General Motors Competitive Exposure
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General Motors is a large multinational enterprise with operations in more than 200 different countries. It is an American multinational automotive corporation headquartered in Detroit, Michigan and the world’s largest automaker (2001). It employs 365,000 people in every major region of the world. It produces cars and trucks in 30 countries, and sells and services these vehicles through the following divisions/brands: Buick, Cadillac, Chevrolet, GMC, Opel, Vauxhall, and Holden, as well as two joint ventures in China. Types of Risks Faced by GM
The exchange rate risk associated with the time delay between entering into a contract and settling it. The greater the time differential between the entrance and settlement of the contract, the greater the transaction risk, because there is more time for the two exchange rates to fluctuate Transaction risk creates difficulties for GM as it was dealing in different currencies; due to exchange rates fluctuate significantly over a short period of time. This volatility is usually reduced, or hedged, by entering into currency swaps and other similar securities. Translation Risk
This is the exchange rate risk associated with companies that deal in foreign currencies or list foreign assets on their balance sheets. The greater the proportion of asset, liability and equity classes denominated in a foreign currency, the greater the translation risk.
Why do Companies Hedge?
To reduce transaction costs.
Since individual investors can hedge on their own, why should a firm do so? A firm can likely hedge more efficiently than an individual investor To provide for future investment needs
To manage earnings
To make evaluating a company’s operations easier
To make the comparison of the foreign subsidiary operations easier
2. COMPETITIVE CURRENCY EXPOSURE AT GM (2001: Using Case Info) During 2001, General Motors was world’s leader in automaker industry. At 8.5 million vehicles, GM enjoyed a market share of 15% and annual sales of 5184.6 billion over which it made earnings of 54.4 billion. Besides its automotive LOB, which was responsible for manufacturing and selling SUVs, sedans etc, the company had automobile financing and division, which had annual sales of $ 24 billion in 2001 and earnings of $ 1.6 billion1. The company sold its cars in 200 countries and had its manufacturing operations in 30 countries. Due to its international operations (it covers more than 25% of its sales from outside US); it had organized its main automotive division into 4 geographic divisions:
a) GM North America
b) GM Europe
c) GM Asia Pacific
d) GM Latin America/Africa/Middle East
GM Segment Breakdown of Sales to end customers 2000:-
GM Geographic Breakdown of Net Property 2000:-
Based on sizeable foreign operation, the company encountered significant amount of currency risk. It estimated that liability due to instrument with foreign currency exposure was $13 billion 2000. GM garnered a variety of financial derivative products such as forward contracts, swaps and options to hedge against foreign currency related to losses. For transactions denominated in foreign currencies, GM hedges forecasted and firm commitments up to 1 year. For commodities, it hedges exposure up to 6 years. It suffered losses of $100 million and $162 million in transaction and translation losses in 2000 and 1999 respectively. Their portfolio of vehicles included popular sedans such as Opel, Saab, Bulck, Chevrolet, Cadillac etc. whereas in United States, its major market, GM encountered competition from Ford, Chrysler & BMW and other a host of Japanese automakers such as Toyota, Nisan, Honda, Mazda and Mitsubishi.
Based on increased competition, GM’s market share was slowly diminishing as the following graph depicts new registration for GM as % of total registration was gradually falling. 2.2 Automobile Market in USA
USA automobile market was a well-developed mature market during 2001, which had around 24 companies who were competing in the US market with major products dealing in cars, trucks and buses. GM, ford, Chrysler and PACCAR were the major American companies in the automobile industry. GM operated on a global scale and had manufacturing units outside competition from outside players. Its market share declined to 63% in 2001 from 72.4% in 1994. It was the time when the Japanese, Korean and German companies were fetching the lost market share of these American firms. As we can observe in below figure, the market share of Japanese companies rose from 22.84% to 26.29% during the same period (1994-2001).
Even the German car makers share rose from 2.15% to 5.62% the major Japanese players were Honda, Nissan and Toyota each having a market share of 6.91%, 4.03% and 9.97% in 2001. Its competition from foreign firm was also unpredictable because of the exchange rate fluctuation dynamics and offering competitive advantage to some. The incentives given to customer per vehicle were on average around 1593. GM was already giving an incentive higher than this whereas Toyota and Honda and giving around one-third of what GM was giving. This depicts that the GM was running its business on very narrow margins. The dilemma of yen depreciating was normally a critical problem of US automakers. They also had to be wary of German and Korean car manufactures.
