Hedging Currency Risk

Currency Risk is Growing in Importance

With the recent American dollar devaluation, CFOs and comptrollers around the world face an additional risk while managing their international businesses. A few years ago, this would not be even a topic of discussion, since the dollar was been the de facto steady currency for international trade transitions. This picture has changed significantly with the weakening of the US economy and with the constant drop in the American currency. Now, currency risk is becoming a topic of discussion in executive boards.

Let's take a simple example. You own a technology business which is exporting products to the United States. The terms of your contract indicate that the proceedings from sales will be determined in US dollars. This means that, if the US dollar appreciates in value, you will make more money in your local currency and, if the US dollar is devaluated, you may make less money. In the past, these variations were minimal and, to a certain extent, predictable. But now, they are becoming quite significant and even affecting financial results.

Indeed, companies are already taking note of the implications of devaluations of the US dollar. In Canada for instance, there was an increase "in the percentages of Canadian companies that consider to be either experiencing a very negative or a very positive direct effect from the appreciation of the Canadian dollar" [Bank of Canada]. From 2002 to 2008, the Canadian dollar to US dollar rate appreciated from 0.63 to 1.01. Thirty-eight percent is much higher than the Canadian inflation rate during these years. The same phenomenon is happening in other regions in the world, including Europe and South America. This may be news to some, but it is becoming a new type of concern to any company trading overseas.

Remember: You are Managing a Business

At university I was very fortunate to have Mo Levi as my macroeconomics professor. He often reminded us the implications of using currency fluctuations carelessly in order to improve financial performance. Making bets for or against currencies can be dangerous. One of his maxims was: “Do you really want to enter into the foreign exchange business or do you want to spend more time improving your business?” In fact, if you would like to take advantage of currency fluctuations in order to boost your profits, you really need to know what you are getting into. Yet, it is more worthwhile to invest effort in improving your competitive advantage and streamlining your business, than playing with the currency market. Improving your business performance will yield long-term lasting results; whereas playing with currency rates may help you reach your immediate targets but won’t help you with your long-term performance.

Managing Currency Risk

From simple approaches to elaborate schemes using derivatives, you can consider different strategies to mitigate currency risks depending on the size of your business. A quick assessment of your organization will give you an indication that some departments are more exposed to currency volatility than others. You should also choose not to mitigate this type of risk, in case the impact currencies have in your business is minimal. One simple approach is to keep your revenues and costs in the same currency. For instance, if you run a consulting company in the Canadian and US markets, you may want to structure it in a way that your consultants in the US are paid in American dollars and your Canadian consultants are paid in Canadian dollars. Revenues can be managed in a similar fashion. This will eliminate the fluctuation in costs and revenues caused by the conversion of currencies and align the business cycles, so when one currency goes down, the sales revenues are affected in the same way as costs, without affecting the other sides of the company.

Pairing costs and revenues may not be feasible in some countries, since in some parts of the world you can only have bank accounts in a local currency, not being able to have bank accounts in foreign currencies. In that situation, you can finance operations by borrowing/investing in the external currency or by using the derivative instruments such as futures and swaps to hedge your transactions. To illustrate this, suppose you need to buy US$100,000 in hardware to be paid at the end of twelve months. Instead of being exposed to currency risk for that period, you could buy an investment in the US funds that will provide you US$100,000 in return at the end of that period and use the proceedings to pay for your purchase. There are many other creative ways to hedge currency risks. Obviously each situation requires a different analysis and some extra costs should be considered in your model (e.g. currency spreads, bid and ask prices) in order to find the appropriate hedging strategy for your firm.

To sum up, your company may be exposed to currency risk. You may use strategies ranging from simple financial instruments to derivatives to hedge this type of risk, but make sure you are first addressing your business operational needs and not speculating on the currency market. Focus on your business competitiveness and look for sound advice. And finally... Keep it simple.

PS: Check my follow up article with some further references related to hedging currency risk.

Lack of Communication Strategy or Simply Spam?

Do you really know what you are delivering to your customers? In the interior of the country, a small but fast growing educational organization decided to venture into Internet marketing. I guess they were keen to have their name out and to be able to reach a larger number of prospective students. So, they decided to contact a local technology company in order to do the job.

On the premise that the more people you reach, the better the marketing campaign will be, the tech company created a mailing list using a cheap CD bought on the internet with millions of e-mails. The mailing list was then given to the school which started advertising its services.

The campaign organizer was exhilarated with the preliminary results: “Gosh, what a nice return on my investment! I've bought this e-mail CD for pennies and now I’m receiving tons of traffic on the school site. People are actually getting interested.” As time passed by, the distribution list was augmented with students who had successfully finished some courses, so they could receive the latest course offerings. At this point the company lost track of who was in the original spam list and who were the actual customers.

