Built by NAFTA: How free trade saved this Canadian manufacturer

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A day or two after someone orders a custom Palliser leather sectional – whether it be in Calgary or Chicago – the cutting and sewing begins in northern Mexico.

If the order is destined for Mexico or the United States, the cover is assembled with other components in one of Palliser's Mexican plants. If the order is headed to Canada, the leather cover is loaded onto a truck for a three-day journey north to Palliser's suburban Winnipeg plant. There, workers cut the furniture foam and the frame that will be covered by the Mexican-sewn segments.

In the cutthroat world of furniture sales, Palliser now boasts that it's the largest producer of made-to-order leather-upholstered furniture in North America. The tariff-free movement of furniture within the continent means the Canadian firm can have two-thirds of its employees in the Mexican cities of Saltillo and Torreon – where the labour-intensive custom cutting and sewing work is completed. The final assembly of furniture is done in either Mexico or Canada, depending on which site can most easily ship to the eventual customer. Most of the research and development, and design and finance jobs – along with about 300 assembly positions – are based in Winnipeg.

This is how Art DeFehr, a doyen of Canada's furniture industry, has made the North American free-trade agreement work for his family-controlled Palliser Furniture Holdings Ltd. As NAFTA renegotiations begin next week – a process that threatens to upend the continent's long-established trade networks – Palliser is a prime example of a Canadian company that has used the trilateral deal to full advantage.

"We call ourselves a NAFTA company," Mr. DeFehr says in a boardroom of his Winnipeg office. "Without Mexico, we'd be a much smaller company, assuming we'd be alive. We'd be a small, Canadian company."

The system has allowed Palliser to take advantage of Mexico's lower wages for skilled manufacturing workers. Mr. DeFehr says Mexican wages are about one-third what they would be in Canada or the United States (when extra benefits for Mexican workers such as subsidized lunches, transportation and housing programs are factored in).

Palliser gathers raw materials from a supply chain around the world, but meeting NAFTA rules means a focus on sourcing products from the three countries: Wooden feet might come from Mexico or Montreal, furniture mechanisms come from Mississippi and the fabrics often are transported in both directions from North Carolina.

Mr. DeFehr says the strategy of leveraging the regional strengths of North America has proved to be crucial in the time-sensitive landscape of furniture sales. The company maintains close proximity to key U.S. and Canadian customers – a key factor in the cost-effective shipment of bulky couches and chairs. As people buy more furniture online, Palliser says its relative closeness to its customers has helped it deliver just-in-time custom pieces to their doorstep faster than companies that rely on overseas exports.

Perhaps most crucially, the strategy of focusing on custom work and manufacturing in Mexico has allowed Palliser to stay relevant even as mass-produced furniture from China has flooded North America since the early 2000s. That change in the landscape of the furniture business, along with a global recession that followed, helped to prompt the downsizing of Palliser a decade ago.

"You look for a lifeboat. And the lifeboat for us was custom leather, with Mexico," Mr. DeFehr says. "And we shrank the company, and we survived on that basis."

Before that change, employees numbered more than 3,000 and annual sales exceeded $450-million. While other furniture companies ceased to exist, Mr. DeFehr's firm got smaller – and extended family members took over some units and created separate companies. Today, Palliser itself has about 2,000 employees and $200-million in annual sales. In the past six years, the company has returned to growth, and doubled its sales.

Mr. DeFehr – who stepped away from many of the day-to-day operations two years ago, leaving Cary Benson as chief executive – remains the owner, chairman and chief executive of the holding company that owns Palliser. But the 74-year-old says the integrated North American system he helped to create has played an important role in Palliser's continuing survival. Canadian managers regularly travel to Mexico and Winnipeg employees are encouraged to learn Spanish. Units from each country are encouraged to engage in friendly competition and learn from one another.

And many of the manufacturing processes in Canada and Mexico are near mirror images. In the noisy woodshop of the Winnipeg plant, automated wood-cutting routers read PDF files to cut 650 frames – in 100 different styles – each day. A similar routine plays out daily in Mexico.

There have been decades of struggle to stay afloat. Mr. DeFehr recalls that in the lead up to the 1989 Canada-U.S. free-trade agreement, the Canadian furniture industry had basically been written off by Ottawa . He says it was believed that the Canadian furniture sector couldn't withstand the competition from the United States, in the longer term. In that vein, the government was prepared to allow U.S. furniture to come into the country duty-free within five years of the deal being signed, while at the same time maintaining high tariffs on the core raw material for Canadian furniture manufacturers – textiles – imported from south of the border for much longer.

"In a tough environment, that can kill you," Mr. DeFehr says. The issue was only resolved, he says, after an unofficial trade mission south of the border – with a group including Mr. DeFehr and Lou Sklar, of what was then Ontario-based Sklar-Peppler Furniture – that persuaded U.S. textile manufacturers to lobby on their Canadian customers' behalf for more equity in the trade deal.

Mr. DeFehr has always operated as part businessman, part diplomat. The Canadian-born son of German-speaking, Russian Mennonite refugees, his often-repeated biography includes his participation in civil rights and anti-war protests as he attended university in the United States. He says it was this activism that got him barred from a career in Canadian diplomacy, leading to his MBA at Harvard and a return to the family furniture business. Palliser is an offshoot of a small enterprise started in 1944 by Mr. DeFehr's father from the basement of the family's Winnipeg home. He says loyalty to his hometown and country still plays a role in his business decisions. "If we are close enough in cost to use a Canadian factory, we will do that."

But Palliser has often been a part-time job for Mr. DeFehr, with months or years away with his wife Leona working on aid projects in countries around the globe. The couple adopted their daughters, Shanti and Tara, while working on Mennonite Central Committee projects in Bangladesh.

