Foreign Exchange Hedging

Strategies at General Motors

Competitive Exposures

by Sacha Singh|Shemair Lewis|

Martin Massiah|Diandra Touissant

Case Summary

In 2001, General Motors was the world’s

leading automaker

Market share of 15%

Annual sales of $184.6 billion

Earnings of $4.4 billion

GM had manufacturing operations in more

than 30 countries and its vehicles were sold in

around 200 countries.

Case Summary

Majority of sales to end customers were in North

America, however the importance of international

operations are growing.

This results in currency risks and competitive exposures

Japanese automakers were of major concern for GM

The depreciation of the yen lowered their relative cost

structure compared to U.S. and European automakers

Japanese firms’ advantage of lower costs could

erode GM’s market share and market value

Case Summary

Key objectives of GM’s foreign exchange (FX) risk

management policy:

Reduce cash flow and earnings volatility

Minimize management time and costs dedicated to FX

management

Align FX management with how GM operated its

automotive business

Case Summary

These objectives were supported by GM’s formal

hedging policy

Passive hedging strategy: hedge 50% of all

significant foreign exchange exposures from cash

flows associated with ongoing business

Why is GM worried about

the level of the yen?

Why worry

Due to GM’s international operations, the firm is

vulnerable to:

Currency Exposure: investment in a foreign

currency is subject to the changes in value of

that currency

Eg. GM’s foreign operations

Why worry

Investment exposure: equity stakes in Japanese

automakers

Affiliate Exposure

Long/(Short)

$ Billions

GM Ownership

Stake

Fuji (1.50) 20%

Isuzu (1.02) 49%

Suzuki (0.09) 20%

Why worry

Commercial Exposure:

Forecasted receivables less payables

Financing Exposure:

Yen-denominated loans

Bond issue of $500 million worth of outstanding yen-

denominated bonds

Competitive Exposure: exposure resulting from

competing against companies with different currencies

Eg. Japanese automakers and the depreciation of

the Yen

Impact of the Yen Depreciation

Major Japanese automakers had large

portions of their cost structure denominated in

yen

Any depreciation lowers their cost structure

in comparison to foreign competitors (eg.

GM)

Lower prices can achieve normal

profitability levels for Japanese firms

GM’s operations would be affected by

currency risk, eroding market share and market

value

Example

Cost of Manufacturing a Car = $40,000

Selling Price of Car = $50,000

45% of components sourced from Japan

Old Exchange Rate: $1= ¥100

New Exchange Rate: $1= ¥120

Example

Old exchange rate

($1= ¥100)

Components: 45% of

$40,000

Cost ($)= $18,000

Cost (¥)

=$18,000 x ¥100

=¥1,800,000

New exchange rate

($1= ¥120)

Cost in Yen: 1,800,000

Cost ($)

=¥1,800,000 ÷ ¥120

= $15,000

Change

$18,000 - $15,000

=$3,000

How Important is GM’s Competitive

Exposure to the Yen?

How important

Japanese automakers derived 56% and 43% of

their revenues from the U.S. Market in 1999 and

2000 respectively.

Feldstein noted: For every one-yen

depreciation against the dollar, Japanese

competitors’ collective operating profit grew

by more than $400 million

How important

GM’s exposure is a competitive one, rather

than a financial one

No projected receivable or payable and no

capital investment or loan to be repaid, yet

there was still a bottom-line impact due to

foreign exchange fluctuations

GM’s competitive exposure to the Yen is

crucial to their profits and market share

Depreciation in Yen leads to

Additional Gross Margin for Japanese

Automakers, who

Passed along some of the benefits to

consumers in lowered prices

Therefore gaining market share in

the U.S.

Which, ate into unit sales at GM

Lowered Gm’s profits

Reduced Gm’s market Value

How important

The average Japanese car had between 20% -

40% Japanese components

Suppliers, labour and plant expenses

Japanese incentives and lower sticker prices

from the depreciated yen were between 15%

and 45% of the cost savings

Example

Cost of Manufacturing a Car = $40,000

Selling Price of Car = $50,000

45% of components sourced from Japan

Cost of Japanese components (old

exchange rate): $18,000

New Exchange Rate: $15,000

Change in Profit Margin: $3,000

Example

Additional margin passed to customers (45%)

$3,000 x 0.45= $1350

New Selling Price: $50,000-$1350 = $48,650

Price Decrease: 2.7% (1350/50,000x100)

