Global Business 3rd Edition by Mike Peng

Exercise 14

Facing rising costs and unfavorable exchange rates, how can Jobek do Brasil, a Brazil-based outdoor furniture and hammock manufacturer and exporter, cope?
Friday morning, Barny sipped his black coffee and shrugged his head when he glanced at the headlines of Valor Econômico, Brazil's leading business newspaper: the US dollar lost value again and the Brazilian government was considering additional measures to halt the accelerating appreciation of the real. What a mess, he thought, and flipped nervously through the remaining pages of the finance section.
Barny's firm, Jobek do Brasil, an outdoor furniture and hammock manufacturer and exporter, has hardly recovered from its biggest crisis. In September 2008, when he returned with full order books from an international fair, he did not even suspect that sales would go down by more than 60% in the following months thanks to the global financial crisis. His French distributor went bankrupt, his former US partner shifted purchasing to cheaper producers in India and China, and his clients reduced or cancelled order volumes in response to the financial crisis. The existing business model-based on in-house manufacturing in Brazil's northeast and an administrative, purchasing, quality assurance, and sales unit in Germany-was no longer viable. Fixed costs were substantial and manufacturing inputs had already been purchased. Sitting on debt and running short of working capital, Barny shut down Jobek's plant in 2010; outsourced production to Reed Isaac, a former local partner; closed down the German unit; and signed a long-term supply contract with Stern GmbH Co KG in Germany. In addition, Jobek temporarily discontinued the already low sales outside Europe as well as the always insignificant domestic sales in Brazil. The measures were necessary to refocus the business and ride down costs.
Brazil's Foreign Exchange Policy
After more than a decade of high inflation, low growth, debt default, and failed stabilization policies, the Brazilian government introduced a new currency, the real (R$), in 1994. The new currency, valued at R$1 per US$1 in 1994, was pegged to the US dollar and could oscillate within an adjustable band until 1999. At that time, the effects of the Asian and the Russian crises also increased pressures on Brazil that still suffered from repetitive trade balance deficits and current account deficits. In 1998, Brazil earned only around US$51 billion from export sales, corresponding to 6.5% of GDP. Then, subject to central bank interventions, the real depreciated rapidly and reached R$2.25 per dollar in late January 2002. When it became increasingly likely that José Ignácio Lula da Silva would be elected Brazil's new president, hot money quickly left Brazil and the real dropped to R$3.83 per dollar in late October 2002. Roughly at parity with the US dollar at that time, the R$/euro exchange rate was similar (see Exhibit 1). Contrary to initial expectations, Lula's government gained the confidence of the international financial markets. Brazil's monetary policy aimed to quickly reduce inflationary pressures by raising real interest rates. During the 2003 crisis, for instance, the central bank's reference nominal interest rates (the socalled Special System of Clearance and Custody rate or SELIC-using the Portuguese acronym) topped 26%. Even at the beginning of 2012, nominal interest rates were around 10% and real interest rates were close to 5%, the highest worldwide. Brazil's conservative fiscal and monetary policy quickly showed positive results. After paying back its last IMF loan in 2005, the country obtained the investment grade rating in 2008. The international financial markets honored that and billions of US dollars poured into the country over the last few years. In addition, higher export sales, partly triggered by record commodity prices, led to a high level of foreign exchange reserves of US$356 billion in March 2012. However, the long expected and wellreceived macroeconomic stabilization came at a cost: the R$ had been appreciating since 2004 and about 2,700 exporters (or approximately 12% of all Brazilbased exporters as of 2004) quit international markets between 2004 and 2011 (see Exhibit 2).