2. 3 Competitive Exposure Mechanism
2.4 Yen Exposure Quantified
General motors yen exposure can be categorize into some categories:- 1. Affiliate investment exposure: GM had significant investments companies: Fuji, Isuzu and Suzuki. Due to this it was exposed to yen exposure. Any depreciation in yen would therefore affect GM’s value of investments. 2. Borrowings in yens- GM had recently completed a yen bond issue. It therefore had approximately $500 million worth of bonds outstanding and any depreciation in yen would benefit GM as it would have to pay less in dollar terms. 3. Commercial exposure: This is the exposure that arises because of sell and purchase happening in foreign currency. Based on receivables and payables forecasted, GM was estimated to have 900 million USD in yen exposure. 4. Competitive exposure- This exposure arises due to competitive advantage that GM’s competitors get due to yen depreciation. Also called economic exposure, this arises when Japanese automakers achieve cost savings and are able to pass on to consumers which results in GM losing sell.
3. APPROACHES TO MANAGE GM’s COMPETITIVE EXPOSURE
As observed and analyzed earlier, besides having its operations primarily based in US, GM faces a significant competitive exposure in yen terms. Specifically if yen depreciates its Japanese competitors have a significant cost advantage with a yen based cost structure as against the GM who will be comparatively disadvantaged with a dollar denominated cost structures squeezing its margins. There are several tactical and strategic initiatives that GM can take to overcome the risk arose from its competitive exposure to yen. Which are as following:-
CHARGING ITS COST STRUCTURE:
Major risk of yen depreciation is the relative cost advantage, which provides to Japanese competitors. GM can exploit the same advantage by sourcing its inputs from Japanese suppliers (yen based payables) rather than domestic suppliers (USD payable). Such a move would be relatively easier to implement than making production facilities in japan. Whereas such a tactical move is fraught with risks as automobile industry is based on long term relationships and building a supplier network may not be an easy task. Also, GM might have a contract with its suppliers for long period. To add to it most of the suppliers in japan would have been a part of some keiretsu (group) GM’s competitors who would not be willing to supply to GM. What happens during the currency movement happens in opposite direction?
Other option with GM is to borrow in yen so as it provides a natural hedge against a depreciating yen. Note that since GM will have yen liabilities, are depreciating yen would GM on one hand and give are relative cost advantage to its Japanese competitors, yen properly enjoying benefits of cheap yen. Also, GM will need to improve its R and D and delivery to cater to “premium” tastes. However, the issue remains that Japanese automaker can enter the premium segments as well, there are existing premium players such as BMW, Mercedes and Audi and the company of the size of GM can’t survive by being a niche player.
Another strategic move could be to index the prices based on yen movement so with depreciating yen, the prices of GM automobiles will also be lowered to be competitive with their Japanese counter parts whereas such move is not recommended as it will cause a loss to GM’s margins and is not sustainable in wake of a steady and long term decline in yen value.
ENTERING IN SWAP PAYMENTS:
An agreement can be set with a party having opposite exposure to a currency, for example yen, for payoffs in case of currency fluctuation. For this to be successful GM needs to know about quantitative impact of units change in yen dollar index. Balancing this two affects can virtually nullify each other. Which is an option, which is more flexible In terms of implementation and roll back? Apart from this, interest rate in japan had been very low in japan in early 2000’s in comparison to USA. This resulted in keeping the cost of financing to a low figure. However, taking yen financing without “direct” exposure may not go down well with investors.
IMPROVING OPERATIONAL EFFICIENCY:
Another question which GM needs to ask itself is whether it is operating close to its maximum possible efficiency. If the cost of production can be reined into an extent such that it can pass on the saving to customers/ or increase its margins then the risk of depreciating yen can be control to an extent. However, this would involve making hard decisions and decision to shut down a plant or to may end up being more costly with severances and other cost.
