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Purchasing Implications Under NAFTA: Opportunities or Obstacles?

Author(s):

Dr. Julie J. Gentry
Dr. Julie J. Gentry, Assistant Professor, University of Arkansas, Fayetteville, AR 72701, 501/575-6137

Dr. Linda L. Stanley
Dr. Linda L. Stanley, Assistant Professor Our Lady of the Lake University, San Antonio, TX 78207, 210/434-6711

81st Annual International Conference Proceedings - 1996 - Chicago, IL

Overview.
During this session, the researchers will report the results of a recent survey examining the effects of NAFTA on purchasing decision-making. Primary emphasis is placed on the implications of changing tariffs and duties, extensive paperwork requirements concerning "rules of origin," and potential risks associated with cross-border transportation. Several case studies will also be presented to explore how firms can avoid these potential "new" trade barriers and maximize the strategic purchasing benefits resulting from NAFTA.

Introduction.
The North American Free Trade Agreement (NAFTA) became effective on January 1, 1994. The primary objective of NAFTA is to establish an economic environment in which firms from each country are able to compete on the basis of their competitive market advantages, rather than tariff and non-tariff barriers (Nichols and Taylor 1995). Over a 15-year period, NAFTA will result in the eventual removal of tariff and a reduction of non-tariff barriers to trade between Canada, Mexico, and the United States. Canada and the United States are expected to be duty free by 1998 (Zuckerman 1995).

There is no doubt that purchasing decisions are being affected by the recent passage of NAFTA. The new rules and procedures were originally forecast to greatly increase the degree of sourcing activity across North American borders. However, recent publicity concerning the extensive requirements and tedious paperwork involved to meet NAFTA- eligibility has clouded the positive future outlook for many firms. Regardless of these concerns, the potential savings on duties and tariffs that apply after becoming NAFTA-eligible are too attractive for many American firms to overlook.

Scope of the Research.
NAFTA is an extremely complex and broad area for research, with major features of the NAFTA including diverse topics such as environmental protection; harmonized health, safety, and industrial standards; elimination of import limits; time-phased tariff reductions; equal investment opportunities; and, equal opportunities for trucking operations for firms in any of the three countries. Although each of the provisions is critical for the long-term success of NAFTA, several of these provisions stand out as having more impact on purchasing decisions in the near future. Therefore, this research is limited to three major areas:

  1. General purchasing implications of NAFTA for firms operating in the United States,
  2. Using the "rules of origin" and maximizing potential tariff reductions,
  3. Inbound transportation issues and the changes taking place in the North American transportation environment.

Objectives of the Research.
Given the scope of the research, this session has three primary objectives:

  1. To fully explain the potential risks and rewards of sourcing activities within the NAFTA region.
  2. Report the results of a survey to investigate changing purchasing decision-making since the passage of NAFTA.
  3. Present several case studies to demonstrate how firms are using NAFTA to source more strategically, while successfully dealing with the new rules and procedures.

General Purchasing Implications of the NAFTA. NAFTA is expected to bring sizable increases in trade to the United States, Canada, and Mexico. The Department of Transportation forecasts an increase over the next decade between 24% and 34% in U.S. imports from Canada, and an astounding 125-140% increase in U.S. imports from Mexico (Richardson 1994). Mexican imports to the United States increased by 21% during the first six months of 1994 alone (Fawcett and Smith 1995).

Purchasing from NAFTA countries is desirable for three primary reasons: proximity, NAFTA rules that reduce tariffs, and the recent enthusiasm displayed by Mexico about its trade possibilities with the United States (Karoway 1995). The most favorable attraction to Mexico is its low labor costs and the availability of the labor force. According to the Bureau of Labor Statistics, the hourly compensation costs for production workers in manufacturing (in U.S. dollars) for 1993 were $16.73 in the United States, $16.30 in Canada, and only $2.59 in Mexico. These differences have a substantial impact on the final product price of manufactured goods, allowing purchasing firms to get lower prices by sourcing from other countries.

In addition to lower product prices, NAFTA opens up new opportunities for firms who currently source off-shore to shift sourcing back to one of the NAFTA countries (Waller and Emmelhainz 1995). Goods can typically be obtained in much less time from Mexico than from suppliers located in Asia or Europe. With the recent reductions in duties for North American products, goods manufactured in Mexico will no longer have large import-transaction costs that can negate lower production costs.

NAFTA Rules of Origin. In order for goods to flow duty-free across North America, they have to be wholly produced or transformed in one of the NAFTA countries. Buyers must also be issued a certificate of origin showing the goods are NAFTA eligible. The difficulty in the system is determining if products meet NAFTA eligibility, which is tied to the "rules of origin."

In order to earn a lower or a no-tariff status, manufacturers must trace each product's individual components to find out where they were made. Only goods that "originate" in NAFTA countries are eligible, although goods may include some "non-originating" materials and still meet NAFTA standards (Zuckerman 1995). A two-step process is necessary in order to determine if products fall under NAFTA origin. First, a product must be looked up in the harmonized tariff classification. Next, the specific rule of origin for that classification is determined, since they can vary widely depending on the product (Distribution 1995).

