Shifting Production Among Plants.
Multinational firms with worldwide production systems can allocate production among their several plants in line with the changing dollar costs of production, increasing production in a nation whose currency has devalued and decreasing production in a country where there has been a revaluation. Contrary to conventional wisdom, therefore, multinational firms may well be subject to less exchange risk than an exporter, given the MNC’s greater ability to adjust its production (and marketing) operations on a global basis, in line with changing relative production costs.
A good example of this flexibility is provided by Westinghouse Electric Corporation of Pittsburgh, Pennsylvania. Westinghouse can quote its customers prices from numerous foreign affiliates: gas turbines from Canada, generators from Spain, circuit breakers and robotics from Britain, and electrical equipment from Brazil. Its sourcing decisions take into account both the effect of currency values and subsidized export financing available from foreign governments.
The theoretical ability to shift production is more limited in reality, depending on many factors, not the least of which is the power of the local labor unions involved. However, the innovative nature of the typical MNC means a continued generation of new products. The sourcing of those new products among the firm’s various plants can certainly be done with an eye to the costs involved.
A strategy of productkm shifting presupposes that the MNC has already created a portfolio of plants worldwide. For example, as part of its global sourcing strategy, Caterpillar now has dual sources, domestic and foreign, for some products. These sources allow Caterpillar to “load” the plant that offers the best economies of production, given exchange rates at any moment. But multiple plants also create manufacturing redundancies and impede cost cutting.
The cost of multiple sourcing is especially great when there are economies of scale that would ordinarily dictate the establishment of only one or two plants to service the global market. But most firms have found that in a world of uncertainty, significant benefits may be derived from production diversification. In effect, having redundant capacity is the equivalent of buying an option to execute volume shifts fairly easily. As in the case of currency options, the value of such a real option increases with the volatility of the exchange rate. Hence, despite the higher unit costs associated with smaller plants and excess capacity, currency risk may provide one more reason for the use of multiple production facilities. Indeed, 63% of foreign exchange managers surveyed cited having locations “to increase flexibility by shifting plant loading when exchange rates changed” as a factor in international siting.7
The auto industry illustrates the potential value of maintaining a globally balanced distribution of production facilities in the face of fluctuating exchange rates. For Japanese and Swedish auto manufacturers, which historically located all their factories domestically, it has been feast or famine. When the home currency appreciates, as in the 1970s or the late 1980s and early 1990s, the firms’ exports suffer from a lack of cost competitiveness. On the other hand, a real depreciation of the home currency, as in the early 1980s, is a time of high profits.
By contrast, Ford and General Motors, with their worldwide manufacturing facilities, have substantial leeway in reallocating various stages of production among their several plants in line with relative production and transportation costs. For example, Ford can shift production among the United States, Spain, Germany, Great Britain, Brazil, and Mexico.
7 Donald B. Lessard, “Survey on Corporate Responses to Volatile Exchange Rates,” working paper, MIT Sloan School of Management, 1990.
Plant Location.
A firm without foreign facilities that is exporting to a competitive market whose currency has devalued may find that sourcing components abroad is insufficient to maintain unit profitability. Despite its previous hesitancy, the firm may have to locate new plants abroad. For example, the economic response by the Japanese to the strong yen was to build new plants in the United States as opposed to expanding plants in Japan. Similarly, German automakers such as BMW and Mercedes-Benz have built plants in the United States to shield themselves from currency fluctuations. In 2007, Volkswagen announced it was considering building a new plant in the United States to hedge against a strong euro by offsetting its dollar revenues with dollar costs.
Third-country plant locations are also a viable alternative in many cases, depending especially on the labor intensity of production or the projections for further monetary realignments. Many Japanese firms, for example, have shifted production offshore—to Taiwan, South Korea, Singapore, and other developing nations, as well as to the United States—in order to cope with the high yen. Japanese automakers have been particularly aggressive in making these shifts. Moving production offshore can be a mixed blessing, however. Although it makes companies less vulnerable to a strong yen, it means less of a payoff if the yen declines. For example, when the yen began to weaken in 1995, Japanese manufacturers with foreign production facilities found they could not take full advantage of the yen’s fall.