Agrifood Supply Agrifood Supply Chains in the Chains in the

NAFTA MarketNAFTA MarketJill E. HobbsJill E. Hobbs

Department of Agricultural Economics, Department of Agricultural Economics, University of SaskatchewanUniversity of Saskatchewan

Presented to the 4Presented to the 4thth Annual North American Agrifood Annual North American Agrifood Market Integration Consortium Workshop: Market Integration Consortium Workshop:

Contemporary Drivers of Integration,Contemporary Drivers of Integration, Cancun, Mexico, June 2007 Cancun, Mexico, June 2007

OutlineOutline Do borders still matter? Two hypotheses.Do borders still matter? Two hypotheses. Conceptual frameworkConceptual framework

Identify key drivers for change Identify key drivers for change Effect on Transaction costs Effect on Transaction costs Implications for supply chain relationships Implications for supply chain relationships

Challenges to cross-border supply chains Challenges to cross-border supply chains Border frictions Border frictions National policy responses to regional National policy responses to regional problemsproblems

ConclusionsConclusions

Do borders still matter?Do borders still matter?

Expectations that regional trade agreements Expectations that regional trade agreements will lead to a will lead to a deepeningdeepening of economic of economic integration, e.g. increase in cross-border integration, e.g. increase in cross-border supply chainssupply chains

If borders no longer mattered we would If borders no longer mattered we would expect to see no difference in the way in expect to see no difference in the way in which supply chains are organized within a which supply chains are organized within a country and between countriescountry and between countries

Evidence from Gravity models suggests that Evidence from Gravity models suggests that borders still matter (Jayasinghe & Sarkar, borders still matter (Jayasinghe & Sarkar, 2004; Moodley et al., 2000)2004; Moodley et al., 2000)

Two HypothesesTwo Hypotheses If borders still matter, what will be the effect on If borders still matter, what will be the effect on

vertical coordination across the border?vertical coordination across the border? Two hypotheses:Two hypotheses:1.1. Firms pursue strategy of Firms pursue strategy of closercloser vertical vertical

coordination across borders to better plan for coordination across borders to better plan for border friction and proactively provide information border friction and proactively provide information to reduce border irritantsto reduce border irritants

2.2. Firms pursue Firms pursue lessless vertical coordination across vertical coordination across borders to reduce dependency-based risks borders to reduce dependency-based risks associated with border closures, disruptions, costs.associated with border closures, disruptions, costs.

Depends on characteristics of product & position Depends on characteristics of product & position of border within the supply chainof border within the supply chain

Need a conceptual frameworkNeed a conceptual framework

Conceptual FrameworkConceptual Framework

Transaction Cost Economics Transaction Cost Economics provides insights into changing provides insights into changing nature of vertical coordinationnature of vertical coordination

Information/search costsInformation/search costs Negotiation costsNegotiation costs Monitoring & Enforcement costsMonitoring & Enforcement costs Transaction costs affect the vertical Transaction costs affect the vertical

coordination outcomecoordination outcome

Vertical CoordinationVertical Coordination Spectrum of vertical coordination Spectrum of vertical coordination

possibilities from spot markets, through possibilities from spot markets, through contracts, strategic alliances, joint contracts, strategic alliances, joint ventures, and vertical integrationventures, and vertical integration

Trend toward closer vertical coordination Trend toward closer vertical coordination in domestic agrifood marketsin domestic agrifood markets

Drivers for change: regulatory, socio-Drivers for change: regulatory, socio-economic, technologicaleconomic, technological

E.g. Food quality; food safety; ethical E.g. Food quality; food safety; ethical attributes; environment; information attributes; environment; information technology technology

External Drivers: e.g.

Socio-EconomicRegulatoryTechnology

Product Characteristics

Transaction Characteristics

VerticalCoordination

Transaction Cost Reducing Competitive Pressure

Institutional AdaptationTransacti

on Costs

Adapted from Hobbs and Young (2000)

Conceptual model of forces driving

vertical coordination

Transaction Transaction CharacteristicsCharacteristics

Changes in transaction characteristics Changes in transaction characteristics affect transaction costsaffect transaction costs

Asset specificity:Asset specificity: vulnerability to vulnerability to opportunistic behavior; incentive for opportunistic behavior; incentive for vertical integrationvertical integration

FrequencyFrequency ComplexityComplexity Uncertainty: cUncertainty: closer vertical coordination loser vertical coordination

to mitigate higher search & monitoring to mitigate higher search & monitoring costscosts

UncertaintyUncertainty

Uncertainty for buyer over Uncertainty for buyer over product product qualityquality (search costs; monitoring costs) (search costs; monitoring costs)

Uncertainty for buyer over Uncertainty for buyer over reliability reliability of supplyof supply (quantity & timeliness) (quantity & timeliness)

Price uncertaintyPrice uncertainty for buyer & seller for buyer & seller (time lag)(time lag)

Uncertainty for seller in Uncertainty for seller in finding a finding a buyerbuyer (search costs) (search costs)

Transaction Characteristics Uncertainty

for buyer quality

Uncertainty for buyer:

supply reliability (timeliness

and quantity)

Uncertainty for buyer and seller:

price

Uncertainty for seller: finding a

buyer

Product Characteristics, e.g.

