A detailed copy of this report (electronic version) may be obtained by contacting Ms. Christine Dewar at: dewar.christine@ic.gc.ca

Competitiveness Analysis for North American Automotive Investment

Executive Summary

Background, Objectives And Scope

The automotive industry is a major contributor to the Canadian economy. It employs approximately 145,000 people and represents 23 percent of the country's total merchandise exports. The industry also drives innovation in many types of advanced technologies.

Canada's automotive industry, while substantial, is only a fraction of the size of the auto industry in the United States. In addition, in recent years Mexico's automotive industry has grown significantly, both in terms of size and quality of production. Canada's auto industry now competes directly with both the US and Mexico for new automotive investments.

The terms of reference for this study were to examine Canada's competitive position relative to US jurisdictions, by analyzing the key factors in automotive investment decisions and comparing Canada to leading US states with respect to those factors.

A variety of business cost and business environment factors are typically considered by companies when deciding on a site for a new assembly plant or for expanding an existing plant. This analysis focuses on the following main factors: 

• Business costs:
• Facility construction and tooling.
• Labour.
• Utilities.
• Transportation.
• Taxation, including tax incentives.

• Labour environment:
• Labour availability and quality.
• Unionization.
• Labour stability and flexibility.
• Cost of plant closure.

• Business environment factors, including:
• Utility infrastructure and service reliability.
• Transportation infrastructure.
• Border issues.
• International tax issues, including customs duties and withholding taxes.
• Environmental issues.

The study compares two Canadian and six US jurisdictions that are among the most active North American jurisdictions in the automobile production industry, and focuses on one selected city in each jurisdiction, as presented in Exhibit A.

To compare the financial impact of location-sensitive cost factors, a financial model was developed for a new assembly facility with the characteristics presented in Exhibit B.

1: Varies by location based on land, infrastructure and construction costs.

The financial analysis undertaken in this study is based on the KPMG CompetitiveAlternatives.com Cost Model and its related cost database. The model is designed to compare the estimated costs for many different types of business operations across multiple geographic locations. This information was supplemented with data from industry-specific research, as required.

Location-sensitive costs examined in this study include: 

• Labour costs specific to the automotive industry, including both scheduled and anticipated future wage increases.
• Facility costs for land purchase, infrastructure, and building construction.
• Distribution costs based on delivery of finished vehicles by third-party logistic providers on regular schedule, in full railcar or truckloads.
• Utility costs based on utility requirements of actual plants.
• Interest rates, adjusted to preferential rates typically available to the major auto assemblers.
• Depreciation calculated on all capital assets.
• Taxation, including both income and non-income taxes.
• Incentives impact analysis, based on assumptions about the level of incentives available in each jurisdiction. Two scenarios have been analyzed:
• A baseline scenario. This analysis does not distinguish among jurisdictions based on incentives, as the objective of the baseline analysis is to compare business cost fundamentals in each location.
• An impact of incentives scenario. This analysis is based on an assumed package of incentives in each jurisdiction that is consistent with historical trends and/or current policy.

Summary results for the baseline financial analysis for each of the eight cities examined are presented in Exhibit C. These results do not incorporate the impact of business incentives. All figures are presented in US dollars^*, unless otherwise noted.

^*Exchange rate: US$1.00 = C$1.476; C$1.00 = US$0.6775 (March 2003)

All financial measures indicate a consistent ranking among the cities, with the two Canadian cities, Montreal, QC (1) and Waterloo, ON (2), offering a narrow advantage over all US cities examined: 

• The average unit cost of production measure shows that the two lowest-cost cities, Montreal and Waterloo, offer savings of US$34 to US$185 per vehicle (0.2 percent to 1.4 percent) over the four Southern US cities, and savings of US$396 to US$445 per vehicle (2.9 percent to 3.3 percent) over the two Northern US cities.

• Montreal and Waterloo also have the highest annual average net profits at US$109.5 million and US$106.2 million respectively. This compares with the four Southern US cities where net profits range from US$94.2 million to US$78.1 million, and the two Northern US cities where net profits range from US$43.7 million to US$37.9 million.

• Net Present Value (NPV) is highest in Montreal and Waterloo, at US$642.5 million and US$621.9 respectively. The Southern US cities show an NPV in the range of US$547.0 million to US$449.8 million, while the northern cities show an NPV in the range of $240.5 million to $204.6 million.

