MANAGING THE DOLLAR’S DECLINE
The melting greenback isn’t necessarily bad news, but finding the best way to adjust could be a CFO’s toughest decision this year.
By Kate O’Sullivan

This isn’t an easy time for companies like Infosys Technologies. For every percentage that the dollar slips against the rupee, the Bangalore-based outsourcing firm sees its profit margins shrink by 50 basis points. And the dollar has fallen a long way over the past few years. Two years ago, one dollar bought 44 rupees. Today that same dollar buys 39.

The size of the earnings hit Infosys endures is big but not all that surprising, considering how dependent the business process outsourcing industry is on dollar-denominated business. “About 98 percent of our revenues come from overseas and about 63 percent comes from North America,” says CFO V. Balakrishnan. Unlike his peers in industries such as manufacturing, however, Balakrishnan doesn’t have significant U.S. dollar costs to balance against the hit to revenues—as a service business, Infosys imports little. “Indian companies like ours are very exposed,” he says.

Some 2,400 miles away, in Indonesia, Ratnesh Bedi, the CFO of April, a pulp and paper supplier, has a very different reaction to the dollar’s decline. “Our competitors are greatly hurt by the dollar,” he says. April, on the other hand, has managed to increase its share of the fast-growing Asian market, particularly India and China. The reason is that April’s main competitors, who are in Brazil and Canada, have seen the value of their dollar-denominated sales fall, along with the strengthening of their local currencies. But April’s base currency, the rupiah, has hardly budged. Bedi has been able to keep his export prices low compared to overseas rivals, who are also suffering from the rising cost of oil (shipping logs from Brazil to China burns a lot of gasoline, driving up freight rates.)

The dollar is at its weakest point in decades and CFOs in all corners of the world are scrambling to adjust. As the divergent experiences of Infosys and April suggest, the change rippling through the global economic system is affecting different companies in very different ways. Indian outsourcers are suffering. American manufacturers selling into Europe are celebrating, now that their goods have a price advantage. In Europe, many are considering moving manufacturing operations to a suddenly lower-cost United States.

Every CFO, however, must eventually place a strategic bet on the dollar’s fall, no matter what the relative economic advantage. If the dollar stays weak, what will be the net effect on diverse, global businesses? And what is the best response?

Now or Forever?

This isn’t the first time businesses have lived through a stretch of dollar weakness—during the 1970s, for example, the U.S. currency was in the doldrums, a situation which led, like today, to skyrocketing oil prices and contributed to economic malaise. But there are a couple of important differences between then and now.

For one thing, businesses are far more global and interconnected today, increasing the number of ways that currency values can influence the enterprise as a whole. An American technology company, for example, will likely have manufacturing operations in different parts of the world, some of which share the price benefits of a weak dollar, and others which are now more expensive. Each of those regional operations may be importing components from different countries with varying relative currency values. And the company’s ability to pass on cost increases due to the falling dollar may not be the same everywhere.

The prospect of a major decline in the dollar has long been debated in the public marketplace of ideas, and CFOs of global businesses have regarded it as inevitable. “The U.S. economy is growing slower than much of the rest of the world, which puts continuing pressure on the dollar,” says Greg Hayes, vice president of accounting and finance with United Technologies Corp., a diversified manufacturing company based in the United States. “The deficits we are ringing up to fund the wars in Iraq and Afghanistan add to that pressure.”

Also, today, many CFOs suspect that the dollar’s plight isn’t a short-term phenomenon, but one that could linger quite a while. According to the most recent Duke University/CFO magazine Global Business Outlook Survey, a stunning 60 percent of Asia’s CFOs and 50 percent of Europe’s think the decline in the dollar represents a permanent or long-term devaluation. A third of their U.S. counterparts agree.

“I think it’s a fundamental adjustment,” says Charles Kane, CFO of investment firm Global BPO Services and a lecturer on international finance at the MIT Sloan School of Management. “There are a lot of factors driving the dollar down.” And it could fall still further, for example, if the oil-exporting countries decide to peg oil prices to another currency or to a basket of currencies.

Seizing the Day

The sagging dollar isn’t altogether bad news, of course. The earnings benefit for U.S. companies with overseas sales, for example, is undeniable. According to the Duke/CFO survey, more than half of U.S. CFOs with significant international sales have seen a benefit from the dollar’s decline.

