Monterrey miracle.

Long the industrial capital of Mexico, Monterrey now is challenging Mexico City as a financial hub. The city's businesses have an aggressive exporting tradition, anticipating a North American market long before NAFTA. Its CEOs are a tightly knit troop; many are joined by familial ties.

It's a warm, muggy day in Monterrey, Mexico, and a taxi driver is providing an olfactory tour of the city. "That's the Hylsa steelworks," he says, his vehicle rolling down Constitution Ave. past signs for Philips Lighting, Samsonite luggage, and Kentucky Fried Chicken, and numerous technicolored, electronic billboards that conjure images of a poor man's Tokyo. Some miles later, head cocked and nose twitching, he reports: "That's the Cigarrera La Moderna cigarette factory, the biggest in Mexico." By midmorning, acrid industrial exhaust shrouds the hulking, 8,000-foot peaks of the Sierra Madre Oriental mountain range, stinging the eyes and nose, but the driver is unfazed: "The smog means people are working," he says. "When they are working, I am, too."

Driven nearly to insolvency by debt and currency crises in the 1980s--and by the ensuing recession--Monterrey's largest companies are thriving again. Many have trimmed down, forming alliances with foreign partners to secure an advantage in the expanding domestic market, while others are busy making inroads abroad. Outsiders want a piece of the action because of Monterrey's entrepreneurial business climate, a 140-mile hop to the U.S. border, and an industrial base that likens it to another smokestack second city, Frankfurt, Germany. NAFTA's expected ratification, which would kick off the consolidation of a $6 trillion megamarket, pumps the jackpot even higher. A short list of American companies doing business in greater Monterrey: McDonald's, General Motors, Caterpillar, Ford, Motorola, IBM, Emerson Electric, Du Pont, Dow Corning, PepsiCo, Wal-Mart, Union Carbide, and Stone Container. Other foreigners with operations in the area include Germany's BASF, Belgium's Bekaert Group, and Italy's Metecno.

"We have more visits these days from foreign companies eager to set up a joint venture," says Rafael R. Paez, president and chief executive officer of Grupo Industrial Alfa, a $2.5 billion steel, petrochemicals, and food conglomerate.

"Nobody wants to go to Mexico City," says Felipe Cortes, director general of Alfa's closely held steel unit, Hylsa, employing hyperbole to make a point. Noting that several Monterrey-based industrial groups have taken stakes in banks recently privatized by the government, gaining control of nearly 50 percent of Mexico's financial system, he adds: "The center of gravity in this country has shifted. If you are a big business, or you want to have relations with big business and heavy industry in Mexico, Monterrey is the place to be."

Numbers tell part of the story about Monterrey's growing challenge to Mexico City. This city of 3.5 million people--4 percent of Mexico's population--produces roughly 12 percent of the country's goods and services and one-third of manufactured exports. Six of the country's 11 largest conglomerates are based here. All told, Monterrey companies account for some 40 percent of market capitalization on Mexico's Bolsa de Valores stock exchange. The four largest companies--Alfa, Vitro, Visa, and Cemex--have combined revenues of $9 billion.

The extension of railroads to the city in the late-1800s and the U.S. Civil War provided Monterrey's first industrial and commercial opportunities: While Mexico officially supported the Union, the city's textile mills and trading companies grew rich smuggling goods to the Confederacy. The booty helped to finance the redbrick Cuauhtemoc Brewery--founded in 1890 and still in operation--from which other Monterrey companies were spun off. The largest player in town, glassmaker Vitro, was launched to provide bottles for the brewery, while Alfa became a supplier of steel and cardboard for bottle caps and packaging. The founding families of these firms, the Garza Sadas and the Garza Lagueras, still control some local businesses and boards, although many have been turned over to a new generation of technocrats trained at the world-renowned Monterrey Institute of Technology, known to alumni as El Tec.

Driven by aggressive export strategies, Monterrey managers planned their businesses around a North American market long before the conception of NAFTA. Half of Vitro's sales are in dollars, while some 18 percent of Alfa's production ends up abroad, with roughly one-quarter of that earmarked for the U.S. But perhaps most important, Monterrey companies also develop and market world-class capital goods: Hylsa, for example, plans to export its steel production technology to the U.S. under an agreement with the American Iron and Steel Institute. The agreement calls for construction of a pilot plant in Pittsburgh modeled on the Hylsa facility in Monterrey.

