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Unit 14: Management Control of MNC’s

14.6.6 Strategic Exposure Notes

Competitive exposure is often referred to as “Statistic Exposure” because it has significant
implications for some strategic business decisions. It influences the firm’s choice of markets,
products, source of inputs, location of manufacturing activity and decisions as to whether foreign
operation should be started.
A number of examples from recent history clearly bring out the nature of operating exposure:

1. The increase in dollar during the first half of the 1980s eroded the competitive position of
many US firms where the costs were dollar denominated.

Example: Kodak found that their sales were spread all over the world, whereas the costs
were dollar denominated. They faced stiff competition from Japanese firms such as Fuji both in
the US market as well as third country markets.
2. Further, when the dollar started falling against the yen and the Deutsche mark around
mid-1985 and continued to fall for over two years, Japanese and German car makers found
their operating margins being squeezed. They responded by starting manufacturing in
the US and partly by moving up into premium priced luxury cars where consumer sensitivity
to price increases is relatively less.
3. At home, Indian manufacturers of cars and two-wheelers with significant import content
denominated in yen found that strengthening of yen resulted in cost increase which they
would not allow to pass on to the consumer because of depressed demand conditions and
competitive consideration.

4. US pharmaceutical multinationals like Merck found that during the period of strong
dollar, their cash flows denominated in dollars tend to shrink while most of their R&D
expenditures are denominated in dollars. A shortage of internally generated cash tends to
have an adverse impact in their R&D budgets which is a crucial factor in their long run
competitiveness.
5. The significant fall in South Asian currencies starting mid-1997 hurt Indian exports in the
Western markets as some of these countries are India’s competitors in these markets.
In all these cases, exchange rate changes coupled with concomitant changes in relative cost had
a significant impact on the firm’s ability to compete effectively in particular product market
segments, to undertake good investment projects and thus to enhance their long run growth
potential.

14.6.7 Management of Exchange Risk

Transaction Exposure: A firm is subject to transaction exposure when it faces contractual cash
flows that are fixed in foreign currencies. Suppose that a US firm sold its product to a German
customer on three month credit terms and invoiced in Euro. When the US firm receives Euros in
three months, it will have to convert (unless it hedges) the Euro into dollar at the spot exchange
rate prevailing on the maturity date, which cannot be known in advance. As a result, the dollar
receipt from this export sale becomes uncertain; should the Euro appreciate (depreciate) against
the dollar, the dollar receipt will be higher (lower).
The above example suggests that whenever the firm has foreign currency denominated
receivables or payables, it is subject to transaction exposure and their settlements are likely to
affect the firm’s cash flow position. The various ways of hedging transaction exposure are as
follows:

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