"Custo Brasil": The Costs of Doing Business in Brazil
As if foreign exchange pressures were not enough, other charges, colloquially summarized as "Custo Brasil" or "Brazil costs," were also causing headaches to Barny. Hourly compensation costs in the manufacturing industry are more than six times as high as in China, while port and road infrastructure, critical to the export industry, lag behind. According to World Bank data, in Brazil an average business takes 2,600 hours a year to prepare, file, and pay taxes and other mandatory contributions, which compares unfavorably against China

(398 hours) or the United States (187 hours). Over the years, the government has increased minimum wages from R$200 in 2002 to R$622 in 2012. While this government policy has been very positive to increase domestic market demand and to uplift millions of poor Brazilians to join the economy, competitiveness of several industries has been suffering. Barny complained in an interview:
Brazil is too expensive, also because salaries rose too much. For instance, in 2002, a sewer earned about US$200 per month, today she costs us US$700. The problem about this is that productivity did not rise the same way, it practically remained the same over time.
Counter Measures
Over the last 20 years, Jobek do Brasil built up a strong premium brand, especially in the German market. The branding strategy successfully associated Jobek's products with the Latin American lifestyle. In addition, Jobek managed to link its brand with environmental friendliness by using Foreign Stewardship Council (FSC) certified wood for accessories and with social responsibility by treating employees fairly and by sponsoring community projects. In addition, the Jobek brand was associated with high quality standards. Selling this brand asset to Stern GmbH was a harsh decision. Now, Stern GmbH owned the rights of the Jobek brand for Europe while Barny and his brother maintained the rights for the rest of the world. In exchange, Stern committed to buying all products it sold under the Jobek brand from Barny for the next ten years. If Stern purchases from third parties, it was required to pay royalties for the use of the Jobek brand. Barny commented on the terms of the contract:
We were lucky and negotiated with Stern a cash advance of 66% for each order. When we negotiate a supply contract, we also include a risk-factor of about 10% into the bill.
The product mix also suffered several changes. Discontinuing manufacturing of cheaper hammocks, with export prices of less than €20, was probably the most dramatic. Emphasis was on higher value-added products that could sell for up to €400 (distributor price). Due to the restructuring of the company's operations, marketing to access alternative markets has been delayed.
In addition, Barny also approached their account manager at Banco do Brasil, Brazil's largest and partly state-owned bank, and asked them to make an offer for a swap contract over R$1 million. After six months, Barny still had not received the contract and grumbled that "here in the northeast of Brazil, they are 20 years back in some areas." Indeed, hedging the exposure to the euro is sometimes a problem in a country where, according to a financial risk consultant, "the US dollar is still a synonym for foreign exchange."
Getting Squeezed
As if the past turbulence was not yet enough, more black clouds moved across the horizon and tapped the usually strong sunshine in Brazil's northeast. With the euro in its deepest crisis since its introduction in 2002, many fear that quantitative easing might be used to get rid of the euro zone's mounting debt. With these thoughts passing through his mind, Barny's attention was captured by another article in Valor Econômico's politics section: "Dilma Roussef [the new Brazilian president] sent a message to Mrs. Merkel [the German Chancellor] complaining about 'the monetary tsunami' that is threatening to flood Brazil and other emerging economies with cheap money made available by the European Central Bank." In fact, Brazil was attracting foreign money as never before and received a record amount of foreign direct investment (FDI) of US$66 billion in 2011.
Barny complained that "with the resulting real appreciation, our clients are not very happy." He noted: "On November 29, 2011, Stern placed an order based on an exchange rate of R$2.49 per euro. Today, on Friday, March 2, 2012, the euro dropped to R$2.28, that's an appreciation of about 10% in a very short period. The only way we can sell our products is because we have a strong brand name."
The telephone ringing interrupted Barny's thoughts. It was João Gonçalves, the boss at Reed Isaac, shouting through the handset: "Bom dia, Barny, tudo bem? You know, I am very concerned with the high minimum wage increases that Mrs. Dilma Roussef has pushed through the congress, not to mention the ever rising tax charges. We can hardly survive at such costs, and I am sorry but I need to talk to you about a price adjustment." Barny was almost infuriated but he avoided letting João feel his wrath. Barny politely asked João if he would like to have lunch together. "We cannot be too hard with them, otherwise they back off. But if you are too soft with them, they will take advantage of you," Barny scratched his head about what to say to João at lunchtime. When Barny tried to sip again, he noticed that his coffee mug was empty. Time to think of the turnaround strategy's next steps....
Case Discussion Questions
How do you evaluate Jobek's strategic response to foreign exchange risks?