OLIVETTI'S FOREIGN-EXCHANGE RISK-MANAGEMENT
OLIVETTI'S
FOREIGN-EXCHANGE
RISK-MANAGEMENT
The Company When De Benedetti was offered the CEO spot at Olivetti in 1978, the company was losing $8 million a month, had a debt position in excess of liquid assets by more than $600 million, and also had a management team that was very discouraged. "We had only a few products and a local culture," recalls Elserino Piol, executive vice president for corporate strategies. "We were sort of a country-boy company." As soon as De Benedetti came on board, he instituted massive layoffs, increased the research and development budget significantly, introduced new products, and replaced most of Olivetti's top management.
By 1986 sales were $4.9 billion, and earnings were $380 million. Of Olivetti's sales, approximately 49 percent are in Italy, 32 percent in other European countries, and 18 percent in non-European countries. Olivetti struck strategic alliances with a number of MNEs, including Matsushita Electrical Industrial Co. and Toshiba. As noted by De Benedetti, "The traditional multinational approach is de'passe' [obsolete]. Corporations with international ambitions must turn to a new strategy of agreements, alliances, and mergers with other companies."
However, Olivetti's fortunes began to wane in the late 1980s. As the
Italian economy began to slow in 1989, so did the growth of Olivetti. Profits in 1989 were down 40 percent from their level in 1988, and the company's market share in Europe dropped from 9 to 8 percent. Layoffs in 1990-1991 were expected to reach 5 percent of Olivetti's labor force. De Benedetti and Managing Director Vittorio Cassoni realized that mergers or alliances would be necessary to catapult Olivetti into a solid position in Europe, but they have had trouble finding the right partner. It looked like the 1984 joint venture with American Telephone & Telegraph would do the trick, but the venture fell apart in 1989.
In spite of these failures, De Benedetti wanted to move away from the narrow niche of being a hardware manufacturer to being a firm that solves business problems through hardware and software. Olivetti entered into an arrangement with GM's Electronic Data Systems Corp. to provide computer services in Europe. Currently, Olivetti is the top computer maker in Italy, but it is struggling in Europe and the United States. Given the size and
strength of the U.S. market, especially in the hardware and software industry, De Benedetti is determined to improve Olivetti's position there, even though the venture with AT&T was not successful.
The Olivetti Risk-Management Strategy Olivetti has production and distribution facilities scattered around the world. As a result, it has tried to establish good strategies for managing foreign-exchange risk. Olivetti's strategy is developed by a committee made up of a group controller, the international treasurer, the chief economist, and a member of the operational planning department.
The first thing that the committee does is consider the relationship among three currencies: the local currency (the currency of the country where the operation is located); the currency of denomination (the currency in which a transaction actually is denominated); and the currency of determination (the currency used to determine the global price of products). The committee tries to see how fluctuation in the three currencies will affect Olivetti's competitiveness in the markets where it operates. Once a year, the committee simulates the effect of different exchange-rate scenarios on the profitability of each unit and the company as a whole.
There is a strong interrelationship between the exchange rate and the economic environment. As noted by Angelo Fornasari, Olivetti's vice president of finance: "To maintain market share and satisfactory profit levels, Olivetti must constantly consider the problems of sourcing product input, of funding in different currencies and markets, of reorienting market efforts, of seeking higher productivity levels, of shifting from one currency of invoicing (i.e., of denomination), to another, etc." Olivetti develops its economic exposure scenario three years into the future.
The hedging strategy is centralized at the corporate level so that local managers can concentrate on operating decisions. Transaction exposure is centralized, and hedging activities are carried out for the balances of transactions actually booked, as well as for forecasts of what the balances are expected to be four months into the future.
INTRODUCTION It is February 6, 1989, and you awaken from a good night's sleep to face a bright, sunny day. After a brisk 5000 meter run, you take a shower and think about your upcoming trip to Buenos Aires, Argentina, where you will meet with the treasurer of your Argentinean subsidiary. It has been only a month since you were appointed Latin American regional treasurer of your firm, and you are eager to learn more about the Argentinean operations, which constitute a significant percentage of your region's sales and earnings.
As you sit down to breakfast you turn on the news and hear the following announcement: "Today, the government of Argentina announced an unscheduled bank holiday. It is rumored that the government is planning to move the free-market exchange rate from 16 Australs per dollar to A23:$l. Exchange markets are expected to remain extremely turbulent until the next presidential election."2 Do you spill orange juice on your new suit, or do you relax through breakfast, confident that your operations had been covered adequately?
While the treasury function of an MNE can be exciting and challenging, it also can be filled with surprises and headaches. Among the key challenges are the acquisition and management of funds both external and internal to the firm, different means of financing imports and exports, the management of risk due to inflation and exchange-rate changes, and capital investment decisions.
Coca-Cola is a good illustration of the dimensions of the treasury function. Coca-Cola soft drinks are marketed in over 160 countries, and more than half of the company's operating income is generated outside of the United States. The treasurer reports directly to the Chief Financial Officer (CFO), as do the controller, the tax manager, and the directors of corporate data processing and corporate audit. Coca-Cola's treasurer identified his major challenges as financial risks and financing costs. Financial risks are defined as "currency transaction and translation risks, as well as property and product liability risks. The management of financing costs involves all short- and long-term borrowings companywide, as well as the company's overall cash management. . . ."3
Government policies, interest-rate and inflation differentials, and exchange rates are complicating factors that are not a major issue for domestic firms.
