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Weekly UpdatesAsk Michael dos Santos, CMA, FCMA, president and CEO of Montreal heavy machinery manufacturer Flextor Inc., how his company has managed to ride the wave of Canada's strong dollar with nary a scrape and he'll suggest that it was pure, dumb luck.
"When we set up our business, did we plan for exchange cycles? It never even crossed our minds. Lucky. We were lucky," he says now, 13 years after the company opened shop.
Flextor buys products and material from the U.S., and then sells back to the U.S., thereby sidestepping swinging exchanges in the process. While dos Santos says he's convinced many companies, at least in his industry, are doing the same thing, Jim Copeland, a partner with Grant Thornton LLP in Kentville, NS, isn't so sure that this rosy picture applies to most manufacturers in Canada. Many of his clients are manufacturers who are struggling, in part, due to Canada's appreciating dollar.
"That's an enviable position to be in," he says of Flextor. "Not many companies are there. The appreciation of the Canadian dollar had a huge impact on Canadian manufacturers right across the country, especially if they were exporting. Many manufacturers have been beat into submission," he says.
In fact, some pundits say that structural and cyclical pressures are going to continue to push Canadian manufacturers into recession, not coming up for air until 2008 when output will rebound. The currency, which reached a 28-year high in May 2006, has recently receded as the price of crude oil and natural gas plunged. As a result, there's been a slight exporting spurt this year that might help manufacturers recover slightly. Still, it's not time to pull out the party hats yet.
"No question that most Canadian companies have been affected negatively," says Carol Boivin, CMA, senior manager of the consulting group for the Business Development Bank of Canada in Longueuil, Quebec. "The manufacturing sector was particularly hard hit. The two principal negative impacts remain the reduction of profit margins on exports and a retreat of the volume of sales."
But, like dos Santos, not everyone is hurting. Or at least not everyone is admitting to it. In fact, if you are to believe a recent Canadian survey from 2006, Canadian executives are a fairly optimistic bunch. When asked for their thoughts on the Canadian economy and their own companies, most said they expected to experience growth, despite lingering doubts about the continued impact of the strong Canadian dollar and increased pessimism about the U.S. economy. At the same time, not all of these companies were manufacturers.
So is this glass-half-full mentality merely swagger, or is a robust Canadian dollar not nearly as precarious an economic factor as many fear?
Hedge your bets
Flextor is definitely doing something right. It's practicing natural hedging. In finance, a hedge is an investment that's taken out specifically to reduce or cancel out the risk in another investment. Not all hedges are financial instruments, however. A producer that exports to another country, for example, may hedge its currency risk when selling by linking its expenses to the desired currency.
And that's exactly what dos Santos does when he buys anything from motors to alloy steel in the U.S. and then sells to the U.S. in U.S. dollars. Back when it was extremely expensive to buy those materials, the company was still getting a bonus by selling in U.S. currency.
"Today it's the flipside. You don't get as many dollars when you exchange your U.S. sales, but we're buying stuff in the U.S. for much cheaper," says dos Santos. "If your portfolio of stuff you buy and sell is well-balanced, then the cycles shouldn't affect you."
It also helps that his company designs and manufacturers the entire product so competition for an exact replica of what he is making is not as fierce as it could be. Then there's the question of labour. His labour costs are only 20-30% of his overall expense, he says. That means building his product in Canada, even with higher pay structures for employees, is still profitable--and reduces the risk.
"If you're very labour intensive and you're making it in Canada then exporting it, you would be hugely exposed because you're paying out most of your product cost in labour locally," he says.
It's all global
The strong Canadian dollar compared to the weakened U.S. dollar doesn't concern dos Santos nearly as much as what is happening on the global stage, however. With worries about the sustainability of the fast-growing American current-account deficit, the greenback fell 23% between 2001 and 2006 relative to the U.S. major trading partners and 27% relative to the Canadian dollar. The effect of this has been that many Canadian manufactueres have been priced out of the American market.
