Promoting US exports: trading companies are not the answer

October 14, 1982

Congress and the Reagan administration want to improve the United States balance of trade by encouraging banks to set up Japanese-style trading companies. The measure enjoys wide bipartisan support. It was signed by President Reagan with much fanfare. But there is a problem: it will not work.

The motivation behind the legislation is understandable. Beginning in 1979 the focus of the economic debate began to shift in this country. A recession, triggered by OPEC's redoubling of oil prices, led to a shakeout of competitively weak firms in many industries. National attention was riveted on Chrysler and the problems of the auto industry, but the story was being repeated in other industries as well: machine tools, textiles, footwear, fasteners, tires.

During the campaigns of 1980, the underlying message of these economic events began to seep into our political debate: the competitive problems of our major industries are fundamental, serious, and long-term. We began to look at the policies of other countries - particularly Japan - to see how they stimulate economic growth. As an outgrowth of this initial search for answers, we now have the proposal for encouraging the formation of trading companies.

It is easy to see why the trading company proposal is so appealing: the fact that the Japanese have more trading companies than we do provides one easy and seemingly convincing answer to our competitive decline.

The logic supporting export trading company legislation runs something like this: thousands of small and medium-size US firms produce exportable products but do not currently export; the barriers to exporting primarily involve a lack of knowledge of financial arrangements and foreign markets; it is expensive for small firms to acquire this knowledge; trading companies, by centralizing financial and market information, can lower the cost of entering foreign markets for these firms; however, restrictions on bank ownership of trading companies, as well as antitrust rules, have discouraged the formation of these companies in the US; therefore, we need to lift these restrictions to encourage their formation.

Unfortunately, this logic falls apart on a number of points. For the majority of products of US manufacturers, trading companies represent the wrong strategy for entering a foreign market. Managers in trading companies handle a wide range of products, and they cannot be experts in marketing any of the products they sell. Because of this limitation, it is not surprising that trading companies are most successful with unsophisticated, commodity products which do not require a detailed marketing strategy and where price is the most significant factor leading to competitive success.

In the most important markets in which the Japanese now compete, the effect of trading companies is minimal. Japanese companies have been successful exporters not because they have dumped products on foreign markets but because they have systematically invested in product and marketing strategies designed to build their market share in foreign countries. They have been willing to commit themselves to long-term investments in process engineering, product adaptation, and new product development as well as distribution, pricing, and promotion.

To be competitive with the Japanese, US managers must adopt similar investment strategies. To develop these strategies, they need to experience the pressures of a foreign market directly, not through the intermediary of a trading company. They need to travel to foreign markets to understand the different requirements of consumers and the nature of competition in these markets. And they need to think systematically about market strategy: how should a product be designed, produced, distributed, priced, and promoted in order to build a competitive position in a market?

Yet, even in those markets in which trading companies may represent an appropriate entry strategy to a foreign market, it is difficult to see how reducing the restrictions on bank ownership of trading companies will help matters. Banks aren't experienced in product marketing, and they have only two resources they can bring to a trading company: financial funds and a worldwide network of banking contacts. However, export financing is already available to most smaller exporters through existing banking relationships. And a bank's network of financial contacts will have little relevance to the strategic needs of a company entering a foreign market.

Government officials who hope to address the critical economic issue facing this country - the long-term decline in US competitive productivity - must understand the elements of strategic advantage for US firms competing in world markets. Only then can government programs be devised which complement and promote private sector investment strategies.

The success of the Japanese comes from understanding and exploiting the creative tension between private sector business strategy and public sector industrial policy. By looking at the Japanese, proponents of trading companies have begun to ask the right questions. They just came up with the wrong answer.