Perishability Product Differentiation

Quality variable and visible

Quality variable and invisible

New product characteristics important to consumers

possibly

Regulatory Drivers, e.g. Liability Traceability

Border measures

Border EffectsBorder Effects

Regulatory drivers can affect transaction Regulatory drivers can affect transaction characteristics directly, characteristics directly,

e.g. increased border security measures e.g. increased border security measures following 9/11following 9/11

Border delays increase Border delays increase uncertaintyuncertainty - over timeliness of delivery; - over timeliness of delivery; - over (net) price (higher transportation - over (net) price (higher transportation costs); costs); - over quality (perishable goods)- over quality (perishable goods)

Crossing a border can significantly increase Crossing a border can significantly increase the the complexitycomplexity of the transaction of the transaction

Transaction Characteristics

Uncertainty for buyer

quality

Uncertainty for buyer:

supply reliability (timeliness

and quantity)

Uncertainty for buyer and seller:

price

Uncertainty for seller: finding a

buyer

Frequency of

Transaction

Relationship-specific

investment

Complexity of

transaction (variety of outcomes)

Regulatory Drivers, e.g. Liability

possibly

Traceability

Border measures Source: Adapted from Hobbs and Young (2000)

External Drivers: e.g.

Socio-EconomicRegulatoryTechnology

Product Characteristics

Transaction Characteristics

VerticalCoordination

Transaction Cost Reducing Competitive Pressure

Institutional AdaptationTransacti

on Costs

Adapted from Hobbs and Young (2000)

Conceptual model of forces driving

vertical coordination

External Drivers: e.g.

Socio-EconomicRegulatoryTechnology

Product Characteristics

Transaction Characteristics

VerticalCoordination

Transaction Cost Reducing Competitive Pressure

Institutional AdaptationTransacti

on Costs

Adapted from Hobbs and Young (2000)

Conceptual model of forces driving

vertical coordination

Institutional AdaptationInstitutional Adaptation Institutional adaptation Institutional adaptation

through transaction-cost through transaction-cost reducing innovationsreducing innovations

e.g. private sector: third e.g. private sector: third party service providersparty service providers

e.g. public sector e.g. public sector institutional adaptations: institutional adaptations: GreenLane Maritime GreenLane Maritime Cargo Security ActCargo Security Act

The good newsThe good news NAFTA chapter 11 facilitated more secure NAFTA chapter 11 facilitated more secure

cross-border investments, cross-border investments, e.g. Walmart - expansion into Mexico;e.g. Walmart - expansion into Mexico; Cargill (greenfield investment in Alberta; Cargill (greenfield investment in Alberta; Tysons (purchase of plant in Brooks, Alberta)Tysons (purchase of plant in Brooks, Alberta)

Removal of tariffs likely more important for Removal of tariffs likely more important for increasing transborder trade rather than increasing transborder trade rather than deepening economic relations through closer deepening economic relations through closer vertical coordination (not affect product vertical coordination (not affect product characteristics or transaction characteristics)characteristics or transaction characteristics)

Removal of quantitative restrictions may have Removal of quantitative restrictions may have reduced reduced somesome supply chain uncertainties re: supply chain uncertainties re: access to quota allotmentsaccess to quota allotments

The bad newsThe bad news

Challenges to the growth of cross-Challenges to the growth of cross-border supply chains include:border supply chains include:

Policy distortions, e.g. supply Policy distortions, e.g. supply management, sugar, Canadian management, sugar, Canadian Wheat Board, subsidiesWheat Board, subsidies

Border frictionsBorder frictions Persistence of national policy Persistence of national policy

solutions to regional problemssolutions to regional problems

Border FrictionsBorder Frictions Border delays reduce the efficiency gains Border delays reduce the efficiency gains

available from just-in-time delivery systemsavailable from just-in-time delivery systems Customs procedures and border inspection Customs procedures and border inspection

costscosts Lack of harmonization of standards & Lack of harmonization of standards &

technical regulationstechnical regulations International law opaque with respect to International law opaque with respect to

transboundary liabilitytransboundary liability Exchange rate risk Exchange rate risk People movementPeople movement

Crossing a border within Crossing a border within Europe (Schengen Group)Europe (Schengen Group)

“It’s lunch time . . . this must be Belgium” W.A. Kerr (numerous)

