Application 
A.T. Cross Marks Down Its Pen Prices
In February 1993, following a 10% decline in the dollar (from ¥123 to ¥111), A.T. Cross cut the yen prices of its pens by 20%. For example, a 10-carat gold Cross pen was marked down to ¥8,000 from ¥10,000. Suppose that the manufacturing and shipping costs of this Cross pen were $25 and distribution costs were ¥2,000, giving Cross a pre-exchange rate change contribution margin of $40 (¥10,000/123 − $25 − ¥2,000/123). Assummg these costs stay the same, how much additional volume must Cross generate in order to maintain its dollar profits on this pen?
Solution: The contribution margin given the new exchange rate and the price change equals $29 (¥8,000/111 − $25 − ¥2,000/111). In order to maintain dollar profits on this pen at their previous level, unit sales must rise by 38% (40/29). A sales increase of this magnitude implies a price elasticity of demand of 1.9 (38/20).
Turning now to domestic pricing after a fall in the home currency, a domestic firm facing strong import competition may have much greater latitude in pricing. It then has the choice of potentially raising prices consistent with import price increases or of holding prices constant in order to improve market share. Again, the strategy depends on variables such as economies of scale and the price elasticity of demand. For example, the sharp rise in the value of the yen and Deutsche mark during the 1990s led the German and Japanese automakers to raise their dollar prices and allowed Ford and General Motors to raise their prices on competing models. The price increases by the U.S. auto manufacturers, which were less than the sharp rise in import prices, improved their profit margins and kept U.S. cars competitive with their foreign rivals.
The competitive situation is reversed following appreciation of the dollar, which is equivalent to a foreign currency (FC) depreciation. In this case, a U.S. firm selling overseas should consider opportunities to increase the FC prices of its products. The problem, of course, is that local producers now will have a competitive cost advantage, limiting an exporter’s ability to recoup dollar profits by raising FC selling prices.
At best, therefore, an exporter will be able to raise its product prices by the extent of the FC depreciation. For example, suppose Avon is selling cosmetics in England priced at £2.00 when the exchange rate is $1.80/£. This gives Avon revenue of $3.60 per unit. If the pound declines to $1.50/£, Avon’s unit revenue will fall to $3.00, unless it can raise its selling price to £2.40 (2.40 × 1.50 = $3.60). At worst, in an extremely competitive situation, the exporter will have to absorb a reduction in HC revenues equal to the percentage decline in the value of the foreign currency. For example, if Avon cannot raise its pound price, its new dollar price of $3.00 represents a 16.7% drop in dollar revenue, the same percentage decline as the fall in the pounds value [(1.80 − 1.50)/1.80]. In the most likely case, FC prices can be raised somewhat, and the exporter will make up the difference through a lower profit margin on its foreign sales.
In deciding whether to raise prices following a foreign currency depreciation, companies must consider not just sales that will be lost today but also the likelihood of losing future sales as well. For example, foreign capital goods manufacturers used the period when they had a price advantage to build strong U.S. distribution and service networks. U.S. firms that had not previously bought foreign-made equipment became loyal customers. When the dollar fell, foreign firms opened U.S. plants to supply their distribution systems and hold onto their customers.
The same is true in many other markets as well: A customer who is lost may be lost forever. For example, a customer who is satisfied with a foreign automobile may stick with that brand for a long time.