INCREASING INVESTMENTS IN JAPANESE AUTOMAKERS:
GM already has investments in Japanese affiliates (Fuji, Isuzu and Suzuki) that mitigate its yen competitive exposure has demonstrated earlier. (See point 3 in the table 1 below). 1 way of reducing its yen exposure is to increase investments in Japanese affiliates. This is a relatively easy option for GM requiring little change in its existing operations strategy and still providing a hedge against yen depreciation. Here, important point is that the affiliate have more yen denominated liabilities than assets hence, in a way GM benefited when yen index rose(yen depreciated), thus mitigating competitive exposure to an extent. TABLE # GM Yen Exposure from Affiliates in $ billions
Affiliate Exposure($ billions)
Whereas there may not be enough suitable investing targets as GM needs to acquire stakes of right targets at appropriate price. Finding such combination in M&A space is difficult most of the times and GM may end up paying too much up front and end up with a bad investment decision in quest of currency hedging.
MOVING UP IN VALUE CHAIN/PREMIUM PRODUCTS:
Although in theory looks like a good strategy, but retreating from certain parts of market and giving up on market segments will further subsidize Japanese Auto makers who already are enjoying benefits of cheap Yen. Also, GM will need to improve its R&D and delivery to cater to “premium” tastes. However, the issue remains that Japanese Automakers can enter the premium segments as well, there are existing premium players such as BMW, Mercedes and Audi and the company of the size of GM can’t survive by being a niche player.
IMPROVING OPERATIONAL EFFICIENCY:
Another question which GM needs to ask itself is whether it is operating close to its maximum possible efficiency. If the cost of production can be reined in to an extent such that it can pass on the savings to customers or increase its margins then the risk of depreciating yen can be controlled to an extent. However, this would involve making hard decisions and decision to shut down a plant or two may end up being more costly with severances and other costs.
ENTERING IN SWAP PAYMENTS:
An agreement can be made with a party having opposite exposure to a currency, say yen, for payoffs in case of currency fluctuation. For this to be successful GM needs to know about quantitative impact of unit change in Yen dollar index.
4. GM’s COMPETITIVE YEN EXPOSURE (993-2005)
GM filed for bankruptcy in 2009 so we would use two sets of analysis one for the old entity which field for bankruptcy in 2009 and one for the new entry. For analysis of the “old” entity we had to rely SEC for the financial data points of GM Company (the old records are present with entity name “Motor Liquidation Company” at the Sec website). The records were available as far back as the first quarter of 2005. The quants for 2006, 2007 and 2008 were not considered for analysis as during those period GM was on verge of collapse and the changes in GM’s numbers were mostly driven by its own uncertainty.
CONCEPTS OF LAGS:
When yen depreciates, the effect of this can be seen only after certain period on US Markets as the company will take time to decide on passing the benefits to customers whereas some inventory with dealers will be there which has been procured at “higher rate”. Therefore, the influence is said to lag the change in Yen Dollar rate.
LAG 1 depicts the depreciation of yen in Q1 will have impact by Q2 whereas Lag 2 means depreciation of Yen in Q1 will have impact by Q3.
4.1 GM’S US Car Sales Exposure
To analyze the impact of the yen dollar exchange rate on GM US Sales, we gathered the data for GM US quarterly sales, quarterly to dollar exchange rate, quarterly US GDP < quarterly US SAAR and Quarterly Dollar index over the period of 1993 to 2005.
GM US Sales are not only influenced by the yen dollar exchange rate but many other factors such as Trade Weighted Dollar index, US SAAR auto sales impact the number of units sold, therefore regression for all the variables is done and it is found that US GDP is a significant variable and other variables have insignificant p-values including the yen dollar exchange rate. We further hypothesized that yen dollar exchange rate with lag might have impact on the GM US Sales. We have regressed that GM US Sales with US GDP has significant explanatory power but the coefficient of the US GDP is negative which is counter intuitive and not possible. Appropriate regression with yen dollar with Lag1 shows that it significantly impacts the GM US Sales. Further it is tested with lag 2 and lag 3 of yen dollar exchange rate, but the regression equation has the most explanatory power at lag 2. Final Regression statistics are as shown below:
Regression equation means that with one unit increase (depreciation of Yen) in Yen Dollar exchange rate will decrease the quantity of GM US sales by 3,500 units, which is around 0.5% of GM US sales level. 4.2 GM’S Market
To analyze the impact of the yen dollar exchange rate on GM US Sales, data for GM US quarterly sales have been gathered, quarterly to dollar exchange rate, quarterly US GDP < quarterly US SAAR and Quarterly Dollar index over the period of 1993 to 2005.