Vitro, a $3 billion manufacturer of glass containers and products, and household appliances, sells specialized machinery to Japan, Korea, and Malaysia through a subsidiary, Fama. "We are an exporter of technology, not just products," says Vitro CEO Ernesto Martens. Perhaps the most global-minded Mexican company, Vitro was the first to acquire a Fortune 500 company. In 1989, the company closed a $920 million deal to purchase the No. 2 U.S. glassmaker, Anchor Glass Container in Tampa, FL. Vitro has spent heavily to retool Anchor with Fama machinery, boosting productivity and slashing costs in the process.

Another company on the move outside Mexico is Cementos Mexicanos, or Cemex, a $2.2 billion manufacturer of cement and concrete. In 1989, CEO Lorenzo H. Zambrano, 49, paid $800 million for cement companies in Mexico, Texas, and California, and last year he picked up the pace, shelling out $1.9 billion for majority holdings in two Spanish cement companies. The strategy was geared partly to protect Cemex against the possibility of a price war on cement in its home market--ever more likely as competition pours in. "We had to become one of the biggest global companies," Zambrano says. "If we didn't, someone undoubtedly would have acquired us."

Monterrey firms are racing to attain world-class status ahead of NAFTA, under which most tariffs would shrink to zero over a 15-year period. Many are sinking millions into technology and training. But peso-denominated funding is expensive: Mexico's average cost of funds--a prime rate equivalent--currently hovers around 18 percent. Starved for capital, many local companies have hooked up with foreign partners.

Vitro formed strategic alliances with Whirlpool (refrigerators and washing machines), Ford (windscreens), and Dow Corning (glassware). Cemex has a hotel joint venture with Marriott, while Alfa is linked with Stone Container, Du Pont, Akzo, BASF, Ford, and Fiat. Remarkably, Paez estimates that 75 percent of Alfa's business comes from joint ventures. In May, Coca-Cola paid $195 million for a 30 percent stake in the soft-drink operation of Fomento Economico Mexicano, or Femsa, the Monterrey-based company that holds Coke's biggest foreign franchise. "Strategic alliances with U.S. and other foreign firms will be an important part of our strategy," says Othon Ruiz, 50, Femsa president and CEO. The company is the brewing and bottling arm of giant Valores Industriales, or Grupo Visa.

Monterrey's CEOs are a tightly knit group, partly because many are related by blood. Though they are engaging, conversational, and generally more forthright as a group than Asian or European executives, by most accounts it's hard for non-Mexican CEOs--or even heads of smaller local companies--to penetrate the exclusive inner circle of the largest eight to 10 companies.

The circle's center, perhaps, is Club Campestre de Monterrey, a local country club where Alfa's Paez says he and other chief executives meet for tennis and golf. Paez, 62, traded his clubs for rackets several years ago, he says. "Golf takes too long to play. It took me away from my business and my family." CEOs also meet at social functions. "In some ways, Monterrey is still a very small city," says Zambrano of Cemex. "Many of the CEOs in Monterrey were in school together at El Tec, so they are about the same age." A case in point: Until recently, Paez walked to work, cutting across the rolling grounds of Alfa's headquarters complex from his home a mile away.

Small-town charm also lures President Carlos Salinas de Gortari to the Monterrey area. Though born and educated in Mexico City, Salinas returns annually to celebrate Easter in Agualeguas, a short drive from Monterrey, where his father and other family members were born.

The work ethic binds as well. "We get up earlier in the morning" than competition in the South, Paez says with a chuckle. To boot, CEOs of the top Monterrey companies host informal luncheons on a rotating, if irregular, basis. "Whenever someone has something on his mind, he will call the others up and ask them over," says 50-year-old Cortes of Hylsa. As if to prove the point, when asked for an introduction to Vitro's Martens, Cortes has him on the line in an instant. Later that day, an interview is arranged.

The city's cosmopolitan appeal isn't lost on interlopers. "Most Americans would find the living conditions here quite satisfactory," says Thomas Tomko, director of GM's Packard Electric Mexican Operations East. "There are some very fine amenities and residential areas." Even so, most executives are attracted to Monterrey because of its reputation as a business hub. A major reason for setting up shop anywhere in Mexico, of course, is cheaper labor. But why select Monterrey over, say, Mexico City or Guadalajara? For starters, there's a central location in the booming Northern Mexico-Southern Texas minizone. Dallas and Houston are just an hour away; 12 flights daily link Monterrey with these U.S. cities. Consider also placid labor relations, a pool of highly skilled managers pumped out by El Tec, and an infrastructure a cut above anywhere else in Mexico. A four-lane toll road connects Monterrey with the Texas town of Laredo. A new, eight-lane bridge links Laredo with the Mexican border town of Colombia.