One day, the technology provider had a serious glitch in its mailing system. Suddenly all replies to the ad e-mails, which had previously been disregarded, started bouncing back to the entire mailing list. This included e-mails from very unhappy customers who wanted their name removed from the distribution list, distraught clients who were unsatisfied with the course offering and unrelated spammers who had figure out that the mailing list had been compromised. At this point, it became very clear that a large number of consumers were not very happy with the e-mails being sent to them. Many of them were even challenging the credibility of the educational institution.

The damage was done. With the milk spilled, by the time the technology provider was able to turn off its mailing servers, there were hundreds of e-mails flying around with all sorts of less than fortunate experiences related to the school. The word was out; prospective customers were unhappy about receiving spam; current students were disappointed that their organization’s reputation was being demolished in front of them.

The solution was to switch technology providers and publically apologize for breaching their customers’ trust by allowing their information to be broadcast in the Internet - an interesting move, which may not have helped them to recover their credibility. Indeed, this may have resolved the technical issues faced, but it was far from resolving any customer perception issues about that school’s brand. Not an easy issue to resolve once the damage is already done.

The bottom line of this story is that, as a strategist, you need to be aware of what is being sent to your customers. Every time something using your brand reaches a customer, it is an opportunity to make or break the relationship with your target market, influencing how your products are perceived. It may not be clear in this story, but there are some things you cannot delegate to a technology company or IT department, and managing your strategic communication may be one of them. I am convinced that customers can be your best sales people, especially if you have small/medium-sized Company that cannot afford to hire a large sales force. Every interaction with your customers helps them become your indirect sales force; even simple e-mails. This is important because you may need to spend lots of effort trying to properly reposition your brand after an unfortunate association with spamming, yet very little time if you do it properly from the beginning. So, ask your folks what types of e-mails they have been sending to your customers lately!

Tip the waiter and the environment

Vancouver is famous for being a green city. I am used to seeing all sorts of environmentally friend things around the city. From simple garbage bins with a separate recycling space to dispose used plastic bottles to extreme tree-huggers camping out on tree tops protesting against the removal of ancient trees. This time, something totally unexpected came to my hands.

As I was finishing my conversation with a friend at a pizza place called Rocky Mountain Flatbread Co., in the Kitsilano neighborhood, I decided to ask the waiter for the bill. The place has a reputation for its awesome pizza made of organic ingredients. The bill arrived and I saw an entry for "carbon contribution". I raised my eyebrows in a gesture of pleasant surprise noticing the environment around me. I realized that the owners have gone to great lengths to try to make this more than just "another" pizza place.

Well, they went to a new level of market differentiation. Offering customers to optionally offset their carbon footprint not only provides them some extra money to contribute to clean energy projects, but also increases the bond between their customers and their brand. I am sure they have a large quantity of customers who enjoy their pizza and are happy to pay some extra cents to help the environment.

I am always surprised with the level of novelty found in businesses in this green city. I never thought one could differentiate a pizza place, but Rocky Mountain Flatbread Co. does it very well. This is about building a business on an idea and on an ideal, and walking the corporate talk to build customer loyalty. Regardless of the debate on the effectiveness of carbon offsetting, this differentiation will make people talk about this place and most likely bring in even more customers.

Awesome pizza, awesome customer experience! Perfect lesson on how to differentiate a business!

Creating Personal Development Plans

Personal development plans are yearly career plans that contain the employee’s goals and are used to measure their performance throughout the year. I am often asked how I deal with creating such plans for my team members. My answer is simple: “I don’t”. I strongly believe that development plans should first be created by the employee, not by the manager. After employees define their goals, then it is the manager’s job to align the employee’s goals with the corporate goals.

This approach has several advantages. First, employees will likely feel a stronger ownership of their goals. Second, it gives the manager a chance to discuss and address any eventual gaps between the employee’s goals and the company’s goals and, obviously, address them. Finally, it’s a good way to calibrate expectations between the employer and employee and to motivate employees by providing achievable and valuable goals that are beneficial for both them and the organization.

In addition to defining project goals in their development plans, I often instruct my staff to include a separate individual goal that relates to their personal development, such as improving a soft skill or enhancing even further a personal strength. This way they have a chance to measure the growth in their professional careers, as well as their performance when executing projects.

Lately, this approach has been working quite well. Well, after trying many approaches to managing performance, this method was the one that produced the most positive results for both my company and the employees on my team.

One point to keep in mind is that the development plan can be part of a long-term career plan. The clearer you make your development plan, the easier it is for you to evaluate opportunities and determine if you are progressing towards your long-term career goals. The personal development plan is an important and worthwhile investment.