The GM market in US is affected most by the Yen Dollar exchange rate with Lag 2, whereas other variables are not very significantly impacting the GM US market share including the US GDP. The regression coefficient for Yen Dollar exchange rate is -.00085, which means that one unit increase (depreciation of Yen) in Yen Dollar exchange rate will decrease the Market share of GM US by 0.085%.
4.3 GM’S Net Income Exposure
To analyze the impact of the yen dollar exchange rate on GM US Sales, data for GM net income from automotive segments collected, daily yen to dollar exchange rate, quarterly US GDP quarterly US SAAR and Quarterly Dollar index over the period of 1993 to 2005.
The GM net margin from auto segment is affected most by the Yen Dollar exchange rate with Lag 2, while the other variables are very insignificant explaining the GM automotive net income. Its regression coefficient for Yen Dollar exchange rate is -27.5; it means that one unit increase (depreciation of yen) in Yen Dollar exchange rate will decrease the net income from Automotive Segment of GM by $27.5 Mn. It seems like a very large number but it is a cumulative effect of drop in market share, volume sales and increasing cost structure. GM had a very volatile net income during the same period ranging from high losses of more than $2.5 billion to profit of $ 1.5 billion.
4.4 Implication of result on hedging strategy
Above performed analysis clearly indicates that for every unit rise in yen dollar index GM loses US$ 27.1 million per quarter (in the quarter next quarter to next quarter: lagged 2). Apart from trying to hedge this with conventional methods such as investments, Yen financing changing cost structure etc. as discussed in earlier, the company can also try a swap agreement with a party facing counter risk on Yen dollar rate. The counter party may be another exporter from japan who loses when yen dollar index goes down (Yen becomes costly) for example canon. The swap can be set such that for every unit rise in yen Dollar index GM receives US$ 27.1 million per quarter from canon and vice versa.
The issue with type of agreement is that in case one sided movement is expected (meant long term depreciation of Yen) GM may not find a counter party as the Japanese exporter will not see good value in the deal. However in the period 1993-2005 the yen Dollar exchange rate was range bound, so this type of strategy might have worked. This ignores the other exposures which GM may have and which can net out this competitive exposure. Already the R Square for all analysis is quite low %age of times change in value of Yen explains change in GM’s number implying further research might be required before implementing the results. 5. NEW GM’s COMPETITIVE EXPOSURE
Its present scenario is completely distinct. Recently the Japanese Yen has settled around a relatively high mark of 80 Yen/USD. This high benchmark has increased the cost fro the Japanese manufacturers who now are making choices to move their factories overseas particularly to places like China and even USA to hedge the currency exposure. Also, South Korean manufacturers have made significant dent in the US Auto markets. The figure below shows the increasing presence of South Korean automakers in USA.
Even till early 2000’s, GM’s 70% of the Auto units were sold in North American region. Now, nearly 60% of Auto Sales is contributed by countries outside North America. This is displayed in the chart provided in the next page.
5.1 Issue in measuring quantifying exposure using regression The “new” GM has been in existence for only 14 quarters and even in the same period has made profit only in 10 quarters. To identity impact of the currency movements on General Motors, we have included Korean Won also in the mix as the US market share of Hyundai and Kia has increased. As was done in the previous case, we have tried various combinations of dependent variables (Total World Wide Vehicles Sold, Total Sales and Net income) with respect to a combination of independent variables (Yen Dollar index, Won Dollar index and Euro Dollar index with and without lags, GDP Growth rate and US SAAR Auto Sales). While regressing we realized that there is no benefit of using a net income kind of variables due to lack of data. Hence, we have used number of cars sold (worldwide) and Net Sales to identify the dollar impact. Through these we will try to go to a Net income model will be discussed later on in the section. 5.2 GM’s Unit Sales Exposure (Worldwide)
As discussed earlier, currently GM is having greater global exposure in terms of sales. Hence, we have used GM’s total worldwide unit sale as a dependent variable, while trying out various combination we found out that Japanese yen and Korean Won both have significant impact(good t-stat, more than 2 for both, R-Square close to 11) on number of units sold by GM Worldwide. Here, one unit increase in yen Dollar rate (Yen depreciation) reduces the number of GM units sold worldwide by roughly 18,920 units per quarter. Also, one unit increase in Won Dollar rate by one unit reduces number of GM units sold worldwide by 1,700 Units.
