International Business, Update 2003 Cases
Harley-Davidson (B): Hedging Hogs
Harley-Davidson’s
competitive
comeback
in
the
late
1980s
is
one
of
the
few
protectionist success stories. It is the story of a firm that used government
protection to adjust to a changing competitive global market. But Harley’s success
in the late 1980s brought along new problems that threatened to undermine much of
the progress already attained. Harley’s primary problem was the same problem faced
by many undiversified international firms: it produced its motorcycles, hogs, 1 in
only one country and exported its product to all foreign markets. But exchange rates
change, and prices and earnings originally denominated in foreign currencies end up
being worth very different amounts when finding their way back home to the dollar.2
Exporting Hogs
Harley’s sales in 1990 were more than $864 million. Of total sales, $268 million, or
31 percent, were international sales. Harley had been exporting for a very long
time: for 50 years to Japan and more than 80 years to Germany. New markets were
growing in countries such as Greece, Argentina, Brazil, and even the Virgin Islands.
Although
international
sales
were
obviously
very
important
to
Harley’s
present
profitability, they also represented its future. The domestic market in the United
States for motorcycles—any firm’s motorcycles—was beginning to decline. This was
generally
thought
to
be
a
result
of
changing
consumer
profiles
and
tastes.
International market potential for Harley looked quite promising, but Harley had
only 15 percent of the world market. It needed to do better, much better.
Harley’s problem was that foreign distributors and dealers needed two things for
continued growth and market share expansion: (I) local currency prices and (2)
stable prices. First, local currency pricing, whether it be Japanese yen, German
marks, Australian dollars, or Canadian dollars, would allow the foreign dealers to
compete on price in same currency terms with all competitors. And this competition
would not be hindered by the dealers and distributors adding currency surcharges to
sticker prices as a result of their own need to cover currency exposure.3 Harley
needed to sell its hogs to foreign dealers and distributorships in local currency,
but that would not really solve the problems. First, Harley itself would now be
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International Business, Update 2003 Cases
responsible for managing the currency exposure. Second, it still did not assure the
foreign dealers of stable prices, not unless Harley intended to absorb all exchange
rate changes itself.
Figure I illustrates the foreign currency pricing issue for sales of Harleys in
Australia and Japan. Australian consumers shop, compare, and purchase in Australian
dollars. Starting at the opposite end, however, is the fact that Harley hogs are
produced
and
initially
priced
in
U.S.
dollars.
Someone
must
bear
the
risk
of
currency exchange, either the parent, the distributor, or the consumer; it rarely
will be the consumer.
Currency Risk Sharing at Harley
John Hevey, manager of international finance, instituted a system that Harley calls
“risk sharing.” The idea is not new, but it has not been fashionable for some time.
The idea is fairly simple: as long as the spot exchange rate does not move a great
distance from the rate in effect when Harley quotes foreign currency prices to its
foreign dealers, Harley will maintain that single price. This allows the foreign
dealers and distributors, both those owned and not owned by Harley, to be assured of
predictable and stable prices. The stable prices needed to be denominated in the
currency of the foreign dealer and distributor’s operations. Harley would then be
responsible for managing the currency exposures.
A typical currency risk-sharing arrangement specifies three bands or zones of
exchanges: (1) neutral zone, (2) sharing zone, and (3) renegotiation zone. Figure 2
provides an example of how the currency zones may be constructed between a U.S.
parent firm and its Japanese dealers or distributors. The neutral zone in Figure 2
is constructed as a band of 1/25 percent change about the central rate specified in
the contract, ¥130.00/$. The central rate can be determined a number of ways, for
example, the spot rate in effect on the date of the contract’s consummation, the
average rate for the past three-month period, or a moving average of monthly rates.
In this case, the neutral zone’s boundaries are ¥136.84/$ and ¥123.81/$.4 As long as
the spot exchange rate between the yen and dollar remains within this neutral zone,
the U.S. parent assures the Japanese dealers of a constant price in yen. If a
particular
product
line
was
priced
in
the
United
States
at
$4,000,
the
yen-
denominated price would be ¥520,000. This assures the Japanese dealers a constant
supply price in their own currency terms. The predictability of costs reduces the
currency
risks
of
the
Japanese
dealers
and
allows
them
to
pass
on
the
more
predictable local currency prices to their customers.
If, however, the spot rate moves out of the neutral zone into the sharing zone,
the U.S. parent and the Japanese dealer will share the costs or benefits of the
margin beyond the neutral zone rate. For example, if the Japanese yen depreciated
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International Business, Update 2003 Cases
against the dollar to ¥140.00/$, the spot rate will have moved into the upper
sharing zone. If the contract specified that the sharing would be a 50y50 split, the
new price to the Japanese dealer would be
$4,000 x
3 ¥130.00/$+ (¥140.00/$2¥136.84/$)/24
= $4,000 x ¥131.58/$ = ¥526,320.