How would you go from

the information in the

case about competitive

interaction with

Japanese manufactures

to value exposure of GM

Value Exposure GM faces

Eroding:

Market share

Profitability / Unit Sales

Market Share

Examine how changes in the exchange rate

change the market share of your company

Japanese Market Share

Yen Depreciation

Market share exposure

GM faces currency risk due to lower costs for

Japanese firms would lead to lower required

prices to achieve the normal profitability levels,

thus eroding GMs market share and market

value

Unit Sales

Examine how changes in the exchange rate

change the unit sales of your company

Japanese Car Sales

Yen Depreciation

Unit Sales

5% in price could be expected to lower unit sales by 10%

(sales elasticity of 2)

Solution - In an effort to isolate the impact on GM, they

assumed that any market share losses to Japanese

automakers would be shared equally among and entirely by

3 Big automakers in Detroit.

Are there less information-

intensive methods that might

allow you to assess the

competitive exposures of GM,

specifically, or other firms

generally? How would you

implement such a method?

What is competitive exposure

Exposure resulting from competing against

companies with different currencies

Less information-intensive methods

Examine how FOREX volatility affects

Market Share

Cost Base

Debt

Revenue

Unit Sales

Profit

Market Share

Examine how changes in the exchange rate change the market share of your company

Look at how your market share expands and contracts in response to changes in the exchange rate

If you notice that you lose market share as your currency appreciates against another currency that your competitor uses, you can identify an exposure

Cost Base

Examine how changes in the

exchange rate change the

cost base of your company

Identify what currencies your

costs are denominated in

Compare the share of foreign

currency to your functional

currency and there is where

your exposure lies

57%24%

14%

5%

US$ XCD$ ¥ £

Debt

Examine how changes in

the exchange rate change

the debt of your company

Look at the currencies that

you incur debt in

As the exchange rates

change, your debt will also

change if you are repaying

it with another currency

That is where your exposure

lies

$100,000 $100,000

$80,000

$20,000

$20,000

$0

$20,000

$40,000

$60,000

$80,000

$100,000

$120,000

$140,000

Base Increase Decrease

Changes in Debt

Revenue

Examine how changes in the

exchange rate change the revenue of

your company

Identify how revenue changes at

different exchange rates

If you sell soursop ice-cream to parlors

in Europe, your revenue will decrease

as the Euro becomes weaker against

the EC dollar even if the unit sales

remain the same

This is where you can see your exposure

Units Sales

Examine how changes in the

exchange rate change the unit

sales of your company

As exchange rates change, your

product will become more

expensive or more affordable to

your customers

Your product may then be subject

to the laws of supply and demand.

This is where you will see your

exposure

Profit

Examine how changes in the exchange rate

change the profit of your company

Contracting Market Share

Drop in Car Sales

Short Fall in Profit

References

Academia.edu,. (2015). Financial Statement Analysis. Retrieved 24 March 2015, from http://www.academia.edu/621055/Financial_Statement_Analysis

Elvis Picardo, C. (2005). Economic Exposure Definition | Investopedia. Investopedia. Retrieved 24 March 2015, from http://www.investopedia.com/terms/e/economicexposure.asp

Managementparadise.com,. (2015). Foreign Exchange Hedging Strategies at General Motors by Balajiv Ganesh in Finance category on ManagementParadise.com. Retrieved 24 March 2015, from http://www.managementparadise.com/balajiv.ganesh/documents/7309/foreign-exchange-hedging-strategies-at-general-motors/

Measuring and Protecting against Economic Exposure. (2014). Boundless. Retrieved from https://www.boundless.com/users/233416/textbooks/money-banking-and-international-finance/transaction-and-economic-exposures-19/transaction-and-economic-exposures-40/measuring-and-protecting-against-economic-exposure-150-15248/

Public.kenan-flagler.unc.edu,. (2015). Assignment 3. Retrieved 24 March 2015, from http://public.kenan-flagler.unc.edu/faculty/browngr/macroweb/assignment_3.html

Suwanto, S. (2015). Harvard Business School Study Case: Foreign Exchange Hedging Strategies at General Motors (2004) | Futurum Corfinan. Futurumcorfinan.com. Retrieved 24 March 2015, from http://www.futurumcorfinan.com/2014/09/harvard-business-school-study-case-foreign-exchange-hedging-strategies-at-general-motors-2004/