A typical Schengen Border Crossing

From border post . . . to coffee shop

US border US border

Border DelaysBorder Delays

““Often Often it takes from two to five daysit takes from two to five days and at least three pieces of equipment and at least three pieces of equipment (trucks and trailers) and three or four (trucks and trailers) and three or four drivers, to cross the Rio Grande river drivers, to cross the Rio Grande river with a loaded truck, while actual with a loaded truck, while actual driving time from Chicago to Laredo driving time from Chicago to Laredo (1600 miles) is only two days” (1600 miles) is only two days” (Haralambides and Londono-Kent, (Haralambides and Londono-Kent, 2004, Intl. J of Transport Economics, 2004, Intl. J of Transport Economics, emphasis addedemphasis added))

Border delaysBorder delays

““Transport of a trailer over the 1600 miles Transport of a trailer over the 1600 miles from Chicago to Monterrey involves 10 from Chicago to Monterrey involves 10 movements with a minium of three different movements with a minium of three different trucks and various pieces of equipment for trucks and various pieces of equipment for loading and unloading “. . . pre-clearance at loading and unloading “. . . pre-clearance at the US border is “the US border is “a process that takes 12 a process that takes 12 to 74 hoursto 74 hours”. Following pre-clearance, a ”. Following pre-clearance, a Mexican truck transfers the product across Mexican truck transfers the product across the border “the border “crossing time varies 1 to 8 crossing time varies 1 to 8 hourshours” (Haralambides and Londono-Kent, ” (Haralambides and Londono-Kent, 2004, 2004, emphasis addedemphasis added))

Border DelaysBorder Delays

““it takes from two to five days it takes from two to five days … a process that takes 12 to 74 hours … a process that takes 12 to 74 hours . . . Crossing time varies 1 to 8 hours” . . . Crossing time varies 1 to 8 hours” uncertaintyuncertainty

Estimated time northbound Mexico to US Estimated time northbound Mexico to US across Nuevo-Laredo border varies from across Nuevo-Laredo border varies from 1.6 to 13.11.6 to 13.1 hours; hours;Southbound US to Mexico varies from Southbound US to Mexico varies from 12.1 12.1 to 82.4to 82.4 hours (Haralambides & Londono- hours (Haralambides & Londono-Kent, 2004) Kent, 2004)

ImplicationsImplications

Problem for perishable productsProblem for perishable products Problem for just-in-time delivery systemsProblem for just-in-time delivery systems Uncertainty: reliability of supply; qualityUncertainty: reliability of supply; quality Suppliers may be restricted to Suppliers may be restricted to

participating in less efficient supply participating in less efficient supply chain relationshipschain relationships

Retailers will prefer to source Retailers will prefer to source domestically rather than across the domestically rather than across the border (e.g. Walmart in Mexico)border (e.g. Walmart in Mexico)

“It’s lunch time . . . this must be Belgium”

Compared to . . . Compared to . . .

Customs Procedures & Customs Procedures & Border Inspection CostsBorder Inspection Costs

Particular challenge for B-to-C Particular challenge for B-to-C Ecommerce in perishable and specialty Ecommerce in perishable and specialty food productsfood products

Lumpiness in border inspection costs put Lumpiness in border inspection costs put smaller-scale Ecommerce shipments at a smaller-scale Ecommerce shipments at a competitive disadvantagecompetitive disadvantage

Incentive instead to vertically integrate Incentive instead to vertically integrate across border and ship in bulk for across border and ship in bulk for distribution within target countrydistribution within target country

Failure to harmonize Failure to harmonize standardsstandards

E.g. different organic standards (definition, E.g. different organic standards (definition, protocols, labeling requirements); different protocols, labeling requirements); different regulations on natural health productsregulations on natural health products

Transborder movement of organic products Transborder movement of organic products may require closer vertical coordination to may require closer vertical coordination to reduce monitoring costsreduce monitoring costs

NAFTA committees on harmonization of NAFTA committees on harmonization of technical regulations and standards not technical regulations and standards not delivereddelivered

Implication: increased transaction costs Implication: increased transaction costs leading to institutional adaptation, e.g. leading to institutional adaptation, e.g. growth of private standards such as growth of private standards such as retailers’ Good Agricultural Practicesretailers’ Good Agricultural Practices

Different commercial legal Different commercial legal systemssystems

Growing emphasis on traceability, in Growing emphasis on traceability, in part to facilitate assigning liability for part to facilitate assigning liability for food safety problems & encourage due food safety problems & encourage due diligencediligence

Transboundary liability is unclearTransboundary liability is unclear Complicates cross border supply chain Complicates cross border supply chain

relationships between independent firmsrelationships between independent firms Implication: increases the complexity of Implication: increases the complexity of

the transaction, increases uncertaintythe transaction, increases uncertainty

Exchange rate risk – North Exchange rate risk – North AmericaAmerica

Creates price uncertainty for buyers & Creates price uncertainty for buyers & sellerssellers Hedge E/R risk but major structural Hedge E/R risk but major structural shifts a problemshifts a problem Vertical integration across the border a Vertical integration across the border a possible strategy to internalize the price possible strategy to internalize the price riskrisk

Europe (13 countries)Europe (13 countries)

(now much easier to go to Belgium for lunch!)

