DownPillow, Inc., a small U.S. manufacturer of down comforters and pillows, sells nationally through high-quality retailers. The company is known for its quality of materials and production. Its raw materials include cotton fabric, unfilled cotton shells, and down fills. These materials are not produced in the United States in sufficient quantities to meet the needs of the U.S. market. The HTS classification for unfilled comforter shells is 6307.90. The classification for finished down comforters is HTS 9404.90.
For many years, DownPillow purchased materials from Europe and paid in foreign currency. Gradually, costs rose because European suppliers faced higher labor and overhead costs. A declining U.S. dollar made goods more costly, but as costs rose, the company could not pass them on in price increases. When the U.S. market became more competitive in the early 1990s, DownPillow looked to China for cheaper materials. China is the world's leading producer of cotton textiles and down fill. Chinese textiles enter the United States under strict quota limits, enforced by U.S. Customs. Quota category 362 includes unfilled shells, comforters, quilts, bedspreads, and other top-of-the-bed products.
DownPillow negotiated with a Chinese manufacturer for low-cost materials priced in dollars. The new products were introduced to U.S. customers in 1993 at competitive prices. The new lower-priced goods quickly became an important part of the company's line.
However, the political situation changed over time. The United States accused China of illegally transshipping textiles through third countries to get around the U.S. quota. In response, the United States reduced the quota on category 362. The annual quota began to close in early fall. Goods anticipated for shipment during the Christmas season sat in a customs-bonded warehouse at the port until released by U.S. Customs the following January. In the following year, the largest U.S. importers of comforters and bedspreads had bought their merchandise early, and the quota closed in March. DownPillow was barely able to obtain sufficient unfilled shells for its production needs. When it tried to switch its customers back to the higher-priced merchandise made from European materials, they balked. Many threatened to take their business elsewhere.
1. Management is desperate for a solution. It has learned that Canada will permit the entry of Chinese textiles. They also know that Canadian trade negotiators put a little-known rule of origin in NAFTA providing that a product that undergoes a change from category 6307.90 to category 9404.90 will become a product of North America. (Tariff shifting is not generally available for textile articles, but widely available for many other manufactured and processed goods.) They would like your opinion on answers to the following questions:
a. May they bring the Chinese cotton shells into Canada and ship them to the United States despite the quota? What processes would have to take place in Canada to do this? If they did, what would the tariff rate be? Would they see any net tariff savings?
b. Production in Canada would give ready access to the Canadian home-fashions market. Should the company explore the possibility of investment in a plant in Canada? What are the pros and cons of such a move? How would they be affected by NAFTA investment provisions?
c. Canada is a good supplier of goose down. If DownPillow produces finished comforters in Canada, would it make a difference if it used down from Canada geese, as opposed to down plucked from geese in, say, Poland, and imported into Canada?
d. Every state requires that comforters may only be sold if they are manufactured or imported by licensed bedding manufacturers. Bedding manufacturers are subject to state health codes. Does NAFTA prohibit the application of state health codes to Canadian and Mexican companies or to products made by them?
e. The company also has had some interest from buyers in Mexico. Would any import duties apply on shipments of either its U.S.- or Canadian-made products to Mexico? What would the tariff rate be? What special textile labeling rules are applicable, and how would they affect the company's ability to market there?
f. Management is concerned about meeting foreign health standards applicable to a natural product like down and feathers. Where would they go for information on foreign regulations?
2. Discuss the wisdom of DownPillow's decision to switch its source of supply to China. Describe the impact of customs and tariff law on a North American firm's strategy. Describe how this small company was affected by international political events out of its control. Do you think the company underestimated its customers and its market?