SPECIAL REPORT

CONTINENTAL DESTINY

AMERICAN AND CANADIAN FIRMS DRAFT NEW STRATEGIES TO DEAL WITH FREE TRADE

D’ARCY JENISH July 3 1989
SPECIAL REPORT

CONTINENTAL DESTINY

AMERICAN AND CANADIAN FIRMS DRAFT NEW STRATEGIES TO DEAL WITH FREE TRADE

D’ARCY JENISH July 3 1989

It had all the flair and flamboyance of a typical Peter Nygard production. In mid-January, the chairman of Toronto-based Nygard International Inc., Canada’s largest fashion designer, unveiled his fall 1989 collection during a cross-country road show. Nygard flew an entourage of 20 models, choreographers and lighting specialists to Vancouver for a lavish production that included a fashion show, cocktails, a laser display and dancing. A day later, the entire group flew to Montreal for two shows, then back to Nygard’s Toronto base for another performance in front of buyers and media. But as he presented his first line of elegant, high-priced women’s office wear, Nygard was also revealing a critical part of his strategy for survival under the Canada-U.S. Free Trade Agreement. With tariffs abolished on clothing, he plans to manufacture his new line of quality garments using expensive equipment and skilled labor in Canada, for sale in both countries. At the same time, he plans to shift production of his medium-priced, casual clothing to Los Angeles and ship the finished product to Canada. Said Nygard: “Because of the globalization of the world economy, free trade is just another step toward specialization and [finding] your niches.”

Nygard is one of many company leaders designing strategies to take advantage of the FTA. In both Canada and the United States, where businesses tend to regard the accord as part of the overall globalization of trade and investment, the most forward-looking managers already have their drafts in hand and are busily executing the plans. By 1998, all tariffs between the two countries will be phased out, and although the agreement is only six months old, it is already evident that a new market order is taking shape.

For one thing, although trade between the two countries already exceeds $180 billion annually—with Canada having a trade surplus of $12.9 billion in 1988—senior executives across the country predict that the FTA will put new pressures on domestic companies to export even more to the $3.9-trillion U.S. market. Robert McLean, a partner with the management consulting firm Woods Gordon in Toronto, said that research conducted by his firm revealed that only 26 per cent of Canadian manufacturers, accounting for 13 per cent of the country’s manufacturing output, are currently exporting to the United States and other countries. But within just 10 years, at least one-third of Canadian manufacturers who are not currently exporting to the United States will have to do so in order for the Free Trade Agreement to be as beneficial as promised by many business groups.

At the same time, many American businessmen who have operated only in the domestic market say that the FTA provides both access to a valuable market of $110 billion and a first step in the process of becoming globally competitive. And even U.S. multinationals already active in both countries are reorganizing and consolidating on a North American basis to confront Western Europe when it emerges as a wholly integrated market in 1992. Mortimer Zuckerman, a Montreal native who owns the Washington-based newsmagazine U.S. News & World Report, the 127-year-old Atlantic Monthly magazine and a large real estate company, said that companies that are competitive in one large North American market will improve their chances of survival in the era of global commerce. Said Zuckerman: “Nobody has any choice, because it is beyond the ability of any country to control its economic destiny within its own borders.”

To thrive under the FTA, many experts say that Canadian companies will have to become at least as productive and efficient as their U.S. counterparts. And Canadian executives acknowledge that they will be forced to adopt American business practices simply because Canada is the smaller and less powerful of the two trading partners. That may mean a greater emphasis on short-term financial performance, a sharp rise in executive salaries, greater mobility among senior managers and shorter contracts between suppliers and producers. Said Edward Newall, chairman and president of Mississauga, Ont.-based Du Pont Canada Inc.: “Weak businesses die. Give them all the help you can give them and you might add five years to their life.”

After extensive interviews with company managers, consultants, lawyers and accountants in both Canada and the United States, a pattern of leading FTA strategies emerged. They include:

Taking stock:

Preparing for new, continent-wide competition, some Canadian and American companies are taking drastic action. In Canada, some are critically reassessing the viability of plants, equipment and manpower in an attempt to become more competitive. And sometimes the results are painful. As part of its free trade strategy, Montreal-based Dominion Textile Inc., Canada’s largest textile manufacturer, is in the process of eliminating its less profitable lines, spending $18 million to upgrade two Quebec plants and eliminating 370 jobs (page 76).

At the same time, Du Pont Canada Inc. will spend an average $150 million annually until 1991 upgrading its Canadian plants, compared with $90 million yearly in the previous three years. Newall said that Du Pont will increase its capital spending because exports to the United States should more than double to $500 million by 1991 due to tariff reductions.