• Return On Investment (ROI)^* in Montreal at 41.1 percent, and Waterloo at 38.7 percent, is from 6 to 12 points higher than in the four Southern US cities, and from 22 to 27 points higher than in the two Northern US cities.

^*Defined as return on shareholders' capital.

1: US$ average cost of production per vehicle, before income taxes, at 2003 cost levels.
2: Effective combined corporate income tax rate, including federal, state/provincial, and local income taxes, as applicable to each jurisdiction.
3: Seven-year average net profit after tax (non-discounted).
4: Net investor cash flow over seven years, discounted at marginal cost of capital (interest rate on debt).
5: Seven-year average net profit after tax (non-discounted) / equity investment.

When looking at unit costs of production, after automotive components which account for over 80 percent of total production costs, labour costs represent the next highest cost of production and the largest cost factor that varies based on the location of the plant. The lowest total labour costs, including wages and benefits, are found in Dothan, AL, which has a labour cost advantage of 3.3 percent over Waterloo, ON, and 2.2 percent over Montreal, QC. The location with the highest labour costs is Saginaw, MI, where costs are 38.1 percent higher than in Dothan, AL.

For major business investments, it is common practice for most governments to offer significant business incentive packages. This is particularly true for new auto assembly plants.

The packages offered typically comprise a complex set of incentives and programs, tailored to the specific investment and job creation opportunity. These packages may typically include: 

• Site acquisition assistance and/or free land.

• Subsidized infrastructure development.

• Tax abatements and credits, against income, capital, sales and/or property taxes.

• Training and workforce recruitment programs.

• Financing assistance.

The total value of the assumed incentives package in each jurisdiction has been based on the recent history of incentive offerings in each location^*, for both new and retooled assembly plants, over the last (approximately) 10 years. The largest incentive packages are assumed to be offered in Mississippi and Georgia, reflecting the recent aggressive actions of these states in successfully pursuing new auto assembly plants.

^*Except for Quebec and Ontario. In Quebec, no incentives have been provided to an auto assembly plant since the late 1980's, when the only remaining Quebec assembly line undertook its final major retooling. Given the age of this data, and the recent introduction by Quebec of as-of-right incentives for major strategic investments, figures for Quebec represent estimates for the new as-of-right incentives. In Ontario, recent history has not been used, so as to reflect the Province's stated policy of "no special incentives".

Exhibit D illustrates the impact on return on investment of the incentive packages assumed to be provided in each jurisdiction.

Key conclusions from the analysis of incentives are: 

• Montreal - Quebec's assumed total incentive package of US$176 million is somewhat less valuable than the typical incentive packages in the Southern US states. Under these assumptions, the ROI for this facility in Montreal is still competitive with the Southern US states, but no longer shows a clear advantage.

• Waterloo - Ontario has, in the past, offered significant incentive packages for auto assembly plants, but its current incentives programs focus on new vehicle development and R&D, rather than assembly. With the current policy of "no special incentives" for vehicle assembly, no significant incentives are assumed to be available in Waterloo. This makes the ROI for Waterloo uncompetitive with Montreal and the Southern US states, although it continues to be higher than the ROI for the Northern US states.

• Columbus, Saginaw - The moderate incentive packages assumed for these Northern US cities help them to improve their ROI relative to Waterloo. However, because assumed incentives in these locations are lower than in all locations except Waterloo, these cities do lose ground relative to the US South and Quebec.

• Atlanta, Dothan, Greeneville, Jackson - The generous incentive packages assumed for these jurisdictions result in significant improvements to the facility ROI in each location. Indeed, after incorporating the impact of incentives, Jackson offers the highest ROI among the eight locations examined - although ROI for Jackson, Montreal, Dothan and Atlanta are all very closely grouped.

Different financial measures, including Net Profit and NPV, give results that are generally consistent with these ROI comparisons.

Workforce issues are of key importance to auto assemblers.

• Labour quality and availability - All locations examined have access to large pools of skilled labour, and auto assemblers are easily able to attract qualified employees. However, over the longer term, Northern US and Canadian plants that typically have an older workforce, may find it more difficult to attract skilled labour, as current employees retire. The Southern US states generally have a younger demographic, and a correspondingly younger workforce.

