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:
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.
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.
The peso devaluation caught global economists by surprise and the forecasts following the devaluation included the spectrum of options:
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:
Evaluation of Strategic Options:
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:
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.
Template for Evaluating Environmental Changes
What is the change?
How does it impact the external forces:
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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