A Practical Example
If you are looking for an example on how to create your own career plan, here is a suggestion on how to approach it. This is the way I have been approaching my personal development plan in my career.

Start From the End – State Your Long-term Goal
Instead of setting your immediate goals first, try starting with the end in sight. You need to be clear about where you want your career to go, so spend some time articulating where you want to be in five years from now. So, you can start with a long-term goal:

Example:

Long-term Goal: In five years, I see myself working as the lead bread baker in the baking department of our main downtown store. Using the skills learned throughout my career, I would like to not only bake bread, but also bake the best cakes in town. To get to that stage, I need to improve my cooking skills, learn to sharpen knives, and learn to bake different types of bread and cakes.

Your long-term goal is your final destination in five years and may change slightly from year to year. This goal relates to where you want to go in the organization. Your long-term goals are completely yours and no one else has the right to say whether they are wrong or right – that’s your call. It may take a few days to identify your true long-term goal. It is a good idea to write it down, then set it aside, have a good nights sleep, and then check it again the next morning to see if it still makes sense.

Taking the time to clearly describe your long-term goal clearly and concisely will save you considerable time when it comes to creating your other goals. If your long-term goal is confusing, too complex, or all over the place, your personal development plan will likely not fit together well. So, making your long-term goal clear and specific is very important.

Create Development Goals – What Do You Need to Learn
Next, you move into a more tactical level and specify goals for the coming year. It is time to identify the areas you need to grow to achieve your long-term goal. What tools do you feel would help you achieve your goal? What skills do you need to invest time, in order to develop your goals?

Instead of creating a laundry list of things you can improve, think about your strengths and identify two to three things you can strengthen further to make a huge difference to your future success. For instance, you can become a better communicator, a better writer, a better singer, a better coder, a better tester, as well as a better husband. But, if your development goals are all over the place like this, you won’t be able to excel in any one of them. At best, you will be “average” in each of those new skills, and you don’t want to be average, you want to be “great!”. So, limit your development goals to two or three; choose goals that build on your strengths; but choose wisely and have a clear plan for how these goals will impact your long-term goal.

Example:

Objective: Time Management - Develop my multitasking skills
Description: This year, I will develop my ability to multitask and work on multiple baking orders at the same time. At the end of Q2 2008, I would like to achieve this goal (1) by participating in a time management training course for cooks, (2) by reading a book related to time management and presenting the results to other cooks in the bakery, and (3) by organizing myself so I can handle multiple baking orders at one time. This goal is relevant for me because I would like to go back to school and, if I am able to better manage baking orders, I will be able leave the bakery on time to attend my evening classes. I will measure this goal by (1) the number of times an order was late, (2) feedback from customers about the quality of their orders, (3) the time it takes to complete the orders. (Just an illustrative example)

Specify Your Delivery Goals – Build Your Track Record
Next you build your project-related goals. This is where you identify the project deliverables and outcomes you plan to deliver throughout the year. Again, focus on substance rather than quantity and group similar tasks into common topics. This approach will help you create relevant goals.

Example:

Objective: Delivery - Create ten new recipes of multigrain bread
Description: This year, I will create ten new types of bread by developing new bread recipes using different types of grains, such as corn, wheat, and oats. I would like do achieve this goal by the end of Q1 2008, providing our customers with samples of the new baked goods. This is relevant for me because I would like to become more creative in the kitchen and use more of the leftover grains in the bakery for two years. I will measure my success in achieving this goal by (1) the number of recipes created at the end of the year (20%), (2) responses from customers about their satisfaction with the new bread recipes (20%), (3) the amounts of each type of leftover grains included in the new bread recipes (60%). (Just an illustrative example)

Put It All Together
Once you complete your development plan, step back and examine your goal titles. If they fit nicely together, congratulations, you have created a coherent plan!

Example:

Long term goal:

• In five years, I see myself working at a bakery as the lead bread baker and being the best baker in town.

Development Goals for this year:

• Time Management: Develop my multitasking skills
• Knowledge Management: Learn how to use foreign condiments & spices

Delivery Goals for this year:

• Delivery: Create ten new recipes of multigrain bread
• Delivery: Reduce the number of complains from customers related to product quality
• Delivery: Bring three innovation ideas to the bakery owner

Validate Your Goals
When you reach this stage, you are ready to meet with your manager, identify any gaps in your plan, and align your goals with the company goals. Most likely, some of your goals will change, but once you validate your goals with your manager, you will know that they are relevant and will make a difference to both you and the company.

Throughout the year, always remember to check your plan (at least once every quarter) to make sure things are still in sync. Keep your plan updated and you will be pleasantly surprised with the effect on your career.

Finally, let me know your thoughts about how you deal with development plans for your team. As always, comments are welcome.