For Nygard, the advent of free trade has created a need to develop new product lines and shift some production from Canada to the United States. He is now producing some of his labor-intensive low-and medium-priced casual women’s clothing in Los Angeles, where industry wages are much lower than in Canada. On the other hand, he can manufacture top-end women’s garments, which require fewer employees and more expensive machinery, in Canada, and even without tariff protection he can compete against similar American products.

Getting ready for free trade also requires special planning on the part of U.S. manufacturing firms with Canadian subsidiaries. Companies such as the giant Cincinnati-based Procter & Gamble, which has four plants in Canada, have begun developing free trade policies that treat both countries as one. And Adolph Posnick, the Saskatchewan-born chairman of Ferro Corp., a Cleveland-based Fortune 500 company with annual sales exceeding $1.2 billion, declared, “Now that free trade is here, everybody is saying, ‘How do we use our Canadian resources to focus at the big market, which is here in the United States?’ ”

A manufacturer of specialty materials for industry—including enamel coatings for cookware and powder coatings for auto parts and appliances—Ferro Corp. is now developing a new role for its three Canadian branch plants. Previously, those plants served only the small, diversified domestic market. With the FTA, Posnick says that they will handle short production runs and ship to any region where they have a geographic advantage. The American plants, which were designed to serve the huge U.S. market, will continue to be high-volume facilities.

Indeed, while Canadian nationalists have argued that branch plants would be doomed by the removal of tariff protection because their products could be produced more cheaply in the United States, executives such as Posnick and Du Pont’s Newall insist that smaller Canadian factories will be strategically critical. They can tap a huge, rich country that supports a vast variety of specialized products—items that most high-volume American giants have no interest in turning out. As Newall put it: “To survive in Canada, we’ve had to learn how to be very good at doing small things efficiently. Business opportunities that we find exciting, American businessmen look at and say, ‘Well, that damned thing is too small to be bothered with.’ ”

Finding a niche:

One strategy recommended by senior executives and management consultants is directed primarily at Canadians: that firms find a market or a geographical niche waiting to be served in the United States. David Race, president and chief executive officer of Toronto-based CAE Industries Ltd., the world’s largest manufacturer of flight simulators used to train commercial pilots, said that Canadian companies should use their domestic strengths as a springboard into the U.S. market. He added, “Don’t try to manufacture fishing rods, because anybody can manufacture fishing rods.”

Finding such a niche may require major expenditures on research and development—but some of the resulting products may be inexpensive and uncomplicated. Scientists at Du Pont Canada have developed a plastic tray for frozen prepared dinners that can be used in either conventional or microwave ovens. Du Pont began work on the plastic tray in response to food company complaints that existing holders emitted an unpleasant odor when used in microwave ovens. Newall says that North American sales of the tray will likely generate $20 million annually of the company’s $1.2-billion yearly revenues.

For other Canadian companies, the U.S. market has produced even more impressive sales. Fredrick Mitchell, president and chief executive officer of Saskatoon-based Intercontinental Packers Ltd., Canada’s fourth-largest meat processor with annual sales of about $400 million, said that his company began selling gourmet meats to southern California supermarkets in 1985 through a Los Angeles-based subsidiary. By concentrating on a single geographical area with a narrow product line made up of fresh pork, cold ham, roast ham and bacon, the company has achieved annual sales of $50 million and created 230 new jobs.

Controlling costs:

With the FTA, manufacturing decisions increasingly will be based on internal costs and efficiency rather than on the external costs of government-imposed trade barriers. In fact, there are already signs of that happening. Joseph Bausman, a divisional president of Reynolds & Reynolds Cos., a Fortune 500 firm based in Dayton, Ohio, said that in the past its Canadian division has operated autonomously and transborder shipments have been rare because of tariff barriers. Reynolds & Reynolds, a major supplier of computer software programs and business forms to automobile dealerships, operates 11 sales-and-service depots in Canada, as well as a Toronto printing plant. Under the FTA, the company’s Toronto printing plant may now be able to fill orders in upper New York state and other border states.

Investing where it makes sense:

Canadians now rank as only the fourth-largest foreign investors in the United States, while Americans are the largest in Canada. While experts say it is too early to predict where investment dollars will flow in the near future, they say that the FTA may reinforce the overall trend of the past decade—a slowing down of American acquisitions in Canada along with increasing Canadian activity in the United States. Indeed, American companies, no longer forced by tariff barriers to invest in Canada, are already shifting their investments. Shirley Carr, president of the Ottawa-based Canadian Labour Congress says that her organization has counted at least 25 American and Canadian companies, including Toronto-based Inglis Home Appliances Ltd. and Montreal-based Gillette Canada Inc., which have moved production from Canada to the United States or Mexico since the federal election on Nov. 21. Calling it a “continuous flushing of Canadian jobs into the United States, thanks to free trade,” Carr said that the companies were moving production and jobs south of the border in order to take advantage of lower operating costs and wages.

