Volkswagen Expansion

HARVARD CASE REPORT

1. To what extent did Volkswagen face long term currency risk, and what were its sources?

2. How did Volkswagen manage its long term currency risk, and what might have been done differently to improve risk management?

1. To what extent did Volkswagen face long term currency risk, and what were its sources?

1960ÐŽ¦s: Throughout this decade VW consolidated its position increasing marketing, efficiency and production. The weak DM in relation to US dollar contributed to VWÐŽ¦s exports to US. Long term currency risk in this stage was tied to a potential appreciation of the DM in the future, since VW was mainly a big exporter company that traded its local products abroad (especially in the US market).

1970ÐŽV1975: The DM appreciated with respect to the dollar. German exports became expensive. This reduced VW profitability and liquidity and increased share of debt in capital structure (1973, equity dropped 31 to 24%). Japanese competition was taking more of VW US market share. Although Japanese Yen was appreciating this was rate was significantly lower that DM rate. Considering that VW was still a big exporter that produced mainly in one country, and supplied to many others, long term risk in this stage was related to the real appreciation of the DM in relation to the US dollar (a big portion of VWÐŽ¦s sales came from the US market) and other currencies (from the countries of VWÐŽ¦s competitors). Also, the biggest portion of DM denominated debt was another risky issue, considering the volume of revenues in softer currencies (revenues from the US market).

1976-Mid1980s: Although it aimed at reducing DM - US dollar volatility risk, the introduction of the Puebla plant as a supplier of US market, VW added another currency risk that came from the peso-dollar exchange rate. Also, the production in Mexico was less efficient than in the US in terms of volume on a production time basis.

Mid1980s-1992: VW closed its US Westmoreland plant given its low capacity utilization in 1987 and prospective market growth and resumed the supply from Germany. This decision initially meant producing in a hard currency (DM) to supply a soft currency country (US dollar), a non viable option in a market with price elastic demand. VW shifted car production to its Mexico Puebla plant; this decision lessened currency exchange volatility, but didnÐŽ¦t eliminate it.

2. How did Volkswagen manage its long term currency risk, and what might have been done differently to improve risk management?

1960ÐŽ¦s: In this period VW took advantage of weak DM to prevail in foreign markets in Europe and US.

1976-Mid1980s: VW shifted part of its production from Germany to the US, this curbed exchange rate volatility risk between