies.
Acevedos daily presence at SMART Technologies is symbolic of the growing alliances between original equipment manufacturers (OEMs) and contract manufacturers.
Companies like HP are, in increasing numbers, outsourcing the production of their wares to contract manufacturers like SMART Technologies, a wholly owned subsidiary of Solectron Corp., the worlds largest contract manufacturer.
Industry executives interviewed by CARIBBEAN BUSINESS, say the future of manufacturing depends on what is fast becoming a dominant trend in global manufacturing.
For Puerto Rico, the stakes are high. Since the ten-year phase-out of Section 936 of the U.S. Internal Revenue Code began in 1996, virtually no new companies have come to the island to establish operations.
Many existing companies, particularly pharmaceuticals, are expanding and adding jobs. However, as more multinationals seek to outsource manufacturing operations they will look for contract manufacturers that can delivery products efficiently, on time, and cost effectively.
Industry experts say a strong cadre of contract manufacturers on the island could make the difference between companies deciding to keep their subcontracted manufacturing operation on the island or leaving altogether.
"Contract manufacturing will preserve jobs," says SMART Technologies general manager Jorge Rodriguez. "It may not create a lot of jobs in the short term, but right now the most important thing is to preserve the jobs we have."
Contract manufacturing in the electronics industry generated some $60 billion in revenue in 1998 and is projected to grow to $149 billion by 2003, according to BancAmerica Securities.
"Right now, only 25% of OEMs are subcontracting their manufacturing. That is expected to grow to 50% in the next three to five years," says SMART Technologies General Manager Jorge Rodriguez.
Outsourced production of pharmaceuticals generates $15 billion in sales globally and has been growing at a rate of 10% annually. Over the next two years, the growth of pharmaceutical contract manufacturing is expected to explode as mergers of some of the worlds largest drug makers takes effect, says Jose Casellas, vice president of business development at Mova Pharmaceutical Corp.
"In 10 years, many of the pharmaceutical companies doing business in Puerto Rico will sell their plants to contract manufacturers," Casellas predicts.
The reason: Companies that have traditionally made products they invented, want to invest their time, money, and manpower on research and development and marketing, and fewer resources on manufacturing.
The Puerto Rico Industrial Development Co. (Pridco) needs to develop a strategy to turn the island into a contract-manufacturing hub. But so far, the agency has yet to unveil a plan that has been in the works for a year.
The strategy is simple, industry executives say. It entails going straight to contract manufacturers and OEMs in the States to tell them about the islands highly educated, productive, abundant, and relatively cheaper work force; tax incentives; well developed transportation system; and the fact that products made here carry the Made in the USA label.
"Its an opportunity that Puerto Rico should not let pass," says Ramon Cordero, general manager of Symmetricom Puerto Rico Inc. "Its a new trend in the electronics industry and it will likely spread to other sectors as well."
Symmetricom, based in San Jose, Calif., is the worlds leading maker of equipment used to synchronize computers over vast telecommunications networks. The companys only manufacturing operation is in Aguada, where it employs about 300 workers.
In the late 1980s, the company started doing light contract manufacturing for local companies. Two years ago, manufacturing manager Oscar Marrero, pitched the idea of starting a separate company devoted to contract manufacturing.
Corporate headquarters didnt need much convincing. After all, it had a solid manufacturing operation in Aguada, the island had a pool of skilled workers, and transportation costs were relatively inexpensive.
Marrero and Cordero were given the green light to form Manufacturing Solutions Inc., a wholly owned subsidiary. The new company quickly landed contracts to make telecommunications components for California firms Lam Research, Applied Instruments and Orbitech.
The new subsidiary went from less than $1 million in sales in 1998 to $3 million last year. Marrero expects to double sales this year as the company obtains more contracts.
The new company has created 30 new jobs and plans to double the number as it adds another 21 products to its assembly line this year. It is negotiating with Pridco to build a new plant in Aguadilla.
"Weve created an incubator for a new business by using the resources of Symmetricom," Marrero says. "It shows we have the skills, resources, and the people on the island to compete globally."
Need for speed
So far, Symmetricom, Maunfacturing Solutions, Mova , Manufacturing Technology Services Inc., and Solectron are rare examples of contract manufacturing success on the island.
Despite its highly skilled workers, large available work force, wage scale that is relatively lower than the mainland, formidable manufacturing infrastructure, and proximity to the U.S. mainland, Puerto Rico has fallen way behind competing jurisdiction Guadalajara, Mexico in attracting the worlds major contract manufacturers.
Why is Guadalajara so competitive? It has a highly skilled work force (thanks to an impressive educational system), formidable manufacturing infrastructure, greater proximity to the U.S. border, and lower labor costs than Puerto Rico.
"As a company we work in scales of economy. If it makes sense dollar-wise, we will grow the operation. If we have a competitor building products in Guadalajara at a lower cost and we have an operation where the cost is higher, we may move to Guadalajara," says SMART Technologies Rodriguez.
Lower labor costs in Guadalajara ($1.50 an hour compared to $6.50 an hour in Puerto Rico) are just part of the equation. After all, labor is even cheaper in China.
Transportation is another major issue, because the time it takes to transport finished goods from Asia to the U.S. is revenue lost.
Companies, such as Compaq Computer Corp., Ericsson, and Cisco Systems Inc., have come to realize this. Thats why theyve hired contract manufacturers in Guadalajara for more than just inexpensive labor. These companies want to get their products to U.S. markets as quickly as possible. And Mexicos second largest city is just 600 miles from the U.S. border. The Far East is days away.