On the down side, costs for wages and benefits are steeper than those elsewhere in Mexico, says Robert F. Bertsch Jr., director general of Carplastic, located in Apodaca, 10 miles outside Monterrey. Carplastic, a wholly owned subsidiary of Ford Motor that manufactures plastic automotive parts, has 1,100 employees. According to Ford studies, increases in total compensation run between 2 percent and 6 percent above inflation--the pay in other Mexican cities and regions, Bertsch says, tracks inflation more closely. But the more expensive work force, he maintains, largely pays for itself through increased productivity.

Newcomers to Mexico also may find better tax incentives in more rural areas. "The federal government is seeking to broaden the industrial base," Bertsch, 48, says. "So it is placing more severe environmental restrictions on operations in the cities." Corruption and kickbacks, too, remain a problem, though they are less of a factor in larger cities such as Monterrey. Still, one American CEO based in the city acknowledges with a sigh: "Everything is negotiable."

Advice for the CEO planning to take the plunge south of the border? Consider pairing with a local firm: "Having a partner who knew the turf was essential," says Bertsch of Carplastic, formed in 1980 as a joint venture between Ford and Grupo Visa. "The regulations are different and so are labor relations."

Moreover, don't treat Mexico as a single market. "Don't show up in a tie for a business meeting in Veracruz; they'll laugh at you," says Roberto Barto, 40, director general of Lamparas General Electric, a GE lighting products operation with just under 1,000 employees. "And don't schedule the meeting at 2 o'clock in the afternoon." Because of the longer lunch hours in the Mexican south, he says, "no one will come."

Perhaps most important, plan to tailor products to local circumstances. "Mexico is a unique market, so the customization of products is essential," says Luis Sada, 50, director general of Industrias John Deere, the Garza Garcia-based subsidiary of Deere & Co., a U.S. manufacturer of tractors and farming implements that cracked the Mexican market in 1955. "This is not a rich country," Sada notes. "Farmers are poor in comparison with the U.S. and Europe. We had to downscale our tractors, eliminating such luxuries as fancy cabs and air-conditioning."

Vocal over the years in their criticism of Mexico City's revolutionary rhetoric and protectionist inclinations, Monterrey's CEOs are stalwart in their support of President Salinas' opening of the Mexican economy and his supply-side growth initiatives. Nonetheless, some feel the government could be doing more to break out of the current slowdown--economic growth dipped from 3.6 percent in 1991 to 2.4 percent last year and is projected as low as 2 percent in 1993. "Funding is too expensive," complains 63-year-old Fernando Sada, CEO of Cydsa, a diversified fibers, chemicals, and plastics manufacturer. He acknowledges, however, that a tight monetary policy has helped to slow inflation from 160 percent in 1987 to about 12 percent last year and to attract foreign investment needed to sustain expansion.

Another concern involves who will succeed Salinas next year: The president, elected in 1988, is limited by law to one six-year term. Monterrey's CEOs argue that with NAFTA likely to be confirmed--and given the potential windfall the pact represents to Mexico--Salinas' successor couldn't possibly double back on free trade. But there's another scenario. If growth in Mexico continues to stall--or if Bill Clinton can't push the trade agreement through the U.S. Congress later this year--jittery investors might be unwilling to continue to finance Mexico's current-account deficit, projected this year to top $25 billion. In turn, that might prompt a devaluation of the peso, jeopardize Mexico's reputation as a reliable trading partner, and tip the balance of political power in the country away from the pro-U.S., reformist wing of the ruling Institutional Revolutionary Party (PRI), led by Salinas, and toward the party's nationalist wing. Such upheaval isn't unthinkable: Indeed, the last three presidencies ended with sharp devaluations, debt defaults, or popular protests against electoral fraud.

One thing is certain: If there's any backpedaling on economic reform, Mexico's new leader will hear it from a free-market jeering section up north. "The new president will take our views into account," says Vitro's Martens with confidence. "We have a very clear vision of our country's future."