People MovementPeople Movement

Establishing business relationships likely Establishing business relationships likely requires frequent cross-border movement of requires frequent cross-border movement of personnel (search & negotiation costs)personnel (search & negotiation costs)

Ongoing business relationships likely require Ongoing business relationships likely require movement of technical personnel, etc.movement of technical personnel, etc.

Some NAFTA provisions for some Some NAFTA provisions for some professions, but still requires documentation, professions, but still requires documentation, passports; often not a transparent processpassports; often not a transparent process

New passport requirement for US-Canadian New passport requirement for US-Canadian borderborder

Lunch in BelgiumLunch in Belgium

No passport required!

Increased travel

Increased travel

hassles

hassles

Compared to . . . Compared to . . .

People Movement: People Movement: Implications?Implications?

Can affect ways in which cross-Can affect ways in which cross-border supply chains are border supply chains are coordinatedcoordinated

E.g. use subsidiaries to coordinate E.g. use subsidiaries to coordinate after-sales service. Difficult in after-sales service. Difficult in market entry stage.market entry stage.

E.g. contract with foreign firms for E.g. contract with foreign firms for after-sales serviceafter-sales service

Supply chain solutionsSupply chain solutions Joint venture with existing firms as a market Joint venture with existing firms as a market

entry strategy (e.g. Walmart’s initial foray entry strategy (e.g. Walmart’s initial foray into Mexico through JV with Cifra), ORinto Mexico through JV with Cifra), OR

Internalize costs by vertically integrating Internalize costs by vertically integrating across the border, ORacross the border, OR

Use spot markets and hire the service Use spot markets and hire the service providerprovider

Whether border frictions lead to closer OR Whether border frictions lead to closer OR looser coordination will depend on looser coordination will depend on transaction and product characteristics and transaction and product characteristics and the effect on transaction costs at the margin the effect on transaction costs at the margin

Supply chain solutionsSupply chain solutions

Institutional adaptation: growth of Institutional adaptation: growth of firms providing services which reduce firms providing services which reduce the transaction costs of moving goods the transaction costs of moving goods across borders. May reduce the effect across borders. May reduce the effect of borders on supply chainsof borders on supply chains

Difficult to test empirically. Need time Difficult to test empirically. Need time series data on degree & nature of cross series data on degree & nature of cross border commerce and growth/decline border commerce and growth/decline of third party service providersof third party service providers

National Policy Responses National Policy Responses to Regional Problemsto Regional Problems

National policy decisions can increase risks of cross-National policy decisions can increase risks of cross-border supply chain investmentsborder supply chain investments

E.g. increased border security measures following 9/11 E.g. increased border security measures following 9/11 E.g. Effect of BSE on cross-border supply chains: E.g. Effect of BSE on cross-border supply chains:

closure of US border to Canadian cattle for an closure of US border to Canadian cattle for an extended periodextended period

E.g. anti-dumping & countervail actionsE.g. anti-dumping & countervail actions E.g. Threat of country of origin labelling E.g. Threat of country of origin labelling create uncertainty; add to complexity of the create uncertainty; add to complexity of the

transactiontransaction disrupt cross-border supply chains and increase disrupt cross-border supply chains and increase

costs/risks of investments in these supply chainscosts/risks of investments in these supply chains Difficult to anticipate ex anteDifficult to anticipate ex ante

The Canadian-US border The Canadian-US border on 9/12on 9/12

ConclusionsConclusions NAFTA borders still matterNAFTA borders still matter Full potential for Full potential for deepeningdeepening economic integration economic integration

remains unrealizedremains unrealized Bilateral supply chains in North America more costly Bilateral supply chains in North America more costly

than those within one countrythan those within one country Difficult to predict how this inefficiency will manifest Difficult to predict how this inefficiency will manifest

itself:itself: as closer supply chain coordination to internalize as closer supply chain coordination to internalize costs, costs, or looser coordination to avoid dependency risks or looser coordination to avoid dependency risks

Need to examine product characteristics and transaction Need to examine product characteristics and transaction characteristics of specific industries to determine characteristics of specific industries to determine

Further attention needed to border frictions and common Further attention needed to border frictions and common policy approaches within NAFTA to encourage greater policy approaches within NAFTA to encourage greater cross-border supply chain activity in the agrifood sectorcross-border supply chain activity in the agrifood sector

Lunch anyone?Lunch anyone?