Foreign Exchange Hedging Strategies at General Motors: Competitive Exposures

1. General Motors is worried about the level of the yen because:

The primary concern for General Motors with devaluation in the yen comes from the

fact that a depreciating yen gives its Japanese Competitors a lower cost structure

allowing them to pass on reduced costs to customers. According to the case, sticker

prices of cars could fall between 15%-45% of the cost savings.

GM also knew that a 5% increase in the price could lower the unit sales by nearly

10%. This data indicates that customers were fairly conscious of price changes, and

lower costs could allow GM’s competitors a chance to increase their existing market

share and directly eat into GM’s revenues.

In terms of operating profit, research had shown Feldstein that a depreciation of 1 yen

against the dollar enhanced the Japanese competitors operating profit by more than

$400 million. This obviously intensified the competitive pressure on GM and their

performance as seen by its stakeholders.

General Motors also had a yen commercial exposure of nearly $900 million in terms

of net receivables coupled with $500 million worth of exposure in terms of

outstanding yen denominated bonds and also equity stakes in several Japanese

companies.

Thus, GM is concerned about the level of the yen due to the investment and

transaction exposure to the yen, coupled with the competitive advantages the

devaluation of the yen could give its Japanese competitors.

2. General Motor’s competitive exposure to the Yen is important for the reasons listed

below:

North America is largest segment for GM’s sales, and nearly 72% of GM’s sales

come from North America. Any cost benefits that Japanese competitors give

consumers in North America can significantly change the sales and earnings of GM

because consumers are fairly sensitive to prices of the cars. This is a very real threat

to the earning potential GM has from its largest market segment and a devaluation of

the yen against the dollar could lower GM’s market share substantially.

GM would need to control the production and supply of its cars and enhance its

operations in case the devaluation of the yen gives it Japanese competitors higher

market share, and such movements would need to be taken into consideration to

forecast the demand for GM’s cars.

GM also had significant short equity affiliate exposures in some Japanese companies

like Fuji, Isuzu and Suzuki. A fluctuation in the value of the yen would impact the

value of GM’s stake in these companies. Traditionally it has been seen that Japanese

firms were unprofitable when the yen was stronger than 110 to the dollar and

profitable at 120 or more to the dollar.

Finally, the exhibit 4 shows the downward trend that the yen has had against the

dollar in the 2 decades prior to the current scenario, and hence GM needs to integrate

and evaluate its forex and hedging strategy in case there is an appreciation in the yen

as opposed to a continued downtrend.

c. Using the information in the case, how would you go about competitive interactions with

Japanese manufacturers to a value exposure for GM?

Depreciation of Yen will result lower cost for Japanese manufactures because 20% to 40% of parts were sourced from Japan.

Secondly, Japanese automakers pass 15% to 45% of this benefit (gain due to depreciation) to end customer. Case also reveals that every 5% in price decrease (increase) will affect sale by 10%, therefore sales elasticity is two. Any market loss will be share equally by 3 big automakers in Detroit.

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d.) Can you assess GM’s competitive exposure (or any other firm for that matter) by using an

alternative method? (Especially when you might not have as much company specific

information)

- We could calculate GM economic exposure, which is change in firm’s value as exchange rate fluctuates.

- Economic exposure = Transaction exposure + Operating exposure:- We could calculate both demand side by calculating the impact of revenue due to market

loss. Alternatively, cost of COGS due to supply substitution from overseas market.