With or without a formal trade agreement, economic integration within North America is at hand. CE asked a globally focused chief executive to size up the opportunities and how CEOs might capture them.
October 1 1993 by Frederick W. Smith
The proposed North American Free Trade Agreement holds great promise for companies in the U.S., Canada, and Mexico willing to look to the future and abandon old beliefs. No longer will invisible walls of tariffs, import quotas, and customs fees separate the three countries; the signs south of Tucson and El Paso that used to warn “proceed at your own risk” will be replaced with green traffic lights; and highways to prosperity will stream across the old borders, linking Montreal with Monterrey and Chihuahua with Chicago.
Despite determined lobbying by organized labor and environmentalists, and a U.S. federal judge’s ruling in June that the Clinton Administration should not send NAFTA to Congress until it first prepares a formal statement on its environmental impact (an appeal is expected), the agreement is expected to go into effect early in 1994. By lowering duties and other barriers to the movement of goods, services, and capital, NAFTA will create a trading bloc of 362 million people and $6 trillion in GDP stretching from Alaska to the Yucatan.
Though the North American trading bloc still will rank No. 2 behind the European Economic Area, and trade restrictions won’t disappear completely for another 15 years, NAFTA is a powerful instrument of change in the New World. It will accelerate a trend that’s been underway for two decades: the north-south flow of commerce in search of operating efficiencies and untapped markets.
CEOs who want to benefit from new trading opportunities in North America must throw out old assumptions about who their customers are, what persuades them to buy, and how goods and services reach the marketplace. With or without NAFTA, economic integration on the continent continues apace. The opportunities are too great for CEOs to remain on the sidelines until the dust settles. Mexico‘s economy is primed to explode, and U.S. and Canadian companies must prepare to ride that wave into the next century.
Although NAFTA may mean harder times for some industries, the pact’s overall benefits can’t be denied. For U.S. and Canadian companies, NAFTA will unlock the door to what until now has been one of the world’s most shielded economies: Mexico, a country of 86 million people with a burgeoning economy, deep labor reserves, and a middle class hungry for consumer products and services. For Mexican business, the agreement encourages foreign investment and opens the most affluent consumer market in the Western Hemisphere to south-of-the-border farm produce, clothing, and household appliances. NAFTA also is expected to further weaken the barriers still guarding Canada‘s borders four years after the signing of the U.S.-Canadian Free Trade Agreement. Duties on computers and telecommunications equipment, for example, will be eliminated Jan. 1, 1994.
Federal Express business in Mexico has doubled every year since 1990-a reflection of a dramatic upswing in transborder activity as U.S. and Canadian companies position themselves for the realities of the world after NAFTA. The growth extends beyond the border zone, a home away from home to such U.S. manufacturing giants as General Electric, Zenith, Ford Motor Co., and Texas Instruments. Anticipating NAFTA, blue-chip corporations that have expanded their operations deep into Mexico include 3M, Caterpillar, Xerox, Allied Signal, Northern Telecom, and the Bank of Novva Scotia. They are rethinking strategy, structure, marketing approaches, logistics production, and distribution in the context of borders that will become more porous with each passing year.
There are legitimate concerns as Mexico, formerly thought of as a Third World country, increases business with the U.S. Mexican commerce suffers from a customs system still dogged by the perception of corruption and sometimes breathtaking inefficiency; an outmoded, dilapidated infrastructure; uncertainty about continued protection of Mexican autos, textiles, agriculture, and oil; and Mexico’s political stability under the successor to President Carlos Salinas de Gortari. But the opportunities of economic integration and the threat the accord poses to North American makers of products such as clothing, sugar, tuna, and glassware compel decisive action now.
The major attraction for industry in Mexico has been obvious since the 1960s, when the first maquiladoras sprouted along the banks of the Rio Grande. Ultralow labor costs (the average hourly wage in Mexico is $12 less than in the U.S.) more than justify long supply and distribution lines for factories producing computer components, electronics, auto parts, adhesives, and hundreds of other semifinished products for export to the U.S. and Canada. Low taxes and a liberal regulatory policy also help the bottom line.
The ranks of maquiladoras, already 2,000-strong in a belt from Nogales to Juarez, are certain to grow with NAFTA’s passage. Just as Canadian firms such as Varity Corp. (formerly Massey Ferguson) and Northern Telecom moved their operations to America after the U.S.-Canadian FTA, American corporations (and more than a few Canadian exiles) will be lured to Mexico by lower U.S. tariffs and shorter border crossings that make maquiladoras an even better deal. U.S. duties, which are currently less than 4 percent on most Mexican goods, largely will disappear over the next 15 years.
Will skilled manufacturing also migrate south, taking thousands of U.S. and Canadian jobs with it? This is the great fear of NAFTA opponents, but such an exodus is unlikely until Mexico makes giant vocational strides. Overly ambitious companies quickly find out that 20 percent illiteracy and a relative lack of technical skills still plague much of the Mexican work force. Cultural differences also must be considered; it’s not uncommon, for example, for American-owned factories to lose 25 percent or more of their work force at Christmas.