At the same time, some Canadian companies will actually be able to invest more domestically because tariffs will no longer force them to locate south of the border. That is the case with Fishery Products International Ltd., a St. John’s, Nfld., company with annual sales of $400 million and 8,600 employees, which operates two fish processing plants in the Boston area. Company president Victor Young said that the plants, which employ 300 people, produce dozens of different fish products sold to institutions and restaurants across the United States. He added that his company had to build the processing plants in the United States because American tariffs on processed fish were much higher than on raw fish. Now, he said, the company will build any new processing plants where it makes the most sense economically—in Newfoundland.

Buying Canadian firms:

The FTA has led some American companies to buy Canadian firms in order to serve U.S. markets. Ferro Corp., which has had Canadian subsidiaries since 1927, bought a Petrolia, Ont.-based company called Canadian Plastics Concentrate Ltd. in mid-1988. The company produces plastic compounds used in the manufacturing of a broad range of appliances and consumer products. But Posnick added that the company was also ideally located to supply the auto industry in Michigan and will now focus its production on that market. Said Posnick: “We would not have bought that facility if free trade was not being discussed.”

For its part, Worthington Industries Inc., a Columbus, Ohio, company with annual sales in excess of $1.2 billion and earnings of $67 million, bought a Guelph, Ont., firm called Metal Flow of Canada Ltd. Sales manager John Lamprinakos said that Worthington primarily wanted Metal Flow’s manufacturing division to produce large propane tanks. Worthington itself produces a variety of small, reusable propane tanks—the most common model is a five-gallon tank for gas barbecues. As the tariffs on propane disappear, Worthington will use the Guelph plant to capture a share of the U.S. market for the larger tanks, said Lamprinakos.

Forming joint ventures:

For small companies in both countries, finding a joint-venture partner may be the most effective strategy for gaining access to the entire North American market. Already, Nordco Ltd., a Newfoundland company that specializes in the research and development of underwater sensing equipment and signal processors, has formed a joint venture with a Connecticut firm, Ship Analytics Inc. Nordco president Frank Smith said that the partners design and build ship-bridge simulators, which are used to train officers of commercial, military and coast guard vessels.

Nordco has gained access to an American sales organization, while Ship Analytics can pursue Canadian contracts more easily and has also benefited from Nordco’s technical capabilities. Smith said that his company has learned important lessons from exposure to American sales and marketing techniques. Ship Analytics has sent salesmen all over the world trying to sell products produced jointly by the two companies. “They’re much more aggressive than we are,” said Smith.

Capitalizing on the new continental labor market:

Besides easing the restrictions on trade and investment, the FTA will create one North American labor pool for executives, professionals, service representatives and salesmen. Previously, companies in each country had encountered delays, uncertainties and inconsistencies when trying to move employees on temporary work permits across the border. Joseph Grasmick, a Niagara Falls, N.Y., lawyer who specializes in immigration work, said that in the past companies had to wait a year to obtain a work permit for its managers. Under the new rules now in effect, immigration officials at major ports of entry can issue renewable, one-year permits literally within a few minutes if an individual has the right documents and is classed as a professional, added Grasmick.

The biggest immigration change under the FTA was the designation of over 40 occupations—including lawyers, architects, teachers, nine different types of scientists, engineers, hotel managers and journalists—which are eligible for temporary work permits. The new rules do not affect the current process of acquiring citizenship or a green card, which grants permanent residence. Grasmick said that the U.S. Immigration Service has assigned special free trade officers at major ports of entry such as Toronto international airport, Vancouver International Airport and the Peace Bridge in Buffalo to process applications. By June 1, about 1,000 Canadians had entered the United States under the various immigration provisions of the FTA, said John Bulger, assistant director of the U.S. Immigration and Naturalization Service’s Buffalo, N.Y., district office.

The FTA has also eased the entry restrictions for investors in both countries. Indeed, Grasmick said that the FTA is the first agreement between Canada and the United States that provides for the issuing of investor visas. In order to obtain the one-or two-year renewable visas, applicants must prove they will make a “substantial” investment in the other country, wording that allows immigration officials great latitude of interpretation. And in both countries, they appear to have been notably accommodating since the FTA went into effect. Although Canadian figures are not yet available, by early June, U.S. consular officials in Canada had issued investor visas to 156 individuals.