Although the supply costs have indeed risen to the Japanese dealers, from ¥520,000
to ¥526,320, the percentage increase is significantly less than
the percentage
change in the exchange rate.5 The Japanese dealer is insulated against the constant
fluctuations of the exchange rate and subsequent fluctuations on supply costs.
Finally, if the spot rate were to move drastically from the neutral zone into the
renegotiation zone, the risk-sharing agreement calls for a renegotiation of the
price to bring it more in line with current exchange rates and the economic and
competitive realities of the market.
Currency Management at Harley
Harley’s risk-sharing program has allowed the firm to increase the stability of
prices in foreign markets. But this stability has come about by the parent firm’s
accepting a larger proportion of the exchange rate risk. Harley’s approach to
currency management is conservative, both in what it hedges and how it hedges.
The “what,” the exposures that Harley actually manages, are primarily its sales,
which
are
denominated
in
foreign
currencies.
Although
Harley
does
import
some
inputs, the volume of imports denominated in foreign currencies (accounts payable)
are relatively small compared to the export sales (the accounts receivable). Harley
is a bit more aggressive in its exposure time frame than many other firms, however.
Harley will hedge sales that will be made in the near future, anticipated sales,
extending about twelve months out. The ability of the firm to hedge sales that have
not yet been “booked” is a result of the firm’s consistency and predictability of
sales in the various markets. Like most firms that hedge future sales, however,
Harley will intentionally leave itself a margin of error, therefore hedging less
than 100 percent of the expected exposures.
Presently Harley is rather conservative in the “how,” the instruments and methods
used for currency hedging. Harley uses currency forward contracts for all hedging.
Harley will estimate the amount of the various foreign currency payments to be
received per period and sell those foreign currency quantities forward (less the
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International Business, Update 2003 Cases
percentage
margin
operations,
for
Harley
is
error).
now
Like
studying
many
the
other
use
of
firms
expanding
additional
approaches, such as the use of foreign currency options.
international
currency
management
At present, however,
Harley executives are satisfied with their currency management program.
Financial Management’s Growing
Responsibilities
A third dimension of the new financial/currency management program at Harley is the
increased role of financial management with sales. The finance staff keeps in touch
with the sales and marketing staffs to work toward the most competitive combinations
and packages of pricing. Financial staff also attempts to keep information lines
open between its foreign dealers and distributors to help them maintain price
competitiveness.
Harley-Davidson is a firm that continues to be unique in many ways. Not only is it
one of the true “success stories” for American protectionism, but it has continued
to work to improve its international competitiveness by responding to the needs of
not only its customers, but also its distributors and dealers.
Questions for Discussion
1. Why is it so important for Harley-Davidson to both price in foreign currencies in
foreign markets and provide stable prices?
2. How effective will “risk sharing” be in actually achieving Harley’s stated goals?
Is there a better solution?
3. Who is bearing the brunt of the costs of the financial risk management program?
References
Hufbauer, Gary Clyde, Diane T. Berliner, and Kimberly Ann Elliot. Trade Protection
in
the
United
States:
31
Case
Studies.
Washington,
D.C.:
The
Institute
for
International Economics, 1986.
Pruzin, Daniel R. “Born to be Verrucht.” World Trade 5, Issue 4 (May 1992): 112–117.
Quinn,
Lawrence
R.
“Harley
Uses
‘Risk
Sharing’
to
Hedge
Foreign
Currencies.”
Business International Money Report, March 16, 1992, 105–106.
———, “Harley: Wheeling and Dealing.” Corporate Finance (April 1992): 29–30.
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International Business, Update 2003 Cases
Source: This case was written by Michael H. Moffett, the University of Michigan, March 1993. The case is
intended for class discussion purposes only and does not represent either efficient or inefficient
financial management practices. Do not quote without prior permission.
1The motorcycles produced and sold by Harley-Davidson have traditionally been known as hogs. The nickname
is primarily in reference to their traditional large size, weight, and power.
2This
case
draws
upon
several
articles
including
“Harley
Uses
‘Risk
Sharing’
To
Hedge
Foreign
Currencies,” by Lawrence R. Quinn, Business International Money Report (March 16, 1992): 105 – 106; and
“Harley: Wheeling and Dealing,” by Lawrence Quinn, Corporate Finance (April 1992): 29–30.
3For example, an independent Australian dealer who sells and earns Australian dollar revenues but must
pay for the Harley hogs shipped from the United States in U.S. dollars will be accepting currency risk.
If the Australian dealer then adds a margin to the hog price to cover currency-hedging costs, the product
is less competitive.
FIGURE 1
Harley-Davidson’s Foreign Pricing Flow
4The upper and lower exchange rates of the band are calculated as:
(insert formula) x 100 = -5.0%.
and
(insert formula) x 100 = +5.0%.
5The yen price has risen only 1.22 percent while the Japanese yen has depreciated 7.14 percent versus the
U.S. dollar.
FIGURE 2
Currency Risk Sharing
Note: Percentage changes are in the value of the Japanese yen versus U.S. dollar. For example, a “15%” is a 5 percent appreciation in the value of the yen, from ¥130.00/$ to
¥123.81/$.
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