International Business Risks and Mitigation Strategies - Essay Example

Part A: Risks Exposed to International manufacturing organizations

International manufacturing organizations are exposed to various risks as well as opportunities when they decide to engage in international financial activities. There are universal risks that are common for all businesses in the manufacturing, service, media, and any other industry while there are other risks common to each of the companies identified in different industries. International manufacturing organizations are vulnerable to diversified risks that necessitate the application efficient management models for their mitigation. .

Foreign Exchange Risk

Businesses that conduct their activities globally are vulnerable to foreign exchange risk, which arises from doing business with foreign nations that have a different home currency. For example, when a U.S based manufacturing company is asked to consolidate its foreign subsidiaries into another country’s currency, the exchange rates changes; hence, leads to the increase or decrease in liabilities or assets respectively depending on the currency.

Multinational manufacturing companies are repeatedly expected to make overseas payments for their imports such as raw materials priced in foreign currency while at the same time receiving an exchange for their export (Sitkin and Bowen, 2013, p.315). When doing business, a firm always has to be cautious of the currency exchange rates thus minimizing the transaction loss as much as possible. Manufacturing companies lost more than $4 billion in the last quarter of 2013 due to fluctuations in foreign exchange (Chasan, 2013). Foreign exchange risk hurts manufacturers and extends to their international suppliers, employees, investors or any other stakeholder receiving investment payments overseas.

Political Risks

Organizations face numerous risks, particularly at the international level. War, coup, expropriation, restriction on the conversion, and transfer of local currency are all political risks. Global manufacturing companies depend on local suppliers for raw materials among other indispensable resources. The impact of either foreign exchange, political risk, or both can lead to the disruption of company operation such as supply chains that are critical for the continued growth of the industry. Productivity can also suffer a lot in the manufacturing organization because it becomes hard for employees to provide the maximum output when their country is involved in violence or civil wars (World Bank, 2010, p.19). Expropriation whereby governments deny international industries from operating on foreign soil their fundamental rights in their business or project is extremely common. Royalties and tax offers are not enough for governments; hence, they prefer to nationalize such companies and to send them packing back to their host nations (Scales, 2015, p.3).

Mergers and Acquisition Risk

Increased growth in the manufacturing industry puts the organization at a disadvantage because it increases competition for resources, employees, workers, and markets. For example, the food processing industry has been concentrated over the years leaving only room for acquisitions to gain a competitive edge in the industry. 89% up from 80% in the year 2013 have cited risk related to mergers in the industry thus are in constant search for new technologies, products, intellectual property, and distribution channels to improve their market potential (Quality Digest, 2016).

Legal and Regulatory Risk

Multinational manufacturing companies’ conflicts on the use of resources usually raise concerns in the legal and regulatory sector, which leads to increased laws as well as standards that can curtail the development of the business. Companies are forced to meet compliance standards, which leaves them vulnerable to direct competition from other organizations. Such a risk often leads to brand and value vulnerabilities because companies operate with extreme caution not to attract unnecessary attention from regulators. Additionally, some regulations might be costly particularly the policies that might require investing in new technologies to meet compliance levels. Manufacturing industry comprises of a vast scope of operational activities; hence, regulatory standards are vast as well. There is increased pressure to meet political, economic, and environmental standards that are all costly (Quality Digest, 2016)

Skills Gap Risk

Manufacturing requires a sophisticated understanding and relevant individual skills especially within the workers to ensure productivity. Most manufacturing organizations across the globe started during the bloomer baby period and with most of them aging and going to retirement, they are taking their skills and experience together with them. International companies within the industry are faced with a huge talent gap deficit. Introducing manufacturing activities concepts to a new group of workers creates transition problems (Iera, 2014). Productivity ends up being low while the company spends substantial funds in implementing training and development programs. Critical manufacturing tasks in a manufacturing company depend on employees’ skills level to ensure quality production, which if not strategically coordinated, end up being a nightmare to accomplish distorting with the company’s structure of operations.

Part B: Managing Currency Risk

Currency risk is predominantly the most common risk for any business in the international market. Currency risk exposes the company to lose ranging from operational costs, supplier payments, and tax costs if not well mitigated. Organizations could manage currency risk through either rearranging the business activities or using the financial market to the team’s advantage through numerous ways.

Rearranging Business Activities

Currency Netting

Multilateral netting is a management technique used by various international companies to mitigate their intercompany payment processes especially involving many currencies (EuroNetting Inc., 2005). When correctly applied, currency netting can significantly increase yields from reduced foreign exchange trading and increased intercompany settlement efficiency. The technique usually collates the cash flow between netting participants and offsets them against each other to create a single cash flow both to and from each netting participant; hence, settling the net results of all cash flows. Netting system enables multinational organizations cash flows to be converted into a functional currency because it nets cash flows in different currencies, which allow a single net position to settle a specific currency.