Consider UTC. For every penny the euro increases against the dollar, the company records an additional US$10 million in earnings. A behemoth that earns more than 60 percent of its revenues outside the United States, UTC received a roughly US$100 million earnings boost last year as the dollar slid, and slid, and slid a little more. Despite its far-flung revenue streams, the company has never done any financial hedging, says Hayes. Instead, UTC relies on what are essentially operational hedges: ensuring that it makes its products in the markets where they are sold. “The key is to manufacture locally and not put yourself into situations where you’re affected by things you can’t control, like foreign exchange,” says Hayes.

For Compact Power, a small manufacturer of landscaping and construction equipment based in South Carolina, the falling dollar has meant a rapid rise in the company’s overseas sales. The US$100 million company only began selling internationally two years ago, but has doubled its international sales in the past year, and plans to double them again in 2008. “We’ve absolutely accelerated our international growth because of the exchange rate,” says CFO Norman Boling. “The falling dollar has made us competitive in markets where we’re up against established existing competition.”

Compact Power quickly developed two diesel units to distribute in England this year, and has entered into a distribution agreement with an Italian manufacturer to sell that company’s product—tractors—in the United States. To address currency fluctuations, the two companies locked down a rate in their contract, a strategy Compact Power plans to continue with other partners going forward. While the manufacturer does not do financial hedging, “by locking down the exchange rate at which we purchase, we can take out some of the risk,” says Boling. Trade partners have been willing to agree on rates in their contracts because the practice removes uncertainty for them as well. “We might feel a pinch here if the dollar goes back the other way,” says chief operating officer Michael Edwards. “We’re developing sources out of Europe and other regions so that we can play the other side when that happens.”

U.S. companies are also seeing a boost from the dollar’s weakness at home, as tourists from overseas flock to stateside shopping centers. Stephen Sterrett, finance chief at Simon Property Group, the largest shopping mall owner in the United States, says foreign travelers have provided a big boost to the company’s malls and outlet centers in the past year. “We have seen a disproportionate impact on sales in centers where there are a significant number of international tourists,” says Sterrett. “The foreign tourist’s purchasing power is greater than it has ever been before.” While European tourists have packed Simon’s East Coast locations, the company’s shopping centers in Houston have welcomed an influx of travelers from Mexico and South America. Shoppers from Canada have bolstered sales at malls on the northern border, as the Canadian dollar has reached near-parity with the U.S. currency.

Like UTC, Simon is largely operationally hedged. Although most of its business is in the United States, it operates 50 properties in Europe, where it reinvests profits in its local operations. “Our leases are in local currency, we borrow in local currency, and we’re using our profits to reinvest locally,” says Sterrett. “We have a natural hedge.”

In Asia, of course, many companies rely on dollar-denominated exports. Indeed, 43 percent of the Asian respondents to the Business Outlook Survey reported that a weaker dollar is hurting their exports. But as April’s experience with the Indonesian rupiah demonstrates, not every company in the East is bemoaning the weak dollar.

Martin Cubbon, CFO of Swire Pacific, the US$9 billion Hong Kong-based owner of Cathay Pacific Airlines, is unperturbed by the dollar’s slide. “Although we do have a lot of Hong Kong dollar revenue (the Hong Kong dollar is pegged to the U.S. dollar) we also have a lot of renminbi, euro, and yen,” he says “And we have a lot of dollar costs, namely fuel and capital costs. It’s a good position to be in.”

Making Adjustments

For other companies, the picture is not as rosy. In a striking change, many European companies are considering moving manufacturing operations to the United States to reduce costs. Carmakers like Fiat, BMW, and Volkswagen are looking to expand their stateside production to move closer to U.S. consumers and reduce their euro exposure. BMW executives have said that they plan to increase U.S. production by more than 70 percent in response to the dollar’s decline. The French manufacturer Alstom announced plans last December to build a US$200 million facility in Tennessee, in part to mitigate the impact of the weak dollar on its margins. And in perhaps the highest-profile rumored defection from the eurozone, the CEO of EADS, the parent company of Airbus, has said the airplane manufacturer will consider moving some production to the States, much to the dismay of French government officials.

