KPMG’s new Competitive Alternatives 2010 report has been big news lately. According to the company it’s “the most thorough comparison of international business locations ever undertaken by KPMG”, with valuable information for any US firm considering moving operations out of the country. But is it fully relevant for us in the sourcing industry? Of the 10 countries surveyed, the report includes two Nearshore alternatives, Mexico and Canada, and provides great insight on comparative business costs for each. It also looks at the importance of site selection factors, and how companies’ preferences have shifted in recent years. We’ve done our own analysis of this report, and what it brings up that you as a buyer, provider or investment promotion agency should be aware of.
How it Works
First, Competitive Alternatives is not a report focused solely on outsourcing, but on business locations in general. KPMG calculates a baseline cost from four US cities – New York, Los Angeles, Chicago and Dallas – and compares this against costs in each of the surveyed locations. It then arrives at a % cost advantage or disadvantage relative to the US for each country overall, as well as for specific industries in manufacturing, R&D or corporate services. The main factors examined include costs for labor, facilities, transport and utilities, as well as taxation regimes. Also considered are factors not strictly overhead cost-related such as business environment, cost of living and quality of life. The 10 countries are then ranked from least to most expensive.
Mexico is ranked first in the report on almost every category related to business cost, and the reason is simple. Of the other countries – Canada, Netherlands, Australia, UK, France, Italy, Germany and Japan – Mexico is the only emerging economy included in the study. It has an 18.2% cost advantage over the US, and the report admits that “this rating reflects Mexico’s status as the sole emerging industrial country among the 10 nations studied”. We asked Luis Ricardo Rodriguez, Partner at KPMG’s Global Location and Expansion Services (GLES) Latin America, why that was. “We do acknowledge that Mexico is the only developing country, but its track record of economy, population and infrastructure growth over the last decade has been stable, and that’s why it was included”, says Rodriguez, who was involved in developing the study. “Other LatAm countries like Brazil or Argentina don’t have that record. Also because it’s a NAFTA country, we thought it was interesting to compare it to the US and Canada”.
But how does he think Mexico’s cost environment rates against other Latin American countries? “There are still many areas where Mexico is most competitive, especially in shared services because of the lower costs and the proximity. Brazil is definitely more expensive, but I do think that Chile and Argentina are very competitive on other areas of site selection”.
Cost index – Compared to the US baseline of 100, Mexico’s index for Back office/Call center operations is 46.6, for Software design is 68.3 and for R&D activities overall is 61.1. The country’s main outsourcing cities Monterrey and Mexico City are ranked first and second respectively out of more than 95 others. The Mexican peso has also depreciated 17% against the dollar since 2008 – in fact the report says that Mexico’s cost competitiveness holds across a range of future exchange rates. “Even if the currency were to appreciate by 20% against the dollar, the resulting cost index would still be more than 14% lower than the US benchmark”.
Labor costs and tax rates – For labor costs, which the report deems most important for site selection, the average salary in Mexico across various business functions is US$ 26,319 – again ranking cheapest on the study. However Mexico curiously fares worse than some industrialized countries on utility costs and tax rates. Its effective income tax rate for Corporate and IT Services is 28.7%, placing it fourth. Average taxation for R&D is higher at 30.3%, ranking it seventh after even the US. The reason is that countries like Canada, Netherlands, France, UK and many US states offer significant incentives in these fields, sometimes resulting in ‘negative tax rates’ or government subsidies for companies. Mexico can’t afford to lower its tax rates much more, since that revenue is needed to counter the growing government deficit.
Other competitiveness factors – Since it’s being compared to fully industrialized countries, Mexico will of course be cheaper from a pure cost perspective. The other side of the coin however, is that it will also perform worse on general business environment factors like competitiveness. Its Competitiveness Index rank by the World Economic Forum is last of the 10 countries on the study. In terms of availability of skilled labor, 15.9% of the population has a tertiary education level, ranking the country ninth. It also ranks ninth on Ease of Doing Business, and tenth on Quality of Infrastructure.
