How can the Chinese subsidiary of a multinational company both hedge its currency risks and still meet the sales and profitability objectives directed by leadership?
Paul Young was the financial controller of Xian-Janssen Pharmaceutical Ltd. (XJP), the Chinese subsidiary of the U.S.-based multinational, Johnson & Johnson.
Paul was preparing for a meeting with his CEO, Christian Velmer, which would focus on the business plan for the coming 2004 fiscal year.
XJP was expected by leadership (corporate) to generate 1.2 billion renminbi in earnings in 2004, a 20% increase over a highly successful 2003 year
This would be a challenge given that XJP was suffering from a number of rising expenses and foreign exchange losses
XJP of China
A joint venture, produces and marketed prescription and over-the-counter (OTC) medications to mostly hospitals in China (which made up roughly 80% of sales)
Most sales in the Chinese market were through tender sales, reverse auction markets in which companies produced bids for sales to individual hospitals and were awarded sales on the lowest cost bids (also termed a Dutch Auction in some places in the world)
XJP had closed 2003 with a 98% success rate on tenders
XJP purchased nearly 95% of all its product from Europe
Most product purchases from Europe were from J&J Europe, and therefore the prices were transfer prices – prices set internally within the company
Paul Young believed that most of the transfer prices XJP was paying were relatively high, increasing the profitability of the European business but increasing his costs in China (and therefore decreasing his profitability)
All European purchases were priced and invoiced in euros, and the euro had been rising significantly in value against the Rmb (since the Rmb was fixed to the dollar, and the dollar had been falling against the euro, the falling Rmb was a certainty)
All XJP payments for product from Europe were made