Novo Nordisk, a Danish pharmaceutical company, derives more than 30 percent of its sales from North America and an additional 15 percent from other locations outside the eurozone, but makes nearly all of its products in Denmark. The insulin-maker also conducts most of its research and development in a location just outside Copenhagen. CFO Jesper Brandgaard says the company has taken a number of steps to reduce its dollar exposure. In addition to increasing its financial hedging, Novo Nordisk has expanded its production facilities around the world, opening a new facility in Brazil and planning to expand production in China this year. The company also opened an R&D office in New Brunswick, New Jersey in 2006 and has established a 50-person research team in China. “We are looking for a better balance between our production cost base and our income base,” says Brandgaard.

In India, Infosys is pursuing a range of solutions to its earnings squeeze. “Big companies like ours who have a flexible cost structure are able to absorb the impact of the dollar and still maintain margins,” says Balakrishnan. The company is keeping costs low, largely by outsourcing much of its own back office work, fittingly enough for a BPO firm. It is also increasing employee utilization.

Most importantly, Infosys is positioning itself for a long-term rise in the value of the rupee by moving aggressively into higher-margin consulting and enterprise solutions work. “The proportion of our revenue coming from high value-added services will definitely go up,” says Balakrishnan. This could ultimately produce stronger companies in India. “Look at what happened in Japan,” he says. “When the yen was 320 against the dollar and moved to 120, they started setting up operations outside the country and became more efficient and managed it. Large companies in India will try to do the same.”

Infosys rival Tata Consulting Services is also seeking higher-end work, and the company is trying to steer clients toward projects that are based in its own facilities in India, rather than at the client’s location—again, to boost margins. All these changes may not be enough, says CFO S. Mahalingam. “If the rupee gets to 35 [rupees to the dollar], that’s a different matter. Then we will have to look at creating more delivery centers overseas.” At the end of 2007, the rupee clocked in at 39.2 to the dollar.

In contrast, at companies headquartered in the United States, CFOs are putting the brakes on investments overseas. “New investments could become less justifiable because of higher local costs,” says Pablo Edelstein, CFO of Dow Latin America. Because many of Dow’s raw materials—such as ethylene, which is derived from oil—are linked to the dollar, margins will shrink internationally unless the company raises prices. “We do transfer those increases to our selling prices, but sometimes there is a lag, particularly when oil prices shoot up rapidly,” Edelstein says. If the dollar’s weakness lingers, the company will have to reconsider the economics of new investments, he says.

Simon Property’s Sterrett says his company will also proceed with caution as it pursues international acquisitions or new international developments with local partners. “The weak dollar has made it increasingly difficult for us to look at a large-scale acquisition that would require a significant commitment in U.S. dollars,” he says. “It has gotten harder to look for viable growth alternatives outside the U.S.”

Betting on a Comeback

Of course, one danger stemming from the dollar’s fall may be overreacting to it. One sign that patience may be the better course is that the processes that restore economic equilibrium—like increasing exports and foreign investment—are already beginning to bolster the U.S. economy. Edelstein of Dow anticipates that exports and cross-border M&A activity into the United States will rise now that the greenback is weakened. Dow itself just announced a U.S.-based joint venture with Petrochemical Industries of Kuwait to produce and market plastics.

“U.S. assets are becoming cheaper for foreign investors,” adds David Elkins, North American finance chief at AstraZeneca International, the British pharmaceutical company, who adds that he sees more buyouts of U.S. assets by foreign companies in the near future.

As these countervailing forces build, another factor in restoring the dollar to health could be the absence of an alternate currency to take up its mantle. Many doubt that the euro will become the world’s leading currency, despite the occasional endorsement economists give it. “If you look at the prospects in Europe versus the U.S. from an economic-growth standpoint, I would put my money on the U.S.,” says Hayes of UTC.

John Graham, a professor of finance at Duke University’s Fuqua School of Business, agrees: “Europe faces high tax rates, huge social programs, and promises to future retirees. I don’t think the U.S. will be worse off than Europe 20 years from now. But we might well be worse off relative to the Asian economies.”

In Hong Kong, Cubbon of Swire Pacific is equally sure. “The U.S. dollar will strengthen [in 2008],” he says.

“The U.S. has a way of regenerating itself,” he adds. “It’s still the world’s engine. China may become that in the future, but it ain’t there yet.”

Kate O’Sullivan is a senior writer with CFO in the U.S. Additional reporting by Janet Kersnar in London, and Tom Leander and Don Durfee in Hong Kong.