General Motors experiences substantial competitive exposure to the depreciating Japanese yen. The company's hedging policy lacks any guideline on how it should go about such exposure. The company's treasurer and vice-president of finance, Eric Feldstein, must come up with a recommendation on how GM should analyze and manage the said competitive exposure. This case study analysis looks into the impact of yen depreciation on a company's sales and profits.
Mihir A. Desai; Mark F. Veblen
Harvard Business Review (205096-PDF-ENG)
March 09, 2005
Case questions answered:
- Why is GM worried about the level of the Yen?
- How important is GM’s exposure to the Yen?
- How would you go from the information in the case about competitive interactions with Japanese manufacturers to a value exposure for GM?
- Are there less information-intensive methods that might allow you to assess the competitive exposure of GM, specifically, or other firms generally? How would you implement such a method?
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Foreign Exchange Hedging Strategies at General Motors: Competitive Exposures Case Answers
1. Why is GM worried about the level of the Yen?
Eric Feldstein who was the treasurer and VP of finance for GM was highly concerned about the level of Yen. This was because:
- GM had substantial exposure to Yen
- GM was competing against Japanese automakers who had large portions of their cost structure denominated in yen
- Depreciation in yen would provide a substantial advantage to the Japanese automakers as an average Japanese car has anywhere about 20 to 40% of Japanese content (parts, labor, plant etc.).
- A yen depreciation would lead to significant cost reductions for GM’s competitors, which in turn would be passed on to the customers, thus eroding demand for GM’s automobiles and their market share would go down subsequently.
- GM had made investments in Japanese companies such as ISUZU, Suzuki, Fuji
- Apart from that GM also recently completed a yen bond issue which has resulted in a $500 million worth of outstanding yen-denominated bonds
To understand the impact of the depreciation, let us assume the case of a Japanese car which is sold at $20000 and the cost of the car to be $16000. At the current exchange rate of 107 Yen/dollar, 40% of the components that are sourced from Japan would cost around 700000 Yen. Keeping this as a base, let us perform a sensitivity analysis.
Thus, if the Yen depreciated to 120 Yen/Dollar, the Japanese companies can get a savings of around $700 yen per car. If they decide to pass on 45% of these savings to the customers, the price of each car can be knocked down by over $300.
These reasons were adequate to make Feldstein very concerned about the level of Yen as compared to the US Dollar.
2. How important is GM’s exposure to the Yen?
It was extremely important for GM to manage the risk that arose out of their substantial exposure to the Japanese Yen.
GM’s overall Yen exposure could be categorized into
- Commercial Exposure: This exposure is based on forecasted receivables less payables of $900 million.
- Affiliate Investment Exposure: GM had equity stakes in three Japanese companies: Fuji, Isuzu, and Suzuki. Any depreciation in yen would affect GM’s value of investments. Due to these investments, GM was exposed to investment exposure.
- Financing Exposure: GM was also exposed to financing exposure because of the following borrowing in yen:
- Yen-denominated loans
- Bond issue of $500 million worth of outstanding yen-denominated bonds
- Competitive Exposure: Result of competing against companies with different home currencies. E.g. Japanese automakers and the yen depreciation
Feldstein had to take the right steps to protect GM from these risks soon.
3. How would you go from the information in the case about competitive interactions with Japanese manufacturers to a value exposure for GM?
According to Feldstein, the exposure for GM, in this case, was a competitive one rather than financial.
GM faced the following value exposures due to depreciation in the yen:
- Eroding market share
- Decline in Profitability/Unit Sales
The major Japanese automakers had large portions of their cost structure denominated in yen. Any depreciation in the yen lowered their relative cost structure compared to manufacturers from the US and Europe. Thus, Japanese firms would be able to achieve normal profit levels with even lower prices. This would lead to currency risk for GM’s business and would erode its market share and market value.
During the year 1999 and 2000, the Japanese automakers derived almost 56% and 43% of their revenues, respectively, from the US market. According to estimates made, Japanese automakers had incurred a loss in operating profits to the tune of $4 billion because of a steep appreciation of Japanese yen as compared to the US dollar.
However, Feldstein was not too relaxed about the situation as he believed that soon, the US Dollar would gain strength and Japanese yen would start depreciating. This provided a clear advantage to the Japanese automakers.
Feldstein drew the below story in his mind and thought to present to his bosses which would make a compelling case to hedge the risk.
Japanese automakers would usually pass on about 15-45% of the cost savings arising out of the Yen depreciating w.r.t USD. On the other hand, GM usually saw a drop of 10%-unit sales with a 5% increase in price.
Another factor that Feldstein has calculated in his mind was the fact that for every one-yen depreciation against the US Dollar, the Japanese automakers were able to make a combined increase in operating profit of about $ 400 million. This was huge!
Japanese firms were believed to be unprofitable when Yen remained at about 110 level w.r.t US Dollar and were profitable only at or above 120.
4. Are there less information-intensive methods that might allow you to assess the competitive exposure of GM, specifically, or other firms generally? How would you implement such a method?
As GM is competing against Japanese automakers whose reporting currency is different from that of GM, there is an inherent competitive exposure for GM. To analyze this in a more qualitative manner we need to understand the below things for GM, or for that matter any firm operating in similar space:
- Need to understand the correlation of market share of the firm and change in exchange rate.
- Does the market share increase or decrease with the appreciation of the home currency?
- By how much does this market share changes for every unit change in the exchange rate.
- Need to identify how much costs are incurred in foreign currency and how much in domestic currency
- Identify how much investments are made in the foreign country, for example in the GM case, the company had substantial investments in Japanese companies
- If there are any capital raised from the foreign country (bonds, debt) understand the level of impact under every scenario – perform sensitivity analysis with different levels of input. With the change in the exchange rate, the interests paid would also change.
- Understand the revenue impact and changes in demand for the products in the foreign country with the change in the exchange rate (whether products are more affordable or costly to consumers)