• Training - All North American assembly companies operate in-house training programs. In addition, the jurisdictions in which the auto assemblers operate place a high emphasis on workforce development for the industry and provide specialized programs for training advanced automotive personnel.

• Productivity and quality - Productivity of existing facilities is higher in Canadian plants, which have an average productivity of advantage 11.4 percent over US plants. Quality is also considered to be higher in Canada than in the US. However, these factors relate primarily to differences in vehicle design, the number of model versions being produced in a plant, and the degree of plant automation. Because of these considerations, little emphasis is placed on productivity and quality of existing plants by auto assemblers in the site selection process.

• Unionization - In both Canada and the United States, the rate of unionization in the auto assembly industry is driven primarily by the assemblers, rather than geography. The Big Three auto manufacturers are almost fully unionized, while plants operated by the European and Japanese manufacturers tend to be non-unionized.

• Labour flexibility - Unionized plants in the United States have historically been able to schedule more overtime and more effective work schedules (e.g. three-crew production) than unionized plants in Canada. In Ontario, hours of work are governed by the Employment Standards Act, which limits the amount of weekly overtime, while in the US the number of hours of work per week are governed only by union contracts.
  
  Non-unionized plants located in the "right-to-work" states of the US Southeast have very few restrictions on production schedules. Japanese and European assemblers have shown a strong preference for locating their operations in these right-to-work states

• Labour stability - Labour relations at the Big Three (Daimler-Chrysler, Ford, and General Motors) have been very stable in recent years, with no major strikes either in Canada or the US since 1998. Current national union contracts in both countries restrict strike action during the lives of these agreements.

• Health and safety - All automotive manufacturers provide numerous safety measures and training courses in order to maintain a healthy, safe working environment. In Canada, health and safety issues fall under provincial jurisdiction, with relevant regulations in Ontario making assembly line stoppages over perceived health and safety issues (genuine or otherwise) relatively more common in Ontario than in the United States.

• Costs of facility closure - Costs of facility closure are the lowest in the Southern US jurisdictions, where the majority of plants are bound only by federal regulations, which are significantly less stringent that those included in union contracts. In Northern US and Canadian locations, plant closure conditions are negotiated in union contracts making it difficult for companies to close a plant without paying large early retirement and/or income support packages to employees being laid off. Although it is difficult to accurately assess the potential costs for closure of a unionized plant, the highest costs would most likely occur in plants where workers are represented by the UAW.

• Impacts of unionization assumptions on the financial analysis - The results of this study are based on the assumption that in the Southern US states, the model assembly plant is not unionized. While this reflects the experience of the European and Japanese auto makers, Big Three plants in the southern US do tend to be unionized.
  
  If UAW-based labour costs were applied in the four Southern US locations examined, the before-incentives cost advantage of the Canadian locations would be further strengthened. Even after allowing for incentives, for a Big Three, greenfield assembly plant located in the Southern US, with a UAW-represented workforce, Montreal is able to demonstrate a clear advantage over each of the four Southern US locations, while Waterloo is able to remain competitive with the leading Southern US locations.

Automotive companies considering potential sites for a new plant usually consider a number of issues related to the business environment, as well as business costs.

• Exchange rate risk - The financial analysis has been prepared using an exchange rate of C$1.00 = US 67.75¢, based on exchange rates as of March 2003. Exhibit E illustrates the impact that appreciation of the Canadian dollar would have on the financial results for the model auto assembly operation in the Canadian cities examined in this study^*.
  
  In absolute terms, either before or after allowing for incentives, a rise in the value of the Canadian dollar to 70 US cents would result in a decrease in ROI of approximately 2.5 percent, while an increase to 75 US cents would result in a decrease in ROI of 7.3 to 8.3 percent.
  
  In relative terms and before incentives, Waterloo's rank would not change at an exchange rate of 70 US cents, but at 75 US cents would change from second to fifth, behind all of the Southern US cities except Atlanta. After allowing for the impact of incentives, Waterloo manages to hold a constant ranking of sixth at all three exchange rates, ahead of Columbus and Saginaw.
  
  Before considering incentives, Montreal would rank in first position at an exchange rate of 70 US cents, but at 75 US cents would fall from first to second, behind Dothan. After allowing for the impact of incentives, an appreciation of the Canadian dollar to 75 US cents would see Montreal slip behind all four Southern US cities, to rank in fifth place among the eight cities examined.