Our recommendation if you’re a US firm considering Mexico? Use this report for the many data points and detailed analysis of its costs and business environment – Competitive Alternatives has some of the best market research we’ve seen yet. But your decision shouldn’t be influenced by its rankings of the country, simply because Mexico is not being compared to its counterparts in Latin America or anywhere else.
“Canada has managed to consistently maintain a cost lead. If you consider the specific category of Corporate and IT Services, it has a larger cost advantage of 9.8% over the US”
Meanwhile, Canada is being compared to its counterparts – industrialized economies that are more expensive, yes, but focus on higher value services and business functions. And with an overall 5% cost advantage on the US, Canada is the cheapest of them. On nearly all the cost metrics on the report, Canada is ranked second after Mexico with cities like Montreal, Vancouver and Toronto placing high on the list of global cost competitive cities. “For an operation that’s looking to set up within a major developed country, Canada is a great choice”, says Glenn Mair, Director at MMK Consulting and co-author of the report. “Canada has managed to consistently maintain a cost lead. If you consider the specific category of Corporate and IT Services, it has a larger cost advantage of 9.8% over the US”. If we go even more specific and look at Software Design, that advantage rises to 12.1%, which is why many in Canada are calling for a countrywide shift to IT services.
Canada’s second rank has not changed since the 2008 edition of Competitive Alternatives, in spite of the currency appreciating close to the US dollar a few times. The country’s real attraction is its tax policy towards investing companies. For Corporate and IT Services, Canada ranks first with an effective income tax rate of 21.9%. The R&D average rate is even better (-8.3%), since Canada offers many grants, tax credits and incentives programs to attract these activities. For availability of skilled workers, Canada again ranks first with 48.3% of the population having a tertiary level of education. However this does not tell the whole story – companies up north have told us that it’s often difficult to find staff for call centers and IT projects, because Canada’s large natural resources industry soaks up the skilled labor.
Mair disagrees though. “That was true a few years ago, but now because of the recession there are pockets of labor all over Canada eager to work. It does become more of an issue when you’re looking for IT workers with a more specialized skill set. I’d point to Edmonton or Winnipeg to find them, but the lowest costs are usually in Halifax or Moncton”.
In recent years we’ve seen a wave of businesses moving operations back to North America from India or other locations because of customer service issues, distance and time zone complications, etc. This report shows a strong likelihood that a company can operate a call center or sourcing operation better and cheaper in Canada than in the US. So if you’ve decided that you do want your operation in North America in spite of the higher costs, Canada is a good option.
Site Selection Factors
One other noteworthy aspect of this report is the relative importance of site selection factors, and how companies’ preferences have changed since 2007. In the ranking of important selection factors it’s expected that ‘Labor Costs’ tops the list, and it does. In fact four of the top five selection factors are about costs – a wake up call to governments and IPAs who claim that companies care more about innovation and service quality. They’re still focused on cost competitiveness and saving dollars, especially in today’s economy.
On that note, we thought it was very telling how crucial ‘Tax exemptions’ have become. The category moved up from rank 10 in 2007 to place third in this list. Is there just a greater incidence of governments granting those exemptions to attract quality investment? “Definitely, and it’s a large factor in the site selection decision”, says Rodriguez. “Many companies do go after tax exemptions, and it’s getting to the point where they expect it as part of the incentives package”.
The low relative importance of ‘State and Local incentives’ (ranked eighth) is also something to realize, especially for investment promotion agencies. We’ve all seen IPAs spend substantial money and energy discussing complicated incentives to attract companies – should they be focusing elsewhere? “Incentives are important, but they may be better served by marketing to what firms are looking for: lower labor costs, tax rate and utility costs, as well as greater availability of skilled labor”.
Download KPMG’s Competitive Alternatives 2010 report here: http://www.competitivealternatives.com/download/