CRACKING THE GOLDEN TRIANGLE
Forward-thinking CEOs envision more than sunbaked factories churning out components for home consumption when they weigh their options in Mexico. They also see rapidly growing government institutions, schools, and businesses in dire need of modern technology-satellite links, computer networks, medical devices, construction equipment-not to mention 50 million young wage earners desperate for U.S. consumer products such as soft drinks, blue jeans, sporting gear, cosmetics, and other goods.
Most of Canada‘s population lives within 100 miles of the U.S. border. Not so in Mexico. The civic and commercial heart of the country lies farther south, inside a triangle formed by Monterrey in the north, Guadalajara to the west, and Mexico City to the south. Intent on capturing this vast market, U.S., Canadian, and overseas firms already are moving into central Mexico-the leading edge of a migration that will gain momentum over the next 10 years. Faced with a labor shortage in the crowded maquiladora corridor, subassembly manufacturers also are moving south. Magna International, Canada‘s largest auto parts maker, is building its first Mexican facility in Puebla, south of Mexico City, next to a Volkswagen assembly plant.
STRATEGIC OPTIONS ABOUND
NAFTA empowers companies to pursue any number of money-making strategies in Mexico. Exporting is a more viable option than ever. According to the U.S. International Trade Commission, Mexican imports rose 50 percent between 1989 and 1991; in the first half of 1992 alone, they leaped another 29 percent. In 1994, as duties on everything from microchips to shoes begin to ebb, the stream of products from the U.S. and Canada will swell to a torrent. Tariffs on 3M resins, tapes, electrical insulation, and other products, for example, have fallen by one-third since 1987, helping the company to triple its Mexican sales in the same period. NAFTA removes tariffs of 15 percent to 20 percent on Caterpillar’s heavy construction equipment, while maintaining duties against its Japanese rival Komatsu Ltd.
Until recently, broad swaths of Mexico‘s economy virtually were closed to foreign investment. Under NAFTA, the country’s state-owned oil, gas, mineral, and electric utility sectors will remain sacrosanct, but insurance, banking, agriculture, pharmaceuticals, and communications will be opened to U.S. and Canadian investment. Accordingly, consumer and service multinationals are acquiring Mexican firms and setting up wholly owned subsidiaries, the better to court customers and to market to a distinctive culture. Last fall, the Bank of Nova Scotia acquired a 5 percent stake in Mexico‘s fourth-largest financial group. Although the bank invested primarily to support Canadian clients doing business in Mexico, it is undoubtedly aware that the country has a dearth of banks, with only one branch for every 19,000 people, compared to one branch for every 3,500 people in Canada.
For U.S. industries stripped of duty protection by NAFTA, investing in Mexican competitors may be the only way to thrive or even survive in the new environment. Cotton and acrylic mills; furniture and household glass factories; and producers of sugar, seafood, citrus, and peanuts are among the enterprises facing new challenges from Mexico‘s low wages and long growing season.
In certain industries, foreign equity ownership will be phased in over several years. American and Canadian transportation companies, for example, can’t acquire 51 percent of a Mexican carrier until the year 2000. So right now, northern truckers and railroads are biding their time by entering into marketing agreements that allow them to trade services with their Mexican counterparts. Burlington Northern, Roadway Services, and Carolina Freight already have signed contracts to transfer southbound cargo to Mexican carriers. In return, goods have begun to roll off Mexican trucks and freight cars for the journey north.
RETHINKING DISTRIBUTION AND LOGISTICS
Such partnerships illustrate how NAFTA is rerouting the thinking of logistics experts in all three countries. The necessity for a truly Pan-North American distribution strategy that links cross-border demand points is a hot topic at transportation seminars these days. It’s already happening in Canada, where U.S.-owned subsidiaries have found that sourcing from points south makes much more sense than paying high Canadian wages and taxes. Procter & Gamble, for example, closed a Duncan Hines cake mix plant in Quebec, opting to consolidate its North American distribution of cake mixes in Jackson, TN.
A cogent logistical scheme for Mexico has yet to emerge. For the moment, manufacturers, suppliers, and merchandisers seem content to warehouse and ship from traditional U.S. hubs until the full ramifications of NAFTA become clear. But carriers are gearing up for NAFTA, forging the pathways to Mexico that their U.S. and Canadian customers will demand within a few years. Burlington Northern has introduced a rail-barge service from its Texas hub to ports on Mexico‘s east coast. A number of steamship lines have tailored their services to cater to increased traffic out of maquiladoras. And express carriers and freight forwarders are widening their horizons, offering a greater selection of routes into Mexico and more frequent deliveries. Federal Express used to fly to Mexico City from Harlingen, TX; this year our planes began daily non-stop flights to the capital from our Memphis hub.
