Udo Pfeiffer, the CEO of SMS Elotherm, a German manufacturer of machine tools that engineer crankshafts for cars, signed a deal in late November 2004, to supply the US operations of DaimlerChrysler with $1.5 million worth of machines. The equipment would be manufactured in Germany and exported to the United States. When the deal was signed, Pfeiffer calculated that at the agreed price, the machines would yield a profit of $30,000 each. Within three days that profit had declined by $8,000. The dollar had slid precipitously against the euro. SMS would be paid in dollars by DaimlerChrysler, but when translated back into euros, the price had declined. Since the company’s costs were in euros, the falling revenues when expressed in euros were squeezing profit margins.
With the exchange rate standing at £1 = $1.33 in early December 2004, Pfeiffer was deeply worried. He knew that if the dollar declined further to around £1 = $1.50, SMS would be losing money on its sales to America. He could try to raise the dollar price of his products to compensate for the fall in the value of the dollar, but he knew that such a strategy was unlikely to be successful. The market for machine tools was very competitive, and manufacturers were constantly pressuring machine tool companies to lower prices, not to raise them.
Another small German supplier to the US automobile company, Keiper, was faring somewhat better. In 2001 Keiper, which manufactures metal frames for automobile seats, opened a plant in London, Ontario, to supply the US operations of DaimlerChrysler. At the time the investment was made, the exchange rate was £1 = $1. Management at Keiper had agonised over whether the investment made sense. Some in the company felt that it was better to continue exporting from Germany. Others argued that Keiper would benefit from being close to a major customer. Now with the euro appreciating every day, it looked like a smart move. Keiper had a real hedge against the rising value of the euro. But the advantages of being based in Canada were tempered by two factors. First, the US dollar had also depreciated against the Canadian dollar, although not by as much as its depreciation against the euro. Second, Keiper was still importing parts from Germany, and the euro had also appreciated against the Canadian dollar, raising costs at Keiper’s Ontario works.
1.Why was Keiper weathering the rise of the euro better than SMS?
2.Could SMS Elotherm have taken steps to avoid the position it found itself in? What were those steps? Why do you think the company did not take these steps?
3.In retrospect, what might Keiper have done differently to improve the value of its ‘real’ hedge against a rise in the value of the euro?