International Business Policy
In the global business market firms are required to pay attention to currency exchange rates and the exposures that foreign exchange may create for their business. There are three categories of exchange rate risk; Transaction Exposure, Economic Exposure and Translation Exposure. Here, we will pay attention to Transaction Exposure.
Transaction Exposure is related to the way in which exchange rate fluctuations impact the value of denominated cash flows that have been contractually fixed in a foreign currency. In order to evaluate the transaction exposure companies need to assess cash flows on a net basis. This involves matching up the inflows and outflows by currency.
Because one currency may lose value against another, a firm may find that they incur a loss on a payment that has been agreed in a foreign currency; this can impact both accounts payable and accounts receivable.
If the loss is significant enough a firm may find themselves facing financial difficulties and it is therefore important that firms attempt to offset any risk that currency fluctuations may create. Unmatched cash flows are referred to as open positions and the size of the position coupled with the variability of the currency itself (standard deviation in % change in
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External Hedging Methods
Firms who utilize external hedging methods will generally use some type of financial instrument, e.g. a forward contract or an option, whereas those who hedge internally will organize their international operations in such a ways that the impacts of transaction exposures are limited e.g. via pricing policies.
Hedging externally is relatively simple. To hedge accounts payables in a given currency a firm will purchase a futures contract and/or buy a call option and to hedge the receivables they will sell a futures contract and/or buy a put option. This concept is represented in Figure One.
Figure One: External Methods of Reducing Transaction Exposure
Buy Futures Contract equivalent to the value of the currency and amount contractually exposed within accounts payable
Sell Futures Contract equivalent to the value of the currency and amount contractually exposed within accounts receivable
Purchase a Currency Call Option equivalent to the value of the currency and amount contractually exposed within accounts payable
Purchase a Currency Put Option equivalent to the value of the currency and amount contractually exposed within accounts payable
Internal Hedging Methods
One of the most common ways by which a company will take internally hedge the risk associated with transaction exposures is via processes called Leading and Lagging. Leading and lagging involves adjusting the time at which a payment request is made in accordance with the behavior of a given currency. Leading is where a payment request is expedited and lagging is where it is delayed.
There are three methods by which companies invest in a foreign market. These are as follows:
1) By establishing their own operations overseas
2) Engaging in Joint Ventures
3) Adopting a Greenfield strategy
4) Acquiring an existing firm
Joint Ventures versus Own Operations
A Joint Venture (JV) involves the creation of an entirely new enterprise by two existing firms who contractually agree to work together. Through this agreement a separate legal entity is created which requires its own management team and Board of Directors. An example of a Joint Venture is that of the Nuumi Corporation that was created as the result of an agreement between Toyota and General Motors.
JVs have both advantages and disadvantages. Advantages include the ability of the two companies to benefit from one another’s competitive advantages. In the case of the Nuumi Corporation, General Motors were able to benefit from Toyota’s highly acclaimed manufacturing processes whilst they, in return, provided Toyota with a US based manufacturing line. A further advantage is that one company can provide another company with knowledge and expertise in a local market of the host country. GM had successfully operated in the US market for many years and thus, in addition to providing Toyota with access to this market they were also able to share their extensive knowledge and experience of this market with Toyota. In addition to this, JVs allow firms to spread both costs risk.
Disadvantages of Joint Ventures are often accredited to issues created by two different organizational cultures working together. Whereas the GM JV with Toyota has been relatively successful. An earlier attempt with Ford did not enjoy the same degree of success. Differences in the way in which the two firms were managed entailed that the manager who was selected to manage the new organization did not receive the required level of backing from the new organization. JVs can also pose a risk to the perseverance of a company’s competitive advantage. Although sharing knowledge and skills can create a strong organization under the JV, it also poses a risk to the competitive strengths of each of the existing firms in the other markets.
Greenfield Strategy vs. Acquisition
A Greenfield strategy involves starting an entirely new entity of an existing company within a new country from scratch whilst an acquisition involves purchasing an existing organization.
An example of a company that has engaged in a Greenfield Strategy can be found in the case of Volsbank who have established a small network of businesses within nine countries (Simoneon, 2007). Further examples can be seen in the cases of the Fuji production plant in South Carolina or the Nissan factory in the United Kingdom.