Purchasing/Processing Changes

The multinational organizations foreign exchange risk is heightened through acquisition and processing costs, which push multinational manufacturing companies to offset transactions in a bid to reduce currency exposure. Subsequently, multinationals become more flexible with contract negotiations they make with other companies through the purchase of same opposite transactions, which offsets risks. Additionally, other than contract agreement flexibility, a company can decide to buy its materials from suppliers whose products are priced in the same currency. Relocation of manufacturing and sourcing is another long-term strategy that multinational organizations practice to limit foreign exchange risk. The relocation involves manufacturing in the major consumer locations or obtaining new customers where inputs are sourced making the business more manageable.

Foreign Exchange Debts

The volatility experienced in the international market makes foreign exchange currency always to be in a constant shift. The timing of foreign currencies at some point has inflows and outflows that do not match. When such a phenomenon is well managed by a multinational company, it can be of great importance. Managing time can be achieved by depositing surplus foreign currency in a foreign account for later use. Preferably an organization can also decide to borrow foreign currency to pay foreign currency purchases; hence, at the same time, use the foreign exchange to pay the loan it had already borrowed (CPA Australia, 2009, p.5).

Hedging and Financial Market Techniques

Multinationals can use financial markets and hedging techniques to minimize foreign exchange risk, which they face from time to time other than rearranging business activities to reduce foreign currency exposure. The hedging and financial techniques include forward exchange contracts, foreign currency options, and swaps.

Forward Exchange Contracts

Due to the volatility and frequent fluctuation experienced by international firms in the foreign exchange market, forward exchange contracts enables a business to protect itself from adverse changes in exchange rates by locking in an agreed exchange rate until an agreed date (Jacque, 2014, p.41). Consequently, the transaction is deliverable on the agreed date. A company assesses the currency rates and uses the best prices to enter into forward contracts, which minimizes its foreign currency exchange risk. Apart from forward contracts, there is the futures contract, which is equivalent to the latter contract in function although differing with it in several important features. Futures contracts have standardized and limited contract sizes, maturity dates, and initial collateral in contrast to forward contracts. As much as these strategies are helpful especially in mitigating risk, they are unable to achieve an offsetting position to eliminate a company’s risk exposure (Jacque, 2014).

Foreign Currency Options

Risk is always present in the business sector while success or contractual agreements are not always a guarantee for success. Consequently, organizations purchase or sell foreign currency under a deal that allows for the right but not obligation to undertake the transaction at an agreed future date. Premium prices for foreign currency options transactions protect importers from downward movements in the value of the local currency against the other currency, but at the same time allowing the importer benefit from increases in the local currency against the other currency (Poghosyan, 2010, p.11). Additionally, if the local currency increases in value, the importer can abandon the option. Subsequently, if the domestic currency decreases in value, the importer can rely on the premium option to purchase the goods.

The difference between foreign currency options and other hedging techniques is the fact that it has a non-linear payoff profile. An organization can practice its right to pull out of downside risk without necessarily cutting the benefit from upside risk. Under exercising options, an organization can prefer to choose the basket rate option. Here a company can use its transaction pattern to come up with a weighted average of currency options to buy. Currencies are not always perfectly correlated to the average exchange rate; therefore, it becomes less volatile thus making the option less expensive. The organization can, therefore, take advantage of its natural diversification of currency risk.

Swaps

International businesses can opt to hedge against risk exposure by using currency swaps, which help; enterprises trade notional principles in different currencies thus enabling the payment of interests on the received money. At most, occasion’s swaps aid in hedging the risk associated with exchange rate fluctuations, attaining better-leading rates, and ensuring receipts of foreign money. Notional principles of swaps are transferred at the beginning and the end of an agreement (Chisholm, 2010, p.37).

International businesses prefer to use currency swaps as a tool towards managing currency because of many reasons. Hedging a long-term borrowing commitment in a foreign currency is widely practiced by enterprises. Due to expansion and the risk a company is exposed to when trying to sell outputs gained from such a group through a small proportion of receipts denominated in the new plants’ currency, swaps become exceptionally beneficial. They allow borrowing from local currency to a much stronger regional currency, which meets payment requirements.

The international market is also filled with numerous exchange controls through regulations and policies that limit the exploration of cheaper markets. However, swaps are useful especially in the raising of capital without breaching such regulations. While accessing more affordable markets, the swap can raise funds in one currency before swapping into another. The cost of the swap and any subsequent foreign exchange risk could then be considered as part of the cost of tapping the foreign capital market. The cost becomes lower than if an organization raised funds in the swapped currency.