^* Recent trends and current forecasts for the Canadian dollar have been upwards. Chapter 7 presents recent trends in the value of the Canadian dollar, and also illustrates the potential benefits for the two Canadian cities if the Canadian dollar were to depreciate.

1: US centes per Canadian dollor. Study standard rate is 67.75 US cents.
2: As per the basekine (pre-incentives) financial analysis, Exhibit C.
3: As per the financial analysis incorporating incentives, Exhibit D.

• Transportation infrastructure - All cities examined in the study have well-developed transportation infrastructure, with the exception of Dothan, AL, which is not located on an Interstate freeway or on a Class 1 rail main line.

• Road congestion - Research indicates that Atlanta has the highest urban travel times, followed by Montreal and Waterloo. Travel times are shorter in all of the other US cities examined.

• Border issues - Historically border crossing times have been longer for crossing into the United States than into Canada. However, in the light of the events of September 11th, 2001, a number of initiatives have been implemented to expedite customs clearance for pre-approved suppliers and carriers, without sacrificing border security. These initiatives are reducing crossing times in both directions.

• Customs duties - Parts and components for original vehicle assembly imported into the United States from non-NAFTA suppliers are subject to customs duties, while such parts and components can be imported duty-free into Canada. Both countries impose customs duties on finished vehicles if such vehicles do not meet the NAFTA requirements for 62.5 percent regional content. Financial impacts of these two alternate scenarios have been considered, resulting in the following broad conclusions:
• Canadian assembly locations may hold an advantage when the production process uses imported components, but the value of such imported components is not sufficient to prevent the finished vehicle from qualifying as a NAFTA-made product.
• US assembly locations may hold an advantage when the production process uses a significant portion of imported components, such that the finished vehicle no longer qualifies as a NAFTA-made product. In this case, the vehicle is subject to import duties in Canada, the United States or Mexico, based on the total value of the vehicle, not just on the value of the imported components.
• Withholding taxes - Both Canada and the US withhold taxes on dividend payments to foreign firms. Canada provides a lower withholding tax rate than the US for dividend payments to Japan, while the US provides a lower withholding tax rate than Canada for dividend payments to South Korea. The same rates apply for both countries for dividend payments to Germany. For a plant located in Canada, dividend remittances a US parent corporation would be subject to a five percent withholding tax. Generally, withholding taxes on dividends may be able to be utilized by the parent corporation as foreign tax credits, based on the taxation rules in the country where the parent corporation is located.
• Environmental considerations - Based on a brief review of plant environmental standards, emissions and wastes, there is no evidence to suggest that emissions or waste standards vary significantly from region to region or are enforced with noticeably less severity in any particular jurisdiction. Rather differences in emissions levels appear to be more closely correlated with plant age than any geographic factor, with several new assembly plants in the Southern US states being among the cleanest assembly plants currently in operation.

Key conclusions for Canada in respect of business costs are as follows: 

• The Southern US states (as well as Mexico) represent the main competition for Canada in terms of business costs. The Northern US states, with their established UAW workforce, are not cost-competitive relative to Canadian jurisdictions.
• Before allowing for the impact of incentives, Canadian auto assembly locations offer a cost advantage over the Southern US states in terms of business cost fundamentals when compared at current exchange rates. However, this advantage would largely disappear if the Canadian dollar were to appreciate to 75 US cents.
• The business incentives typically offered in the Southern US locations more than offset the advantage Ontario has in pre-incentive business costs. More generous incentive packages offered in Quebec enable it to maintain a slim advantage over the Southern US states, even after allowing for the impact of incentives.

Among non-cost decision factors, the labour environment is a critical consideration for auto assemblers. While Canada's labour force is well regarded in terms of available skills and production quality, the Southern US states also offer a quality labour force, with low rates of unionization, high labour stability and flexibility, and significantly lower costs related to facility closure.

Given the perceived labour environment advantages of the Southern US states, some of which cannot be readily quantified, Canadian locations would need to demonstrate a clear financial advantage, including the provision of business incentives, to be viewed as being competitive with potential locations in the Southern United States.

While great care has been taken in performing this study and developing its findings, the results of this study are necessarily of a general nature. Therefore, they should not be interpreted as a definitive opinion on the merits of locating any specific facility in one jurisdiction over another. Further investigation is required of both financial and non-financial factors, to determine the best site for any specific facility.