Forex Operational Risk Management through Production Management

There are four production related strategies available to deal with foreign exchange operational risk. These are input-mix, plant location, relocation of production and cost cutting.

  1. Input-mix: Global sourcing is a great strategy to deal with operating risk. In a survey of 152 manufacturing companies world over, the Machinery and Allied Products Institute, a research firm, found that 77% of them had increased their global sourcing since the rise of the dollar, which rises dollar cost. This is as it should be. The principal effect of a real exchange rate change is to change the price of domestically produced goods relative to foreign goods. A well-managed firm should be searching constantly for ways to substitute between domestic and imported inputs, depending on the relative prices involved and the degree of substitution possible.
  2. Plant Location: A firm without foreign facilities exporting to a competitive market, whose currency has devalued against currency of the exporting firm’s country will find its profit to decline. It can go for outsourcing from the export market itself but it may find that sourcing components abroad is insufficient to maintain unit profitability. To strengthen itself the firm may have to locate new plants abroad. Third-country plant locations are also a viable alternative in many cases, depending especially on the labor intensity of production or the projections for further monetary realignments.
  3. Relocation of production: Multinational firms with worldwide production systems can allocate production among their several plants in line with the changing costs of production. The management of a multinational corporation should consider the option of increasing production in a. nation where currency has devalued, and decreasing production in a country where there has been a revaluation. Of course, the theoretical ability to shift production is more limited in reality. The limitations depend on many factors, not the least of which is the power of the local labor unions involved. A strategy of production shifting presupposes that the firm has already created a portfolio of plants worldwide.
  4. Cost Cutting: Cost supremacy is the greatest of all competitive edges. Many companies world over assaulted by foreign competition have made earnest efforts to improve their productivity-by closing inefficient plants, automating heavily, and negotiating wage and benefit cutbacks and so on. Many have also started programs to heighten productivity and improve product quality through employee motivation.

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