Harvard Case - Alliance Design Concepts: Foreign Exchange Risk
"Alliance Design Concepts: Foreign Exchange Risk" Harvard business case study is written by Ryan Orchard. It deals with the challenges in the field of General Management. The case study is 9 page(s) long and it was first published on : Oct 3, 2014
At Fern Fort University, we recommend that Alliance Design Concepts (ADC) implement a comprehensive strategy to mitigate foreign exchange risk, focusing on a combination of hedging techniques, operational adjustments, and strategic partnerships. This strategy should be tailored to the specific needs of each project and client, considering factors such as project duration, currency exposure, and risk tolerance.
2. Background
Alliance Design Concepts (ADC) is a successful architectural firm specializing in designing and constructing high-end residential and commercial buildings. ADC has expanded its operations internationally, particularly in emerging markets like China and India. While this expansion has brought significant growth opportunities, it has also exposed ADC to significant foreign exchange risk. The case study highlights the challenges faced by ADC due to fluctuations in the value of the Chinese Yuan (CNY) against the US Dollar (USD), impacting project profitability and client relationships.
The main protagonists of the case study are:
- David Miller: CEO of ADC, responsible for overall strategy and decision-making.
- Sarah Jones: CFO of ADC, responsible for financial management and risk mitigation.
- Peter Chen: Project Manager in China, responsible for managing projects and dealing with local currency fluctuations.
3. Analysis of the Case Study
To analyze the situation, we can utilize a framework incorporating Strategic, Financial, and Operational perspectives:
Strategic:
- Globalization Strategy: ADC's expansion into emerging markets is a strategic decision, but it exposes the company to various risks, including foreign exchange volatility.
- Competitive Advantage: ADC's expertise in high-end design and construction provides a competitive advantage, but it needs to be protected from currency fluctuations.
- Risk Assessment: ADC needs to conduct a thorough risk assessment to identify and prioritize foreign exchange risk, considering the specific projects and markets.
Financial:
- Foreign Exchange Exposure: ADC's exposure to CNY fluctuations is significant, impacting project profitability and cash flow.
- Hedging Strategies: ADC can utilize various hedging techniques like forward contracts, options, and currency swaps to mitigate risk.
- Financial Reporting: ADC needs to ensure accurate financial reporting and transparency regarding foreign exchange risk and its impact on financial performance.
Operational:
- Project Management: Project managers need to be equipped with the skills and knowledge to manage foreign exchange risk effectively.
- Client Communication: Transparent communication with clients regarding currency fluctuations and potential impact on project costs is crucial.
- Supply Chain Management: ADC should explore alternative sourcing strategies and suppliers to minimize currency exposure in the supply chain.
4. Recommendations
1. Implement a Comprehensive Foreign Exchange Risk Management Strategy:
- Develop a clear policy: Define ADC's risk appetite and tolerance for foreign exchange fluctuations, outlining specific guidelines for project managers and financial teams.
- Conduct regular risk assessments: Identify and prioritize projects with significant currency exposure, considering factors like project duration, contract terms, and client risk tolerance.
- Utilize hedging techniques: Employ a combination of hedging techniques, including forward contracts, options, and currency swaps, to mitigate risk. The specific techniques should be tailored to the individual project and market conditions.
- Monitor and adjust: Regularly review the effectiveness of hedging strategies and make adjustments as needed based on market fluctuations and project progress.
2. Enhance Project Management and Client Communication:
- Train project managers: Provide comprehensive training on foreign exchange risk management, including best practices for managing currency fluctuations and communicating with clients.
- Develop clear communication protocols: Establish transparent communication procedures with clients regarding currency fluctuations, potential impact on project costs, and risk mitigation strategies.
- Consider contractual clauses: Include clauses in contracts that address currency fluctuations, allowing for adjustments based on agreed-upon exchange rates or hedging mechanisms.
3. Explore Strategic Partnerships and Operational Adjustments:
- Partner with local firms: Collaborate with local architectural firms or construction companies in emerging markets to leverage their expertise and mitigate currency risk.
- Source materials locally: Explore sourcing materials locally to reduce reliance on imported goods and minimize currency exposure in the supply chain.
- Consider project pricing adjustments: Evaluate the possibility of incorporating currency fluctuation clauses into project pricing to account for potential changes in exchange rates.
5. Basis of Recommendations
These recommendations are based on the following considerations:
- Core competencies and consistency with mission: Managing foreign exchange risk aligns with ADC's mission of delivering high-quality projects while ensuring financial stability and client satisfaction.
- External customers and internal clients: Transparent communication and risk mitigation strategies build trust with both external clients and internal stakeholders.
- Competitors: Implementing a comprehensive risk management strategy allows ADC to maintain a competitive advantage by minimizing the impact of currency fluctuations on project profitability.
- Attractiveness ' quantitative measures: Hedging strategies can help stabilize project costs and improve profitability, while strategic partnerships can reduce currency exposure and enhance operational efficiency.
- Assumptions: These recommendations assume that ADC has access to financial resources for hedging and is willing to invest in training and communication efforts to manage foreign exchange risk effectively.
6. Conclusion
By implementing a comprehensive foreign exchange risk management strategy, ADC can effectively mitigate the impact of currency fluctuations, protect project profitability, and maintain strong client relationships. This strategy should be continuously monitored and adapted to changing market conditions and project requirements.
7. Discussion
Other alternatives not selected include:
- Avoiding international expansion: This option would limit growth opportunities but eliminate foreign exchange risk.
- Ignoring foreign exchange risk: This approach could lead to significant financial losses and damage client relationships.
Key risks and assumptions associated with the recommendations include:
- Effectiveness of hedging strategies: Hedging strategies are not foolproof and may not fully mitigate all currency risk.
- Market volatility: Unpredictable market fluctuations could impact the effectiveness of hedging strategies and require adjustments.
- Client acceptance: Clients may be reluctant to accept clauses in contracts addressing currency fluctuations.
8. Next Steps
Timeline:
- Month 1: Conduct a comprehensive foreign exchange risk assessment and develop a detailed risk management strategy.
- Month 2: Implement training programs for project managers on foreign exchange risk management and communication protocols.
- Month 3: Begin exploring strategic partnerships with local firms and evaluate alternative sourcing strategies.
- Month 4: Implement hedging strategies for high-risk projects and monitor their effectiveness.
- Month 5: Review and adjust the risk management strategy based on market conditions and project progress.
By taking these steps, ADC can effectively mitigate foreign exchange risk and continue to expand its operations internationally, ensuring long-term profitability and client satisfaction.
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Case Description
Alliance Design Concepts provided audio system solutions, which involved installing high-quality sound systems in customer facilities (such as large churches). A major cost component (60-80 per cent) for these systems was the equipment (speakers, amplifiers, etc.), which was sourced from the United States and paid for in U.S. dollars (USD). Alliance quoted prices to customers in Canadian dollars (CAD) by converting equipment costs from USD to CAD based on the exchange rate on the day of the quotation. Since it was often months later that Alliance actually converted cash and paid the supplier in USD, it found that a change in the exchange rate during that time could directly reduce the margin on the sale. The operations manager had to devise a risk mitigation strategy and/or business process change.
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