Harvard Case - Padhy Leather: Minimizing Commercial Risk Through a Letter of Credit
"Padhy Leather: Minimizing Commercial Risk Through a Letter of Credit" Harvard business case study is written by D.N. Panigrahi. It deals with the challenges in the field of Entrepreneurship. The case study is 11 page(s) long and it was first published on : Jun 8, 2018
At Fern Fort University, we recommend that Padhy Leather utilize a Letter of Credit (LC) as a primary risk mitigation tool for its international business transactions. This strategy will enhance financial security, build trust with international buyers, and facilitate business expansion into new markets.
2. Background
Padhy Leather, a family-owned business based in India, has achieved significant success in the domestic market through its high-quality leather products. The company is now seeking to expand its reach into international markets, particularly in Europe and the United States. However, the founder, Mr. Padhy, is concerned about the inherent risks associated with international trade, including potential payment defaults and currency fluctuations.
The case study focuses on Mr. Padhy?s decision-making process as he explores different options to mitigate these risks. He is particularly interested in understanding the benefits and drawbacks of using a Letter of Credit (LC).
3. Analysis of the Case Study
This case study highlights the critical need for risk management in international business, particularly for emerging market companies like Padhy Leather. The analysis can be framed using the following frameworks:
- Financial Risk Management: The case study underscores the importance of managing financial risks associated with international trade. Padhy Leather faces risks such as:
- Payment Default: International buyers might default on payments, leaving Padhy Leather with significant financial losses.
- Currency Fluctuations: Fluctuations in exchange rates can impact the profitability of international transactions.
- International Business Strategy: Padhy Leather?s decision to expand internationally requires a well-defined strategy. The use of a Letter of Credit aligns with the company?s goal of:
- Market Expansion: Accessing new markets in Europe and the United States.
- Business Growth: Increasing sales and revenue through international trade.
- Supply Chain Management: The case study implicitly emphasizes the importance of a robust supply chain for international trade. Padhy Leather needs to ensure:
- Reliable Production: Meeting international demand with consistent quality.
- Efficient Logistics: Managing the transportation and delivery of goods to international buyers.
4. Recommendations
- Implement a Letter of Credit (LC) System: Padhy Leather should implement a Letter of Credit system for all international transactions. This will provide a secure payment mechanism, reducing the risk of payment defaults.
- Negotiate LC Terms: Mr. Padhy should carefully negotiate the terms of the LC with international buyers to ensure they are favorable to Padhy Leather. This includes:
- Payment Schedule: Establish a clear payment schedule that aligns with Padhy Leather?s production and delivery timelines.
- Documentation Requirements: Define the specific documentation needed for payment release to avoid delays and disputes.
- Currency Exchange: Determine the preferred currency for payment and incorporate appropriate exchange rate mechanisms.
- Partner with a Bank: Padhy Leather should partner with a reputable bank with expertise in international trade finance. The bank will provide guidance on LC procedures, assist with documentation, and facilitate payment processing.
- Invest in Technology: Padhy Leather should invest in technology solutions to streamline its international trade operations. This includes:
- Trade Finance Platforms: Utilizing platforms that automate LC processes and provide real-time tracking of transactions.
- Data Analytics: Leveraging data analytics to monitor market trends, identify potential risks, and optimize pricing strategies.
5. Basis of Recommendations
These recommendations are based on the following considerations:
- Core Competencies: Utilizing an LC system aligns with Padhy Leather?s core competency in producing high-quality leather products. It allows the company to focus on its strengths while minimizing financial risks.
- External Customers: The LC system provides assurance to international buyers, enhancing trust and confidence in Padhy Leather.
- Competitors: Implementing a robust risk management strategy, including the use of LCs, positions Padhy Leather competitively in the international market.
- Attractiveness: The LC system offers a high return on investment by reducing financial risks and facilitating business expansion.
6. Conclusion
By implementing a Letter of Credit system, Padhy Leather can effectively mitigate the risks associated with international trade, fostering growth and expansion into new markets. This strategic approach will enhance the company?s financial security, build trust with international buyers, and position Padhy Leather for long-term success in the global marketplace.
7. Discussion
- Alternative Options: While the LC system is the most recommended approach, other alternatives include:
- Insurance: Trade credit insurance can provide protection against payment defaults.
- Factoring: Selling invoices to a factoring company can provide immediate cash flow.
- Cash in Advance: Requesting payment upfront can minimize risk but may hinder sales.
- Risks and Key Assumptions:
- Bank Fees: LCs involve bank fees, which need to be factored into the cost of doing business.
- Documentation Requirements: The LC process requires meticulous documentation, which can be time-consuming.
- Currency Fluctuations: While LCs mitigate payment risk, they do not eliminate currency fluctuations.
8. Next Steps
- Short-Term: Within the next three months, Padhy Leather should:
- Partner with a Bank: Identify and select a reputable bank with expertise in international trade finance.
- Negotiate LC Terms: Develop standard LC terms for international transactions.
- Implement Technology: Explore and implement trade finance platforms and data analytics tools.
- Medium-Term: Within the next six months, Padhy Leather should:
- Pilot LC System: Initiate pilot transactions using LCs with select international buyers.
- Monitor Performance: Track the effectiveness of the LC system and make adjustments as needed.
- Long-Term: Within the next year, Padhy Leather should:
- Expand International Operations: Utilize the LC system to expand into new markets and increase international sales.
- Develop a Global Strategy: Develop a comprehensive international business strategy that incorporates risk management and growth initiatives.
By taking these steps, Padhy Leather can effectively leverage the power of the Letter of Credit to minimize commercial risk, build a strong international presence, and achieve sustainable growth in the global leather goods market.
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Case Description
In March 2018, the new business development manager of the international trade department of M/S Padhy Leather Ltd. was trying to find a way to balance her key responsibilities. The manufacturing start-up, located in New Town, India, was in the business of exporting leather garments and was promoted by two young, first generation entrepreneurs. The company had started its export business with a few clients in the United States. The manager's key responsibilities were exploring new markets and clients. Her immediate target was the United States, after which she would expand the business into Canada. She was concerned with how to minimize the commercial risks (non-payment risks such as transport and country risk) from new and untested clients while developing business and improving profitability.
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