Here, the key thing to note that both impact are lag1 impact i.e. impact of currency fluctuation in one quarter will be seen in numbers of next quarter. This impact of Korean won might seem smaller than Japanese Yen, yet we must remember that Korean Won index is more than 1000 in values while Yen index is less than 8. Hence, we must compare 1 unit change of Yen index with 10 unit change of Won index. So, for GM 10 rise in index causes a fall of 17,000 units in worldwide sales per quarter.
Over the last few years Korean Won has depreciated against dollar, thus opening a new front of worry for GM in terms of Competitive currency exposure. The relative fluctuation dynamics of Won and Yen index is seen clearly in the chart provided.
5.3 GM’s Auto Revenue Exposure (Worldwide)
By trying out various combination independent variables on total worldwide sales in US$ million, we observed again that Japanese Yen and Korean Won both have significant impact(good t-stats, more than/close to 2 for both, R-Square close to 80). Therefore one unit increase in Yen Dollar rate (yen depreciation) reduces GM’s worldwide Auto Revenue by US$ 237 million per quarter whereas one unit increase in Won Dollar rate by one unit reduces GM’s worldwide revenue by US$ 37 million. Therefore the key thing to note that both impact are lag1 impact i.e. impact of currency fluctuation in one quarter will be seen in numbers of next quarter. The impact of Korean won might seem smaller than Japanese yen, that’s why we must remember that Korean won index is more than 1000 in value while yen index is less than 80, for GM 10 rise in won index causes a fall of US$ 370 million per quarter. The won figure is mostly more significant because of earlier observed reasons.
5.4 Moving to a net income like exposure
For hedging, we need to estimate impact on a net income like figure. For that we will assume that every extra unit of revenue is making a marginal contribution to the net income. For that we regressed last 14 quarters of revenues against net income and found out following regression output. That one unit extra sales contribute to 0.321 units to net income (significant t-stats, R square and P values).
Sales Impact in Million USD
Net Income Impact in Million USD
Yen Lag 1
Won Lag 1
Therefore we can say 1 unit rise in Yen index will cause reduction in GM’s Net income by US $ 76.1 Million and one unit rise in won will cause reduction in GM’s net income by US$ 11.9 Million per quarter. As we have discussed earlier the won exposure when compared with yen exposure needs to be multiplied by 10 and is probably the major concern for GM right now.
5.5 Hedging the resulting exposure
Here the recent trend has been that yen index has been falling (yen has strengthened over US Dollars) in recent past and the trend is likely to continue. Also, Korean won has been the currency which can provide more problems with its decline against dollar so one can see that GM can probably take steps to hedge against movement of Korean won. This can be achieved by swap agreement with a party facing counter risk on won dollar rate. The counter party may be another exporter from Korea who loses when won dollar index goes down (won becomes costly) – for example Samsung. The Swap can be set such that for every unit rise in won dollar index GM receives US $ 11.9 Million per quarter from Samsun and vice versa.
The issue with this type of agreement is that in case one sided movement is expected (say long term depreciation of won) GM may not find a counter party as the Korean exporter won’t see value the deal. It also ignores the other exposures (including correlation impacts) which GM may have and which can net out this competitive exposure. GM can also look into basket of conventional methods such as investments, won financing, changing cost structure etc. as discussed in section 3. Won financing may not be as appealing as yen financing because South Korean interest rates are higher than US interest rates.
Traditionally competitive exposures are difficult to measure and hedge whereas these can evolve and change with time. Japanese manufactures who kept on terrorizing GM with cheap Yen advantage now have been forced to take measures including shifting production base to USA to safe guard against rising Yen. On other side, GM is now much more diversified in terms of geography as well as currency exposure whereas the current GM is less diversified wrt number of businesses. Its equity investment profile has also changed. Its fluctuation in the currency rates have also a faster impact taking only one quarter to manifest compared to previous two quarters.
Managing Competitive exposure can’t be a standalone process, but all kinds of exposures need to be netted. In case of company such as GM, to overcome competitive exposure is not merely a financial decision but a strategic one therefore entire production, marketing and R&D strategy needs to be optimized besides using appropriate hedging instruments.
7. SOURCES USED for INFORMATION
“Exchange rate exposure and competition: evidence from the automotive industry” – Rohan Williamson, McDonough School of Business, Georgetown University, Washington, DC 20057, USA