"We talk about the Canadian dollar's strength in relation to the U.S. dollar. But if you look at the Canadian dollar's strength in relation to most major currencies in the world over the last two years, it's been the strongest currency in the world. The problems we're talking about with the U.S. are shared by any number of other currencies in other countries," says Copeland.
John Lane, CMA, a manager in the treasury department at Husky Injection Molding Systems Ltd., agrees that you've got to see the global picture.
"When I look at the world, I don't just see the Canadian dollar. I look at currency risk in general," he says.
And that's not the full picture. Emerging markets loom. China, for example, when it was admitted to the World Trade Organization in 2001 opened the floodgates for China's price competitiveness in the manufacturing exports sector. At first the country specialized in labour-intensive and low-cost gadgets and toys. That is no longer the case as it moves into value-added products like machinery.
China is particularly worrisome for large machinery manufacturers that rely heavily on metals that are being highly subsidized in China.
In February, dos Santos was on a business trip to Brazil. According to him, in that country, labour costs are one fourth of what we pay in Canada.
"There's a huge payback to go make stuff in Brazil right now, but I go down there and they look at me and say, 'Why are you bringing work down here? We're busy giving it over to the Chinese,'" he says.
The innovation solution
The increasingly competitive global market, coupled with the strong Canadian dollar definitely has had an impact on Maple Leaf Foods Inc., the largest food manufacturer in Canada. In late 2006, the company announced restructuring plans, shifting its focus from producing fresh pork to producing further-processed--or value-added--processed meats such as pre-cooked sausages and meal brands to provide a better, more stable foundation to accelerate its global agenda.
And yes, it's closing or selling plants across Canada from Lethbridge, Alta, to Burlington, Ont., and canceling others such as a $110-million pork plant in Saskatoon. A poultry plant on the East Coast will also shut its doors.
The publicly traded company says it has had no choice.
"We made a business decision to change our whole business model," says Douglas Dodds, CMA, FCMA, executive VP and chief strategy officer for Maple Leaf Foods Inc. "We concluded that we could not cost-cut our way to competitiveness in the world."
The name of the game is innovation, says Dodds, citing that pre-packaged roasts and such have a much nicer margin than fresh pork.
"The pursuit of competitiveness is relentless. There's always improvement that is taking place somewhere in the world. If you don't continue to look for ways to improve your business or use innovation to improve your products, you're just constantly going to be chasing competitiveness and will never really get there," he says.
At the same time, by focusing on a different product segment, the company is also simplifying the business.
Jim Copeland at Grant Thornton says innovation is especially important right now. Canadian companies are still ahead of the emerging markets in this area, although as mentioned before, that will begin to change in the future. In short, ask yourself how you can add value to the products you're making now, he says. But look at what the market wants rather than innovating for the sake of innovating.
"We need to truly differentiate ourselves in the market as opposed to just trying to compete against what other people are making. We know from day one that we're already at a disadvantage because of our high cost of labour," says Copeland.
Husky, meanwhile, is always on the lookout to find ways to innovate in its industry, but the company is also finding ways to cost-cut by starting a lean manufacturing program that helps to manage cost by cutting waste. Can the company streamline its manufacturing process? Lean helps them do that.
"As the Canadian dollar rose, it certainly hastened the program's rollout," says Lane.
Innovating, hedging and finding ways to cut costs are all areas that manufacturers should be looking at, says Boivin.
"The loss of the artificial price advantage for Canadian exporters has forced Canadian businesses to undertake the necessary investments to make their businesses more efficient and competitive," he says.
That also means companies are encouraged to buy new equipment or technology from the U.S. that will allow them to produce their goods more cheaply.
But this advice is small comfort for companies that have overpriced themselves and are seriously struggling to find clients that will fork over the extra cash for their goods. In other words, if you buy it will they come? Maybe not.
"You've just nailed it on the head," says dos Santos. "How long can you survive without making anything?"
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