What Happens When the Host Country Environment Changes?
A Tale of Currency Devaluation

By Denise A. HarrisonYou Have Successfully Outsourced:

Yes, it sounds terrific, you successfully set up your operation in a country with significantly lower labor costs - and now the country's currency is devalued. What could be better? Your source of cheap labor is even cheaper - but wait, is it that easy? Can you just sit back and rake in the profits?

As president of a financial services firm I faced this situation. Our labor-intensive operations were processed by a number of Mexican maquilladora plants. The exchange rate in 1993 was approximately 3 pesos to the dollar. In December the bottom dropped out of the Mexican financial market and the peso devalued to 6 peso/$. Labor costs were cut in half. Time to kick back and relax? No way, time to assess how our competition would respond to the reduced operating cost - all of us were processing in Mexico. Time to re-evaluate our assumptions and update our strategy!

Competition: how will they respond to the devaluation?

Competitors had three choices:

  1. Keep prices the same and reap the benefits
  2. Lower prices and call on prospective customers to gain market share.
  3. Sit and wait and respond after the first company starts cutting prices

Our assumptions concerning competitors' future moves: we had recently become the number one player in the industry and our competitors were still smarting from the loss of market share. We assumed that they would respond aggressively by lowering prices to try and regain market share.

Customers - what would they do?

Customers had moved to us due to our superior service, processing speed and accuracy. While these benefits were important when prices were similar a significant drop in prices would be incentive for the customers to move their business. Switching costs were fairly low.

Technology

We had been investing in technology to automate the operation - so far the processing exceptions stymied out attempts to automate. With labor costs cut in half some of our investments in technology could be slowed, it was cheaper to process with labor than to automate the operation.

Economy

The peso devaluation caught global economists by surprise and the forecasts following the devaluation included the spectrum of options:

  1. Peso would stay were it was.
  2. Peso would return to previous level.
  3. Peso would continue to devalue.

Nothing like a little diversity of opinion to help with the decision making process. There was no clear cut answer so we decided flexibility would be an important consideration as we developed the strategy to meet this changing environment.

The assumptions we made:

  1. Competition would lower prices aggressively to regain market share.
  2. Customers would move business if price differential was significant.
  3. The peso would continue to fluctuate and we needed to maintain flexibility for as long as possible.

Strategic Options:

  1. Lower prices to meet competitive onslaught.
  2. Maintain current pricing and move when competitors called customers with there new pricing.
  3. Develop a rebate program where a portion of the processing savings (due to the currency fluctuation) is refunded back to the customers.

Evaluation of Strategic Options:

  1. Lower prices to meet competitive onslaught
    1. Benefit: Prevents market share loss
    2. Risk: If peso returns to previous level then it would require a price increase - easy to say, difficult to implement
    3. Risk: Lowers profitability (does not take advantage of a profitable circumstance)
  2. Maintain current pricing and move when competitors called customers with there new pricing.

    1. Benefit: Reap the profit before the competition presents lower pricing options
    2. Risk: Angers customers, they perceive that we have been gauging them.
    3. Risk: Loss of market share as customers move to competition due to lower prices or frustration that we did not lower prices quickly enough.
  3. Develop a rebate program where a portion of the labor savings is refunded rebated back to the customers.

    1. Benefit: Wins customer goodwill, they get rebate without asking. This rebate lowers the cost of this line item in the customer's budget and helps them look good at their company as they are under budget on this line item.
    2. Benefit: Give us flexibility with currency fluctuation rebate goes up and down - the more savings we have the more goes to the customers; if the peso goes in the other direction the rebate is smaller. This occurs without a change in prices.
    3. Benefit: Customer goodwill after receiving the rebate gives us the time and ability to respond to competitive pricing as the competition makes proposals to larger customers.
    4. Benefit: Buys time and flexibility, pricing agreements only change as fast as the competition can call on customers. While we may have to go to lower pricing, this will happen over time, not all at once. Giving us flexibility as we gain a better understanding of where the currency will stabilize.
  4. Strategic Choice

    We choose the rebate strategy because it offered us the most flexibility in a changing environment and offers benefits to customers without locking in on a lower price until forced to by competitive bidding.

    What actually happened?

    Competitors aggressively pursued a lower pricing strategy to gain market share. Our customers remained loyal to us due to our rebate policy; however, over time they did negotiate lower prices with us as the competition continued to offer them better deals. The rebate gave us a window of time where we could develop better information about where the peso was headed and reap the benefits of the percentage of the savings that was not rebated to the customer. Still this strategy generated a significant amount of goodwill from customers because:

    1. The rebate effectively lowered what they paid to us - and they didn't have to ask. Many gained recognition for bringing a significant line item in under budget.
    2. Many customers thought the rebate concept exemplified a company with the business savvy to develop a strategy for an uncertain currency environment.

    In the End

    The peso continued to devalue and has stayed close to 9-10 pesos/$. We did make money during our rebate program and did not lose market share during the pricing wars that our competition introduced.

    Lessons Learned

    1. Don't be greedy! If we had not offered the rebate we would have made a significant short term profit, but lost market share long term.
    2. When your business environment changes look at it strategically:
      1. Try to understand how it will impact all of the external forces
        1. Customers
        2. Competition
        3. Technology
        4. Suppliers
        5. Economy
        6. Regulatory
        7. It may not impact all of these areas, however it is good to take a look so that you will not be blind-sided.
    3. Develop options that allow for flexibility. Market changes may precipitate additional market changes. Try to keep from being locked in to the environment as it stands now.
    4. Think of ways to generate customer goodwill in a changing environment.
    5. Don't operate in a vacuum. Your competitors will respond - be prepared!

    Template for Evaluating Environmental Changes

    What is the change?

    How does it impact the external forces:

    Customers/Market Segments

    Competition

    Technology

    Suppliers

    Economy

    Regulations

    What are the possible courses of action?

    What are the benefits/risks of each of the above choices?

    What is the best course of action?

    How will you implement this strategy? What are the key objectives that support this strategy?

    Denise Harrison is a Consultant with Center for Simplified Strategic Planning, Inc. SHe can be reached via e-mail at

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