Although the process sounds relatively simple in theory, firms that are trying to meet NAFTA rules of origin compliance have voiced numerous complaints. First, due to the complexity of the process, some firms find it necessary to use a manual approach to country of origin research, although there are software programs available to assist with rules of origin classification. Additionally, NAFTA has special provisions for auto parts, textiles, and agricultural products. Finally, a new record-keeping requirement is being imposed as a result of the Customs Modification Act, of which NAFTA is a part (Zuckerman 1995).

Many firms claim that in order to exploit the full NAFTA tariff reductions, it is absolutely necessary to use a specialist who is educated in both the NAFTA and the classification area, which is difficult to find. Regardless of the numerous difficulties, firms continue to pursue NAFTA tariff reductions in order to reduce their overall purchasing costs.

The Changing Transportation Environment.
The changing transportation environment cannot be ignored when evaluating sourcing opportunities under NAFTA. In order to justify purchases across NAFTA borders on the basis of lower prices, reduced transit times, or increased reliability, inbound transportation must be factored into the purchase decision.

The tremendous increase in border traffic between Mexico and the United States has created unique logistical challenges (Fawcett et al. 1995). Border traffic is expected to quadruple by the end of the decade, emphasizing the need for increased efficiencies in customs procedures at existing border crossings. The increasing traffic has been intensified by the fact that U.S. and Mexican carriers have not been allowed to make cross-border deliveries into each other's countries. Until recently, U.S. trucks were not allowed to enter Mexico at all, and Mexican trucks were limited to short border zones in the U.S. Intermediaries are commonly used to coordinate the passage of shipments across borders to a domestic firm and to insure all customs documents are in order. If shipments are physically stopped for inspection, typical delays have ranged from two to 12 hours (Fawcett et al. 1995).

As of December 18, 1995, both Mexican and U.S. motor carriers will have reciprocal access to each nation's border states. In the U.S. this includes California, Arizona, New Mexico, and Texas. Mexican border states include Baja California, Sonora, Chihuahua, Coahuila, Nuevo Leon, and Tamaulipas (Traffic Management 1995). Additionally, Canadian carriers will be able to enter the Mexican border states. This phase of NAFTA focuses on motor carriage since most cross-border traffic is transported by motor carriers, with 85% of U.S.-Mexican trade transported over land (Berzon 1995).

This important date is forecast to affect almost every aspect of cross-border trade, but the exact implications are not yet known. Surveys and case studies will be used after the first of the year (1996) to assess immediate changes and implications of this new transportation environment on the purchasing function of U.S. firms. Important issued to be investigated include changing freight charges, damage and loss issues, detention charges, insurance, and changes in transportation service reliability.

Summary.
Since the passage of the North American Free Trade Agreement, firms across North America have been challenged with new sourcing opportunities, but not without numerous obstacles. It is important to keep in mind that the signing of the agreement marked only the beginning of a unification process-not a discrete moment in time for total integration of operating environments.

In order to maximize the potential benefits for U.S. purchasing firms resulting from the passage of NAFTA, it is important to understand the significance of the NAFTA rules of origin, to be aware of new record-keeping requirements, and to realize that a changing transportation environment will affect NAFTA purchasing decisions. More importantly, it is necessary to continue to monitor the evolving integration efforts and changing rules in order to remain competitive in the future.

REFERENCES

  1. Berzon, Michael B. "Its Time has Come: Universal B/L." American Shipper, September 1995, 37-42.
  2. "Everything You Wanted to Know About the NAFTA Rules of Origin." Distribution, February 1995, 20.
  3. Fawcett, Stanley E., and Sheldon R. Smith. "Logistics Measurement and Performance for United States-Mexican Operations under NAFTA." Transportation Journal 34.3 (Spring 1995): 25-34.
  4. Fawcett, Stanley E., John C. Taylor, and Sheldon R. Smith. "The Realities of Operating in Mexico: An Exploration of Manufacturing and Logistics Issues." International Journal of Physical Distribution & Logistics Management 25.3 (1995): 49-68.
  5. Karoway, Cherish. "Going Global: Purchasers Take the Plunge." NAPM Insights, July 1995, 46-48.
  6. Nichols, Ernest L.,Jr., and John C. Taylor. "Sourcing Implications of the North American Free Trade Agreement." International Journal of Purchasing and Materials Management (Spring 1995): 26-34.
  7. Richardson, Helen L. "It's Not Culture, It's Opportunity." Transportation & Distribution, May 1994, 37-40.
  8. "Shippers, Carriers, U.S. Agencies Counting Down to Dec. 18". Traffic Management, October 1995, 17-18.
  9. Waller, David G., and Margaret A. Emmelhainz. "The North American Free Trade Agreement: Strategic Implications for Logistics Management." The International Journal of Logistics Management 6.1 (1995): 1-12.
  10. Zuckerman, Amy. "NAFTA and the Paper Chase." Inbound Logistics, April 1995, 18-24.

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