As foreign investment feeds Mexico‘s economy, the cross-border flow of raw materials and finished goods will extend south into the populous “triangle” market. New distribution facilities serving the American Southwest as well as Mexico most likely will emerge just south of the border. In time, Los Angeles may conduct more business with Guadalajara than with New York.
ROADBLOCKS TO PROGRESS
Mexico needs to improve its internal systems to maximize NAFTA’s potential benefits. The short-term impediments to free trade with Mexico are an inadequate infrastructure and a sometimes obdurate bureaucracy-these have more negative impact than lingering duties and quotas. Mexico‘s systems of roads, bridges, railroads, airports, telephones, and data links aren’t yet capable of handling the huge surge in demand that will come as U.S. and Canadian companies venture into Mexico. Less than 9 percent of the country’s highways exceed two lanes; major rail lines can’t handle the heaviest grain or chemical tank cars used in the U.S.; hour-long waits for a telephone dial tone aren’t unusual; and advanced data and image transmission is virtually nonexistent.
Because the Mexican government lacks all of the necessary resources to bring the country’s infrastructure into the 1990s, foreign companies will have to shoulder some of that burden by building roads and fuel-supply depots, installing their own telecommunications and waste-disposal systems, and investing in new equipment.
But private industry can’t do much about Mexico‘s customs’ service, which is notorious for inefficient red tape and perceived corruption. In their zeal to streamline rules and procedures for NAFTA, customs officials all too often hamstring express carriers, importers, and exporters by enacting new regulations with little or no notice. Freight stranded in limbo between the old rules and the new can be held in Mexican customs for days, ruining carefully laid logistical plans. In contrast, time-sensitive exports to Canada generally clear customs while in transit and certainly within one or two hours after arrival.
Priority express carriers particularly are frustrated by the inability-or refusal-of customs inspectors to examine cargo electronically. Systems such as Federal Express’ ExpressClear can forward manifest data to customs while a plane is en route, allowing officials to flag specific items for closer inspection upon arrival. In some countries, including Canada, computers download data directly to customs authorities. Yet in many cases, Mexican customs officials insist upon physically inspecting incoming freight, turning a one-day delivery into a two-day odyssey. And, despite President Salinas’ reforms, some perceived corruption still exists among inspectors.
NEW LAND, NEW EXPECTATIONS
Post-NAFTA prosperity will come to companies that can adapt to Mexico‘s unique cultural, social, and political environment. Smart, informed marketing is crucial, whether you’re selling construction equipment, phone service, or soft drinks. For the most part, U.S. marketers don’t have to dream up separate sales and advertising campaigns for Canada-much of English-speaking Canada has been exposed to American products and consumer values by TV commercials beamed across the border. Only Quebec forces multinationals such as Chrysler, Honeywell, and Procter & Gamble to translate their messages into French, hire bilingual sales representatives, and practice cultural sensitivity.
Companies must do all of the above in Mexico, a Spanish-speaking country that cleaves closer to Latin America than to its neighbors to the north. Continent-wide marketing campaigns can be conceived in San Francisco, Atlanta, or Toronto, but in Mexico they must be executed to reflect the lifestyle and mores of Mexicans. Blue Diamond Growers, a California cooperative that will benefit from the Jan. 1 elimination of a 25 percent duty on U.S. almonds, conferred with two Mexican consulting firms before launching its marketing plan. The recommendations: Design a new label for Latin consumers and flavor southbound cocktail nuts with chili peppers, cheese, and lemons. Marketers needn’t worry about the misappropriation of precious brand names and slogans by Mexican knockoff artists: NAFTA calls for the protection of intellectual property rights, including trademarks, patents, and copyrights.
Community relations is also vital in a country where the standard of living is far below that of the rest of North America. Environmentalists and labor advocates have blamed U.S. companies for the polluted, squalid conditions that exist around some of the maquiladoras, and the Mexican government has responded by beefing up health and environmental inspections. Corporations doing business in Mexico can’t be expected to solve the country’s myriad problems, but good corporate citizenship is and ought to be expected under the NAFTA accord. Companies can foster alliances with government officials and community leaders by hiring local managers whenever possible, paying competitive wages and benefits, investing in employee education, and subsidizing meals and transportation.
Although NAFTA doesn’t apply to the rest of Latin America, it has thrown a spotlight on a region of immense promise. By extending America‘s free trade zone to the Guatemalan border, NAFTA brings North American multinationals within striking distance of 46 countries representing one-sixth of the world’s population. South America‘s emerging economies already generate considerable excitement in boardrooms, including that of Federal Express. The success of NAFTA could well lead to a re-examination of trade throughout the Western Hemisphere as the 21st century rapidly approaches.
Frederick W. Smith is chairman, president, and chief executive of Memphis, TN-based Federal Express, a $7.8 billion company that was the first to win the Malcolm Baldrige National Quality Award in the service category. It is the world’s largest express transportation company, shipping 1.6 million items to 187 countries each workday.