Greenfield strategies are advantageous because they allow companies to select their own site on the basis of it’s merits, establish the firm without any previous reputation and adopt to a new country at its own pace. However, successfully establishing Greenfield companies requires a great deal of time and patience and can be risky because of a company’s lack of experience and knowledge in the laws, culture and regulations of a given country. A good example of this can be seen in the case of Euro Disney. When Disney built a theme park in France they underestimated the importance of the French culture and found initial attempts to enforce the American way of working in the employees there disastrous.
Through purchasing an existing company firms can gain a presence in a new market much quicker and can benefit from the knowledge and skills the company have already established within that market. They can also learn from the competitive advantages of the company they have purchased. However, acquisitions also have disadvantages and often fail completely. Cultural clashes are often provided as being the most prevalent cons of acquisitions (Stahl, 2004, Pooley 2005, Moyer, 2004). Corporate Culture is embedded deeply in the organization and in the behavior of the people there but is not always easily identified from the outside. As such companies that acquire another company may find that it can be very difficult to impose their culture on that company.
A further disadvantage is that the purchasing company will adopt all the liabilities of the company they have bought and often the reputation of the manufacturing operations there.
Multinational firms will face a number of issues in establishing international operations. These issues are vast and will vary according to the method by which a company enters a market and the market they enter. Some of the common issues associated with production, distribution and marketing functions and described below. These are by no means exhaustive.
· The ability to coordinate relationships between multinational partners, facilities and organizations creates a large challenge. Management needs to identify how resources should be allocated, how control and quality can be maintained and where autonomy needs to remain.
· Establishing methods by which production can remain efficient whilst simultaneously containing the flexibility required to meet varying customer needs is a significant issue for companies who have multiple lines in different countries.
· The intellectual capital exposure associated with the implementation of an overseas operation can make establishing product lines in foreign countries quite risky. Where intellectual property is associated with the manufacture of a product companies who are taking a risk that this may be leaked to competitors.
· Ensuring quality control is consistent across lines can be problematic.
· Firms will not have expertise of all markets and they will therefore often be required to engage the services of a local distributor to assist in a market within which they are unfamiliar. They need to ensure that they select a distributor who knows the market well and have the resources to successfully market their product. However, as more and more firms attempt to gain presence in key markets the competition for distributors will grow and preferred distributors may be handling other company’s products. Firms will be faced with the question of whether they should choose an experience distributor who cannot offer them exclusivity.
· Engaging in agreements with distributors will impact the profit potential of MNCs.
· Where companies operate exclusively through distributors in a given market their reputation will be linked one for one with their distributor. If the host distributor fails to market or distribute the products well this could severely, and permanently, damage the MNC’s reputation in this country.
· Where companies opt to enter a foreign market via export, the lead times for their products will be longer than if they were to produce locally. Logistical costs associated with packaging, transporting and warehousing goods will also impact earnings potential. Maintaining appropriate levels of customer service for their overseas customers will be challenging.
· Consumer incomes on a per capita basis will vary according on a country-to-country basis. However, with the technological capabilities of today it is not always possible to sell products at different prices according to the purchasing power of the market. This presents a problem. For example, if an MNC attempt to sell a product cheaper in China that in the US they may find people in China selling their product back to the US at a cheaper price than the one they themselves offer. However, if they try and sell a product in China at the same price as that sold in the US they may out price many potential buyers.
· Multicultural needs and preferences of customers will change on a country-by-country basis. Firms are faced with the issue of whether to create a global brand that transcends cultures or implement localized branding on a country or market level that is able to respond to the cultural nuances of different markets.
· Market research can be very difficult to implement in some countries. China for example, is very geographically diverse and traditional market research methods may not be successful in ascertaining the real size and needs of the market. Without this information MNCs can struggle to develop a value chain that meets customer requirements.
Moyer, Don (2004), “The Sin in Synergy,” Harvard Business Review, Vol. 82 Issue 3 (March), 131.
Pooley, Richard (2005), “When Cultures Collide,” Management Services, Vol. 49 Issue 1 (Spring), 28-31.
Simonian, H (2007). Volksbank: Greenfield strategy reaps rich rewards. Financial Times. Monday Oct 29 2007 02:00. Retrieved 16th November 2008 from <
Stahl, Gunter K. and Andreas Voigt (2004), “Meta-Analyses of the Performance Implications of Cultural Differences in Mergers and Acquisitions,” Academy of Management Proceedings, pl1-5.