Product Strategy.
Companies often respond to exchange risk by altering their product strategy, which deals with areas such as new-product introduction, product line decisions, and product innovation. One way to cope with exchange rate fluctuations is to change the timing of the introduction of new products. For example, because of the competitive price advantage, the period after a home currency depreciation may be the ideal time to develop a brand franchise.
Exchange rate fluctuations also affect product line decisions. Following home currency devaluation, a firm will potentially be able to expand its product line and cover a wider spectrum of consumers both at home and abroad. Conversely, home currency appreciation may force a firm to reorient its product line and target it to a higher-income, more quality-conscious, less price-sensitive constituency. Volkswagen, for example, achieved its export prominence on the basis of low-priced, stripped-down, low-maintenance cars. The appreciation of the Deutsche mark in the early 1970s, however, effectively ended VW’s ability to compete primarily on the basis of price. The company lost more than $310 million in 1974 alone attempting to maintain its market share by lowering DM prices. To compete in the long run, Volkswagen was forced to revise its product line and sell relatively high-priced cars to middle-income consumers from an extended product line, on the basis of quality and styling rather than cost.
The equivalent strategy for firms selling to the industrial rather than consumer market and confronting a strong home currency is product innovation, financed by an expanded research and development (R&D) budget. For example, Japanese exporters responded to the rising yen by shifting production from commodity-type goods to more sophisticated, high-value products. Demand for such goods, which embody advanced technology, high-quality standards, and other nonprice features, is less sensitive to price increases caused by yen appreciation.