Part C: Foreign Exchange Risk Management Strategies Evaluation

Effectiveness the Strategies

The risk mitigation strategies discussed in part b to manage foreign exchange risks associated with international organizations require a fair amount of administration proportional to the complexity of the strategies. Forward contracts are the most effective of currency management risks since results are known at the inception of the plan (Paul and Horan, 2015). Besides, the fact that forward contracts are easier to administrate increases their efficiency in the market. Companies at the international scene often require skilful and experienced workforce. Forward contracts create an opportunity where companies can concentrate more on other pressing issues and plan in advance since results concerning currency risk are already known. Furthermore, forward contracts give the business and option to either buy or sell while foreign currency options only give the right. Companies prefer to be in the control seat regarding matters of risk exposure and having the obligation to either buy or sell is far more efficient.

Costs and Benefits

Foreign currency risk management strategies, ought to be weighed regarding costs and benefits to ensure that a given organization chooses the best and most effective option. Although neither strategy is without cost, the benefits ought to outweigh the costs to consider the best approach. Forward contracts are rigid, but they allow organizations to strike a deal at a lower cost unlike other options (Levi, 2005, p.265). The probability of losing cost value through downside risk is another cost benefit, which allows organizations to become more efficient in their cost operation strategies especially through purchased option strategies. Option strategies have a strong leveraging power compared to other management strategies. Investors can obtain stock positions that mimic stock positions identically but at a huge cost saving (Carbaugh, 2009, p.385). There are times when buying options are riskier than owning equities. However, business organizations at the international level identify the effectiveness of buying options, which is less risky. It all depends on how one uses options. Relative resistance to the potentially consequential effects of gap openings and less commitment from investors makes options less risky as well. Options offer investors a high percentage return that other strategies. They provide an opportunity to spend much less money and make almost the same profit (Correia, 2007, p.20).

Advantages of Different Approaches

Currency Netting

Though seen as a complicated strategy, currency netting is usually applied as a simplifying measure. Foreign exchange exposure is no longer present at organization's subsidiary levels. This is minimized through the creation of cash pools that span international boundaries, so there is no need for cross-border transfers between cash pools (Siddaiah, 2010, p.313). The result is a virtually risk-free transfer within the company subsidiaries. The total amount of foreign exchange purchased and sold declines when currency netting is applied which reduces the amount of foreign exchange commissions paid out.

Foreign Currency Options

Global businesses experience two primary benefits when exercising foreign currency options. An option can be exercised to hedge loss risk while still leaving it open to the possibility of benefiting from a favourable change in the exchange rate (Asian Development Bank, 2015, p.17). Additionally, an organization can exercise an option within a predetermined date range, which is useful when there is uncertainty about the exact timing of the underlying exposure providing options for date variability.

Limitations of the Different Strategies

Forward exchange contracts are binding once an organization has arranged it regardless of whether an organization circumstance changes. It is used as a risk countermeasure, but the volatility of the market can make the strategy unpredictable and risky to initiate since uncertainties are too broad (Mohapatra, 2012, p. 32). Also since when setting forward contracts one has to make a fixed rate when more favourable exchange rate appear soon after the agreement and before the transaction period a company cannot benefit from any such movements (Blake, 2006, p.23).

Regarding costs, options may expire worthless. The risk increases the greater the extent the option is out of money and the shorter the time until expiration. Organizations are disadvantaged through expiry and would be required to make payment once the option has expired regardless of the return gained (DeRosa, 2011, p.87). Hedging could turn out to be less than perfect due to incorrect timing of stock and prices. Options leverage can influence the downside as well, which organizations of naked calls are exposed to an unlimited number of risks. Even though options allow for the replication or mimic of different stock portfolios, such diversifications cannot eliminate systemic risk (British Chambers of Commerce, 2012, p.149).

Conclusion

Multinational manufacturing companies conducting businesses are exposed to numerous risks in the business market, which requires an enabling as well as an integrated understanding of the market environment. Most forms of firms on a global platform, be they in different industries, are subjected to the same risks due to foreign currencies involved. As a result, it is up to an organization to manage these risks by implementing different strategies that offer more options towards attaining a fair and sustainable business structure that mitigates every risk possible. Currency cash flows present the primary concern that most organization face in the international scene. Volatility and uncertainties of currency exchange rates keep organizations on alert at all times. Any shortcoming or vulnerability on the organization’s financial strategies needs to be flexible to accommodate all primary risks it is exposed to. However, at times, these risks overlap each other creating a cycle of uncertainties, which an organization is expected to manage at all costs possible. Not all risk management strategies are effective but they must meet a desirable cost and benefit threshold.

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