Strategic Operations Management, Exchange Rate Exposure Management - Coursework Example

Critical Issues in Global Business [Client’s Name] April 30, 2009 Globalization has changed the business environment in many ways. Small and medium enterprises that were once unable to compete in the bigger market are given the same opportunities with larger companies; products and services found larger markets as movement of product from one geographical location to another becomes easier with advances in transportation technology; products can be sold in various locations in the globe without having to construct physical stores as internet technology gives people access to almost everything they need; banking can now be done using mobile phones. As businesses expanded into a global scale, they are also confronted with serious issues that threatened to topple their stability. Any fluctuation in the socioeconomic and econo-political stabilities of one country affects the trading and commerce of other countries. When businesses operate in the global scale, they are also subject to these fluctuations. This is the reason why corporate strategies must include all the global factors that may affect the business’ profitability in order to anticipate possible problems that may arise in the process. One of the most important considerations that should be taken into account by companies operating on the global scale is the exchange rate exposure management. Strategic Operations Management Majority, if not all, of business strategies are done to increase the profitability of the company or to position the company in the most productive situation even if the circumstance are difficult for the company. In the simplest sense, whatever is beneficial for the company is pursued while the elements that threaten the stability of the company are either extinguished or are placed at tolerable levels. Elements such as new markets, growth opportunities, and strategic management are actively pursued while elements such as risks, economic declines, and stacking of inventories are extinguished or are kept at minimum. However, the shift of trade and commerce to a global scale has introduced new opportunities as well as issues to companies. Companies that have ventured in the global market need to be aware not only of the performance of their businesses in various countries but also of the performance of the country’s currency compared to the preferred currency of the business. Majority of businesses today take advantage of the features of a globalized economy. Multinational companies that operate in various countries acquire funds and investments from one country, purchase materials and/or labor from countries that have lower labor/material costs, send their products and services to countries that has the demand, and they get paid with the local currency. Multinational businesses use foreign currencies in various ways which include importing, exporting, joint ventures, and investments on money markets and they typically take into consideration various factors that would increase the strength of the position of their investments. The involvement of money of different currencies in the operations of multinational companies makes companies operating on a global scale plan on working or strategizing their position against the fluctuations of exchange rates (Hoontrakul, 1999). Exchange Rate and its Effects on Global Companies A simplistic approach on how the variability of exchange rates is shown in the following. An American company that outsourced its telemarketers in India does so because of the cheap labor force in India and because they gain strong advantage over the exchange rate of Rupee against the US dollar. This hypothetical company pays the Indian counterpart in dollars. Since the economy of India is relatively unstable compared to the US market, the value of the dollar is superior compared to one rupee. This means that the American company can still save money even if it is paying the amount stated in the contract because of the strong exchange rate between the two currencies, especially if it uses this to its advantage. Exchange rate is the measurement of the value of one currency against the value of another currency (Thompson Learning, 2003). The value of one currency against the other varies from time to time and the variation depends on a multitude of factors like political instability, increased import/export trading, new technology, natural disasters, and the like. Changes in exchange rates affect multinational companies in different manner, including massive loss of investments done on losing exchange rates to the profitability of investments due to currencies getting stronger positions. The exposure of the company’s finances in the international market operating with different currencies poses threats to the stability of its investment. For example, when a company who sells products in US$ and expect to gain profits at an exchange rate of, say, 1£ = 1.40US$ and the fluctuation of the market caused the exchange rate to drop by, say, 1£ = 1.29 US$, the 0.11¢­­­­­­­­ difference in the exchange rate could mean $11 million loss on the part of the company since the movement of the money at this scale typically involves millions. The need to protect the financial performance of multinational companies prompts the necessity of incorporating exchange rate exposure management to the strategic plans of each global company. Of course this is a simplistic approach to a very complicated economic relationship between currency exchanges. It would be difficult to explain the whole concept without touching serious exchange rate theories such as purchasing power parity. Purchasing power parity (PPP) is a theory that is based on the law of one price which states that goods that have the same features and characteristics must have the same price in a market where efficient trading is expected (Ethier, 1995). PPP is used to balance the value of two trading currencies in order to balance the trading capacities of both currencies. It computes the real exchange values of the currencies of both countries in relation to the countries’ foreign exchange trading, taking into consideration economic factors such as GDP, inflation rates, cost of living, buying power, and market volatility. Global companies, like the governments of these countries, are affected by the factors that determine the country’s PPP. The stronger the effects of these elements are to global companies, the more they are affected by the ups and downs of the currency trading in these markets and economies. This implies that global corporations must also be aware of the elements that determine the PPP of a country’s currency in order to gain advantage of the movements of the foreign exchange market. Since there is no way for global corporations to influence how the exchange rate of different currencies work, global corporations must be able to make good use of strategic management to at least lessen the negative impact of such movements to the company. Hard earned money that involves expense paid in a currency of a higher value can get lost over a petty political squabble in another country and more often than not, there is no way to predict and control such drastic changes. These unwanted shifts in the values of money would have negative consequences in the long run and the need to efficiently and effectively curb the effects of exchange rates becomes more apparent. But influencing the external factors is beyond question. A better way for global companies to manage heavy financial loses due to exchange rates is to look at the available financial schemes and use them to its advantage. Exchange Rate Exposure Management The methods typically employed to manage the exposure of global corporations to the fluctuations of exchange rates involved natural hedges, cash management, international financing hedge, and currency hedge. Companies operating in a global scale are in a sensitive position when the exchange rate is taken into account and since these schemes presented by the exchange rate exposure management places the companies in situations where volatility is controlled to some degree and where their position in the market is stabilized on acceptable levels, the need to employ them as a part of the strategic process is undeniable. For example, cash management allows the companies to control the spending of a particular currency, implement an effective budget using that currency, minimize the cost of borrowing (or related expense) at the same time maximize the opportunity cost of resources to increase the volume of cash coming in and thus curb the effect of the unstable exchange rate of the currency. In simpler terms, the company needs to borrow at the lowest interest rates, minimize transaction costs, and to generate additional cash to generate more money for the company. Integrating these exchange rate exposure management approaches on any global company’s strategic operations management process would not only stabilize the company’s position against various currencies that the company is trading but also opens opportunities for the company to grow and prosper despite the uncertainty of the whole economic process. Using this tool to the advantage of global companies would not hurt in the long run although there is no real guarantee that global companies can find success using the advantages offered by the different approaches of exchange rate exposure management. References Wilfred J. Ethier: Modern International Economics, 3rd edition. W. W. Norton & Comp., New York/London: 1995. Hoontrakul, P. (1999). Exchange Rate Theory: A Review. http://www.library.ucla.edu/yrl/colls/asia/papers/ph/exchange.pdf. [Accessed: April 30, 2009] Thompson Learning. (2003). Exchange Rate Determination: Chapter 4. http://www.swlearning.com/finance/madura/ifm7e/powerpoint/basic04.ppt [Accessed: April 30, 2009] Read More