FOREIGN-EXCHANGE
RISK-MANAGEMENT
The Company When De Benedetti was offered the CEO spot at Olivetti in 1978, the company was losing $8 million a month, had a debt position in excess of liquid assets by more than $600 million, and also had a management team that was very discouraged. "We had only a few products and a local culture," recalls Elserino Piol, executive vice president for corporate strategies. "We were sort of a country-boy company." As soon as De Benedetti came on board, he instituted massive layoffs, increased the research and development budget significantly, introduced new products, and replaced most of Olivetti's top management.
By 1986 sales were $4.9 billion, and earnings were $380 million. Of Olivetti's sales, approximately 49 percent are in Italy, 32 percent in other European countries, and 18 percent in non-European countries. Olivetti struck strategic alliances with a number of MNEs, including Matsushita Electrical Industrial Co. and Toshiba. As noted by De Benedetti, "The traditional multinational approach is de'passe' [obsolete]. Corporations with international ambitions must turn to a new strategy of agreements, alliances, and mergers with other companies."
However, Olivetti's fortunes began to wane in the late 1980s. As the
Italian economy began to slow in 1989, so did the growth of Olivetti. Profits in 1989 were down 40 percent from their level in 1988, and the company's market share in Europe dropped from 9 to 8 percent. Layoffs in 1990-1991 were expected to reach 5 percent of Olivetti's labor force. De Benedetti and Managing Director Vittorio Cassoni realized that mergers or alliances would be necessary to catapult Olivetti into a solid position in Europe, but they have had trouble finding the right partner. It looked like the 1984 joint venture with American Telephone & Telegraph would do the trick, but the venture fell apart in 1989.
In spite of these failures, De Benedetti wanted to move away from the narrow niche of being a hardware manufacturer to being a firm that solves business problems through hardware and software. Olivetti entered into an arrangement with GM's Electronic Data Systems Corp. to provide computer services in Europe. Currently, Olivetti is the top computer maker in Italy, but it is struggling in Europe and the United States. Given the size and
strength of the U.S. market, especially in the hardware and software industry, De Benedetti is determined to improve Olivetti's position there, even though the venture with AT&T was not successful.
The Olivetti Risk-Management Strategy Olivetti has production and distribution facilities scattered around the world. As a result, it has tried to establish good strategies for managing foreign-exchange risk. Olivetti's strategy is developed by a committee made up of a group controller, the international treasurer, the chief economist, and a member of the operational planning department.
The first thing that the committee does is consider the relationship among three currencies: the local currency (the currency of the country where the operation is located); the currency of denomination (the currency in which a transaction actually is denominated); and the currency of determination (the currency used to determine the global price of products). The committee tries to see how fluctuation in the three currencies will affect Olivetti's competitiveness in the markets where it operates. Once a year, the committee simulates the effect of different exchange-rate scenarios on the profitability of each unit and the company as a whole.
There is a strong interrelationship between the exchange rate and the economic environment. As noted by Angelo Fornasari, Olivetti's vice president of finance: "To maintain market share and satisfactory profit levels, Olivetti must constantly consider the problems of sourcing product input, of funding in different currencies and markets, of reorienting market efforts, of seeking higher productivity levels, of shifting from one currency of invoicing (i.e., of denomination), to another, etc." Olivetti develops its economic exposure scenario three years into the future.
The hedging strategy is centralized at the corporate level so that local managers can concentrate on operating decisions. Transaction exposure is centralized, and hedging activities are carried out for the balances of transactions actually booked, as well as for forecasts of what the balances are expected to be four months into the future.
INTRODUCTION It is February 6, 1989, and you awaken from a good night's sleep to face a bright, sunny day. After a brisk 5000 meter run, you take a shower and think about your upcoming trip to Buenos Aires, Argentina, where you will meet with the treasurer of your Argentinean subsidiary. It has been only a month since you were appointed Latin American regional treasurer of your firm, and you are eager to learn more about the Argentinean operations, which constitute a significant percentage of your region's sales and earnings.
As you sit down to breakfast you turn on the news and hear the following announcement: "Today, the government of Argentina announced an unscheduled bank holiday. It is rumored that the government is planning to move the free-market exchange rate from 16 Australs per dollar to A23:$l. Exchange markets are expected to remain extremely turbulent until the next presidential election."2 Do you spill orange juice on your new suit, or do you relax through breakfast, confident that your operations had been covered adequately?
While the treasury function of an MNE can be exciting and challenging, it also can be filled with surprises and headaches. Among the key challenges are the acquisition and management of funds both external and internal to the firm, different means of financing imports and exports, the management of risk due to inflation and exchange-rate changes, and capital investment decisions.
Coca-Cola is a good illustration of the dimensions of the treasury function. Coca-Cola soft drinks are marketed in over 160 countries, and more than half of the company's operating income is generated outside of the United States. The treasurer reports directly to the Chief Financial Officer (CFO), as do the controller, the tax manager, and the directors of corporate data processing and corporate audit. Coca-Cola's treasurer identified his major challenges as financial risks and financing costs. Financial risks are defined as "currency transaction and translation risks, as well as property and product liability risks. The management of financing costs involves all short- and long-term borrowings companywide, as well as the company's overall cash management. . . ."3
Government policies, interest-rate and inflation differentials, and exchange rates are complicating factors that are not a major issue for domestic firms.
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