During his international travels, Mr. DeFehr stumbled across business lessons as well. In the years after the fall of the Berlin Wall, Mr. DeFehr saw a Europe that had begun working together.

He noticed his Munich-based furniture cohorts sent the most labour-intensive furniture manufacturing jobs to Poland, Hungary or the Czech Republic – where wages were lower. Both the design and finishing work was still done in Germany. It leveraged the economic strengths of each country, moderated costs and made the continent more competitive.

So a few years later, when Canada and the United States extended the free-trade pact to Mexico to create NAFTA, Mr. DeFehr saw a "brilliant" opportunity for North America.

"You get your resources in Canada, your large market in the U.S. and your lower labour costs in Mexico," he says.

"You put the three together, and then we can compete with Europe, and then we can compete with Asia. Not on every item, but the point is we can compete."

Under NAFTA, which came into force in 1994, furniture goods that meet the deal's country-of-origin requirements can move tariff-free between the three countries.

At the time, Mr. DeFehr had contracts with plants in China and Taiwan. But NAFTA gave him the opportunity to look south for manufacturing; he liked the certainty that came with manufacturing in Mexico. Moving there would give him the ability to build his own plant and have control over his own processes – a guarantee that might not come with focusing operations at overseas plants owned by others.

After a scouting mission to nine Mexican states and 20 cities, Mr. DeFehr decided he wanted to avoid the border-town maquiladoras – export-focused manufacturing plants located in centres that often suffer from cartel violence and social problems related to a more transient population. However, locating a facility south of Mexico City would be too far away.

Palliser eventually settled on a plant in the manufacturing centre of Saltillo, just west of Monterrey – not right at the border, but still in northern Mexico – in 1999. They opened a second plant in Saltillo and another plant in Matamoros, just outside Torreon.

As Palliser moved into Mexico, it was heavily involved in the "volumes" business – supplying high numbers of couches and chairs to major chains, including Canadian names such as Leon's and the Brick.

But when China jumped into furniture manufacturing in a major way in the early 2000s, North American furniture manufacturers from North Carolina to Toronto were hit hard. Competition on the volumes side meant Palliser lost 95 per cent of its business within five years, according to Mr. DeFehr. The company was forced to adapt, get smaller and become a custom shop.

It was far from a painless transition. Canadian workers lost jobs as competition with China forced the downsizing of the company at the same time as more manufacturing work shifted to Mexico. Over the past 10 years, Matamoros has become Palliser's specialization centre for the cutting and sewing – including the painstaking work of avoiding the wrinkling and gathering of any of the leather.

"It's not been easy for the textile industry here," says Andrew Willms, Palliser's vice-president of operations and logistics in a boardroom at the firm's Winnipeg office.

"We had tough middle 2000s. Much changed from those early 2000 years, when we were really moving a lot of product out of Winnipeg."

Palliser's Mexican plants operate alongside dozens of American firms including giants such as GM, La-Z-Boy and Mondelez International – the makers of Oreos and other biscuits. But it is harder to find Canadian compatriots in Mexico. Canadian peers to Palliser tend to be aerospace and auto-focused manufacturers, including Bombardier Inc. and Magna International Inc.

But even with NAFTA, there are a multitude of trade quirks or red tape to navigate. Currency fluctuations can take a toll. Canadian drivers can pick up leather covers destined for Canada at Palliser's distribution plant in Laredo, Tex., but no Canadian truck driver can deliver finished goods to any location in the United States.

The advantages, however, are many for the company that has half its business in the United States, 40 per cent in Canada and 10 per cent in Mexico. Being a part of the Customs-Trade Partnership Against Terrorism, a kind of Nexus program for goods, has helped Palliser trucks avoid being stuck in line for hours at the Mexican-U.S. border. In addition, regional preference in colours, sizes and style can be accommodated.

According to Palliser vice-president Bryan Rach, Quebeckers and Ontario customers like smaller, brightly coloured, contemporary furniture. Mexicans also tend to like smaller pieces, in white and red. Texans like their furniture "huge" and brown. On the Prairies, customers are inclined to trendy greys and off-whites.

The proximity to markets is also helping win market share. In 2015, the Canadian furniture company had a target of shipping 95 per cent of custom pieces within 56 days. Last year, the number of days to ship went below 30.

This year, the goal is 25 days. The speed has aided Palliser's push to win mid-market custom furniture and online sales, and has helped recapture some of the British Columbia market share – an especially competitive space given its proximity to Asian suppliers.

"It's a real advantage for us to be close to our marketplace – Winnipeg being in the middle," Mr. Willms says.

Palliser is looking to expand again. It has recently doubled the size of its Matamoros campus.

The company's near-term growth plans include producing more for its line of luxury theatre seating, and dipping a toe back in the volumes business. Opening a plant in Central Canada or the Eastern United States is also an option, depending on currencies and other factors.

Mr. DeFehr has little to say when asked about whether U.S. President Donald Trump's protectionist policies will impact their planning.

"We've operated plants in the U.S. We do a lot of business there. If we had to operate a plant in the U.S., we could either buy one or build one, in months," he says.

"They create the rules and we play the game."

Trade will go on, Mr. DeFehr says. But looking back on NAFTA since 1994, Mr. DeFehr says that while trade in furniture made within the continent might be open, trade for most industries is far from free – it's simply managed.

And he believes that many North American companies, and governments, have missed out on an opportunity to work together. Not everyone has bought into the idea that the trade deal can be an advantage, not a hindrance, he says.

"NAFTA is a part of what should be a core strategy for North America," Mr. DeFehr says.

"I felt that on a more global basis, that NAFTA would allow North America to develop and evolve. We didn't do the evolving part."