Seven of the 10 largest contractor manufacturers in the world have established operations in Guadalajara. Since the inception of the North American Free Trade Agreement in 1994, electronics exports have soared fivefold to $10 billion, according to the Wall Street Journal.
Guadalajara has had electronics manufacturing plants (IBM, Motorola, HP) since the 1970s. But as the production of electronics changed from high end, specialized equipment to commodities, corralling costs became a priority. Thats where contract manufacturers came in and why Guadalajara launched an all-out effort in 1995 to attract them, including Solectron, parent of SMART Technologies in Aguada.
Pridco must adopt Guadalajaras aggressive attitude, say industry executives, if Puerto Rico is to get a piece of the action.
"The government has a great opportunity to reach the big players," says Symmetricoms Cordero. "But we havent seen an aggressive campaign to take the initiative."
"Pridco needs to tell contract manufacturers why its attractive to come to Puerto Rico," adds Rodriguez, who is a regional director of the Puerto Rico Manufacturers Association (PRMA). The PRMA made the support and development of contract manufacturing one of its 15 proposals to rev up Puerto Ricos economy.
"There are companies that are not interested in buying or building a plant. They just want product," says Movas Casellas. "Pridco should not only try to bring new plants to Puerto Rico, but to show [pharmaceutical companies] that we have an infrastructure of contract manufacturers to bring their products here."
Pridco plan under wraps
Pridco appears to have finally gotten the message. "I consider contract manufacturing and the transshipment port the two most important developments that will drive Puerto Ricos economy in the future," said Xavier Romeu, secretary of the Department of Economic Development and Commerce.
Romeu said he would soon unveil a comprehensive plan that will target contract manufacturing.
An informal contract manufacturing committee of Pridco officials and industry executives has been meeting for about a year to help develop the initiative, said William Riefkohl, PRMA executive vice president.
Riefkohl wonders aloud why it has taken Pridco so long to devise a contract manufacturing plan. "I dont see why its so difficult," he says "[Pridco] already carries out a major promotional campaign in the States. They have direct mail and targeted visits. I dont know why contract manufacturing has not been part of that effort."
Riefkohl, who attended several committee meetings, said the initiative is supposed to include visits by government officials and industry executives to contract manufacturers and OEMs in the States to personally convince them the set up shop in Puerto Rico.
"Puerto Rico is in a key position. We have the experience. We have the manufacturing expertise. We have the technology," says Rodriguez.
Another selling point is Puerto Ricos relatively cheap transportation costs, which are lower than Guadalajaras. The islands maritime cargo business is marked with abundant capacity that has forced ocean cargo carriers to lower cargo rates for the last 15 years.
Manufacturing Solutions, for instance, doesnt even charge its customers for shipping.
"We have been able to negotiate with carriers on the local level rates that our parent corporation in California wouldnt be able to negotiate," says Cordero. "In a place like Silicon Valley, our company is one of many companys competing for transportation service. But here in Puerto Rico, our product volume is substantial enough that it gives us leverage to negotiate lower rates. Its more expensive to transport cargo between New York and California than Puerto Rico and California."
There is little doubt Puerto Rico-based contract manufacturers get their products to the U.S. mainland with impressive speed by air and water, but in order to attract more contract work, the island has to contend with other challenges.
High labor and energy costs continue to vex industry executives. But high electricity bills and the minimum wage do not make or break a deal to bring contract manufacturing to the island.
The island, like Guadalajara, needs to appear ready, willing, and able to accomodate contract manufacturers.
"The equation is not only labor and lower taxes. The equation is also quality, efficiency, productivity, technology, and flexibility. All those things together will make you competitive," Rodriguez says.
|Mova: A Contract Manufacturing Pioneer
Puerto Rico could become the capital of pharmaceutical contract manufacturing. At least, thats what Jose Casellas, Mova Pharmaceutical vice president of business development, believes.
"Its within the U.S. jurisdiction and there is a big manufacturing infrastructure here," he says. "As the whole industry evolves into outsourcing, you will probably see that [pharmaceutical] plants in Puerto Rico will become contract manufacturing facilities."
The potential for growth is evident. Since last year, Mova has added six new clients to its roster. And the company wants to acquire a pharmaceutical plant in the U.S. or Europe.
"Were looking for plants that already have volume," says Casellas.
Mova was a pioneer in pharmaceutical contract work, when it was founded in 1987 by CEO and president Joaquin Viso. Today, it is among the islands largest pharmaceutical companys with $81 million in sales in 1998 and plants in Caguas, Manati, and Carolina, which employ 800 workers.
Mova is also among the four big pharmaceutical outsourcing players in the U.S., according to Casellas.
About two-thirds of its production is patented name-brand drugs for companies like Merck. The remainder of Movas production is comprised of generic drugs.
The companys selling strategy is very simple. It takes care of all of the headaches associated with commercializing a drug once it has gone through years of development by pharmaceutical companies, clinical trials, and approval by the U.S. Food and Drug Administration.
Mova does everything from formulating a drug in tablet, capsule, or liquid form to designing the bottle labels. Each step has its own rigorous process that must meet federal standards.
"We have a lot of experience dealing with a variety of products, clients, and regulatory issues on a frequent basis," Casellas says.
Clents benefit from Movas experience and they dont have to build, staff, and maintain manufacturing facilities. That way pharmaceutical companies can focus on developing and marketing new drugs while companies like Mova can continue making them.DRG