Question

7. FX Exposure Management at BMW

BMW Group, owner of the BMW, Mini and Rolls-Royce brands, has been based in Munich since its founding in 1916. But by 2011, only

17 per cent of the cars it sold were bought in Germany. In recent years, China has become

BMW’s fastest-growing market, accounting for 14 per cent of BMW’s global sales volume in

2011. India, Russia and eastern Europe have also become key markets.

The rapid globalization of its operations posed several new financial challenges. Despite rising sales revenues, BMW was conscious that its profits were often severely eroded by changes in exchange rates.   The company’s own calculations in its annual reports suggest that the negative effect of exchange rates totalled C2.4bn between 2005 and 2009. BMW did not want to pass on its exchange rate costs to consumers through price increases. Its rival Porsche had done so at the end of the 1980s in the US and sales had plunged.

To address the issues, BMW took a two-pronged approach to managing its foreign exchange exposure.   One strategy was to use a “natural hedge” – meaning it would develop ways to spend money in the same currency as where sales were taking place, meaning revenues would also be in the local currency. However, not all exposure could be offset in this way, so BMW decided it would also use formal financial hedges.   To achieve this, BMW set up regional treasury centres in the US, the UK and Singapore.

BMW implemented its new FX risk management strategy in several ways.   Regarding the natural hedge strategy it again followed a two-pronged implementation strategy.   The first involved establishing factories in the markets where it sold its products. The second involved making more purchases denominated in the currencies of its main markets. BMW now has production facilities for cars and components in 13 countries. In 2000, its overseas production volume accounted for 20 per cent of the total. By 2011, it had risen to 44 per cent. In the 1990s, BMW had become one of the first premium carmakers from overseas to set up a plant in the US – in Spartanburg, South Carolina. In 2008, BMW announced it was investing $750m to expand its Spartanburg plant. This would create 5,000 jobs in the US while cutting 8,100 jobs in Germany. This also had the effect of shortening the supply chain between Germany and the US market. The company boosted its purchasing in US dollars generally, especially in the North American Free Trade Agreement region. Its office in Mexico City made $615m of purchases of Mexican auto parts in 2009, expected to rise significantly in following years.

Since BMW’s fastest growing markets are in Asia it also had to rethink its Asian strategy in light of risk management needs. A joint venture with Brilliance China Automotive was set up in Shenyang, China, where half the BMW cars for sale in the country are now manufactured. The carmaker also set up a local office to help its group purchasing department to select competitive suppliers in China. By the end of 2009, Rmb 6bn worth of purchases were from local suppliers. Again, this had the effect of shortening supply chains and improving customer service. At the end of 2010, BMW announced it would invest 1.8bn rupees in its production plant in Chennai, India, and increase production capacity in India from 6,000 to 10,000 units. It also announced plans to increase production in Kaliningrad, Russia.

Meanwhile, the overseas regional treasury centres were instructed to review the exchange rate exposure in their regions on a weekly basis and report it to a group treasurer, part of the group finance operation, in Munich. The group treasurer team then consolidates risk figures globally and recommends actions to mitigate foreign exchange risk.

Using operating strategy to address FX risk brought other benefits. By moving production to foreign markets the company not only reduces its foreign exchange exposure but also benefits from being close to its customers. In addition, sourcing parts overseas, and therefore closer to its foreign markets, also helps to diversify supply chain risks.

(a) What is the nature of BMW’s FX exposure?   What fundamental financial principle should BMW use to neutralize the impact of FX rate movements on their results?

(b) How did BMW decide to tackle the problem? Do you see any problems with BMW’s approach and implementation?

(c) What differences if any exist in BMW’s approach to FX exposure management in North

America and Asia?

(d) Why did BMW decide to consolidate FX risk management globally in its Munich group treasury?   What principle are they implementing and what are its advantages for the group?

(e) BMW’s and Western Mining’s pursued to very different strategies to address FX expo- sure. What are their respective FX risk management strategies? Why did each company choose their respective strategy?

Answer 1

a).

I PART

BMW’s FX exposure is experiencing diverfication i.e. keeping the same product and introducing in other markets, by establishing factories in other countries they are witnessing huge fund outflow but the potential returs would far exceed the cost.

II PART

Plan for the Unexpected - Save enough money and stock up on insurance to be able to weather extended unemployment, accidents, catastrophic medical care, large car or house repairs and natural disasters." Increasing the amount of money you save when times are good can help you manage the cost impact of hedging against bumps in the road, making sure unexpected financial exposure does not derail your long-term goals and your family's financial security.

b). BMW decided to develop factories for the production of cars to the native place of buyers which is surely tour out to be a good move as justified by the returns and the social responsibility it fulfiled.

There was no hicups in the planning and implementation of the same, but they should also kept in the contingencies involved and had an alternative for the same.

c). In North America, they purchased the motor parts whereas in case of Asia they set up factories reson being supply is more satisfyed by the demand of the customers in Asia.

d). Diversification is the process of allocating capital in a way that reduces the exposure to any one particular asset or risk. A common path towards diversification is to reduce risk or volatility by investing in a variety of assets. If asset prices do not change in perfect synchrony, a diversified portfolio will have less variance than the weighted average variance of its constituent assets, and often less volatility than the least volatile of its constituents.

Advantages :-

• As the economy changes, the spending patterns of the people change. Diversification into a number of industries or product line can help create a balance for the entity during these ups and downs.
• There will always be unpleasant surprises within a single investment. Being diversified can help in balancing such surprises.
• Diversification helps to maximize the use of potentially underutilized resources.
• Certain industries may fall down for a specific time frame owing to economic factors. Diversification provides movement away from activities which may be declining.