Already, the potential benefits of the new North American labor market have become evident. Bannus Hudson, president of Cincinnati-based Precision Lenscrafters, a retail eyeglasses chain that has grown to almost 300 stores and annual sales of $480 million in five years, said that Canadian employees will gain from better training opportunities and broader retail experience. Precision Lenscrafters opened its first Canadian store in March, 1988, and it now has 11 stores in Quebec, Ontario and Alberta. Said Hudson: “We were surprised how difficult it was to bring people across the border for training and development.” He added that as Lenscrafters becomes more familiar with the new rules, more Canadian employees will be brought to the company’s head office for training or they will be assigned to work temporarily in different regions of the United States.

Easing the restrictions on cross-border business travel is expected to result in major increases in Canadian managerial salaries and compensation packages. Said Douglas Caldwell, chairman of Toronto-based Caldwell Partners International, Canada’s largest executive search firm: “Compensation in the United States is much higher for equal jobs than it is in Canada.” One recent survey by New York City-based Towers Perrin, a consulting firm that specializes in designing executive salary and compensation packages, showed that the average American chief executive officer earns $609,600, compared with the Canadian average of $320,400. Taxes, the cost of living and housing prices are also generally lower in the United States than in Canada. As a result, Canadian companies will be forced to offer competitive salaries or face an exodus of managerial talent, said Caldwell. But corporate boards of directors will likely demand increases in efficiency, productivity and profitability. And executives who fail to perform may be dismissed much more quickly than in the past.

Adapting to a new business culture:

Although Canada and the United States share a common language and have similar cultures, the business climate in the two countries is decidedly different: attitudes and business practices vary greatly. In many cases, the differences are a result of the fact that competition in the United States, where many more companies vie for market share in virtually every industry, is much more intense than in Canada.

Ralph Noble, president of Toronto-based Synergistics Industries Ltd., which produces raw plastic that is used in the packaging industry, provided a clear indicator of greater American competitiveness. He said that one-year contracts between suppliers and manufacturers are standard in Canada. But three-month contracts are much more common in the United States, where Synergistics has two plants. Said Noble: “If we have five suppliers in Canada, our plant in New Jersey will have 20.” As a result, pricing is much more competitive in the United States, and American businessmen will switch suppliers for even the slightest variations in price. The three-month contracts also reflect the fact that short-term financial results are more valued in the United States than in Canada. Said Noble: “We’re going to have to change our ways of doing business, because the Americans are not going to change.”

Meanwhile, Garth Drabinsky, chairman of Toronto-based Cineplex Odeon Corp., describes the United States as “a market of wonderful opportunities” but added that it can also be a treacherous environment. He said that on several occasions, he has reached tentative agreements to buy an American asset, only to have the seller use a Cineplex offer to bid up the price with other potential buyers. Declared Drabinsky: “You are almost compelled to lock the parties in a room with a group of lawyers for fear of the deal leaving when the seller walks out of the room.”

For those companies that already have their strategies in place, FTA will be a challenge rather than a threat. With the rise of powerful trading blocs, the giant North American monolith may eventually provide businesses in both countries with their strongest possible protection.

TELLING STATISTICS

(All monetary comparisons In Canadian dollars.)

Value of Canadian exports to the United States: $100 billion

Of American exports to Canada: $86.4 billion

Amount of direct Canadian investment in the United States: $43.3 billion

Of direct American investment in Canada: $75.2 billion

Exports as a share of GNP in Canada: 28.3%

As a share of GNP in the United States: 6.8%

Ratio of domestic to overseas investment in Canada: 9.5:1

In the United States: 76.5:1

Per capita GDP in Canada: $21,344

Per capita GDP in the United States: $24,108

Average dividend yield of the TSE 300 index as of Dec. 1988: 3.36%

Average dividend yield of the NYSE composite index as of Dec. 1988: 3.6%

The basic federal corporate income tax rate in Canada: 28%

In the United States: 34%

Total personal income tax per capita in Canada: $3,224

In the United States: $3,830

Largest-ever Canadian takeover of an American company: Campeau Corp.’s $8.2-billion takeover of Federated Department Stores Inc. in 1988

Largest-ever American takeover of a Canadian company: the $5.1-billion purchase of Dome Petroleum Ltd. by American-owned Amoco Canada Petroleum Co. Ltd. in 1987

Average annual salary, with benefits, of a chief executive officer in Canada: $320,400

In the United States: $609,600

Rent for prime office space per square foot in Toronto: $41

In New York City: $47

Average price of a house in 1988 in Canada: $134,781

In the United States: $105,409

Richest person in Canada: K. C. Irving, with assets of $10 billion

In the United States: Sam Walton, with assets of $8 billion