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Hedging is a widely used finance term that refers to measures that are adopted by an organization to mitigate or avoid a certain risk. In finance, risks emanate from the uncertainty of future market trends. Risk in finance tends to take various forms. For instance, there is credit risk, business risk, currency risk, political risk, interest rate risk, and volatility risk. With these risks in mind, businesses should come up with strategies to mitigate the impact of the risks. Therefore, hedging is an investment plan that is prepared with the intent to offset or mitigate business losses, which may incur from the operations of an enterprise. Hedging has various strategies that can be implemented. The strategies reflect the dynamic nature of the risk involved. The strategic hedging tools include forward contracts, future contracts, swaps, options, derivatives, and insurance products (Jaeger, 2005).
Schneider Electric was incorporated in 2011. It is a French multinational engineering company, which seeks to specialize in the electric transformation and, automation. Schneider Electric’s hedging strategies are mainly derived from the risks that are faced by the company (Kapferer, 2008). It is very evident that business risk can affect any business, and Schneider Electric is no exception. Measures to mitigate the impact of such risk should be adopted to enhance profitability and business survival.
The risks faced by the Schneider Electric Company
There is a need to enhance a broad understanding of the risks subject to Schneider Electric. In this case, they can be re-categorized into internal and external risk factors. With respect to the internal risk factors, the company lacks an operating history thus making it virtually impossible to predict future business performance. In this case, the company recently changed its name, and it cannot predict whether a future business will be successful. The customers of the company have weak credit histories. This implies that the entities that indulge in business with Schneider Electric might have a wanting credit history. Therefore, they fail to pay up their dues in time (Kapferer, 2008).
Another impending risk is the fact that the company’s revenue is greatly pegged on the efficiency and effectiveness of the company. If the company can manage the terms of the contract, then profitability will be greatly enhanced. As a manufacturing firm, the company is exposed to certain risks that cut across many players in the industry. These include difficulties in hiring skilled labor, predicting the volume well in advance, and availability to source raw materials at competitive prices is also a great challenge. In addition, the immobility of specialized machinery from project to project given the geographical barriers is also a risk. In addition, securing an uninterrupted power source at cost-effective rates is also a great risk to the manufacturing firm. The firm deals with large projects, and hence the insurance covers are exorbitant. At times, the company fails to cover itself from all the economic losses (“Schneider Electric Infrastructure Limited: information memorandum,” 2011).
On the part of the external risks, Schneider Electric is a multinational corporation that is exposed to numerous risks. The company is faced with the exchange rate risk commonly referred to as currency risk. This is the risk in which adverse currency fluctuation between the parent currency and the subsidiaries’ currency leads to losses. However, the risk exposure varies with the transaction that is being undertaken. For instance, when the parent company considers disposing of certain assets owned by the subsidiary, translation risk may occur. There is also transaction risk, which is the possibility of incurring adverse economic losses from currency fluctuations emanating from dealings between the parent company and the subsidiary. There is also an economic risk that comes from a company’s business operations. These are the key external risks that threaten Schneider Electric company (“Schneider Electric Infrastructure Limited: information memorandum,” 2011).
In addition, political and social developments in countries where Schneider Electric has its subsidiaries could adversely affect its business operations. Changes in government policies within the power sector would adversely affect the company. For instance, the company’s growth and development are greatly pegged on the Indian economy. This implies that the growth of the Indian economy will be replicated as the growth of Schneider Electric. However, the vice versa is also true (“Schneider Electric Infrastructure Limited: information memorandum,” 2011).
Schneider Electric operates in a cyclic and competitive market. Therefore, there is the need to develop products that directly address the market needs to ensure business survival and continuity. Another impending risk involved is the level of inflation in the different economies. Very high inflation levels result in the exorbitant cost of business operations, which are then transferred to customers in terms of very expensive commodities and services. Finally, the threat of foreign exchange reserves and their impact on the valuation of the respective country’s currency is present. The liquidity of such reserves dictates the level of prevailing interest rates. The interest rates are important to Schneider Electric as they control the company’s source of funds (Suder, 2007).
Many of the transactions in which Schneider Electric is engaged are international by nature. This leads to foreign exchange risk. Schneider Electric usually engages in forwarding contracts in order to offset this risk. Forward exchange contracts are governed by company policies, and they are regarded as financial derivative instruments. They seek to cover the position of both the seller and the purchaser by locking specified terms that will be fulfilled in the future. The contract uses speculations to calculate the forward exchange rates based on the current or spot rates. Hedging against currency risk seeks to reduce the sensitivity of earnings to fluctuating exchange rates. Forward contracts are forecasting contracts and expire in a short time span, usually 12 months (“Schneider Electric Infrastructure Limited: information memorandum,” 2011).
From the numerous risks that face the company, it will be very important for Schneider Electric to engage in hedging strategies. In order to hedge from the competition risk, Schneider Electric has implemented various procedures. These include business reviews to monitor performance and projections in order to ensure the situation is contained. The company also uses a centralized form of management to manage the risk of competition and other business cycles. However, the procedures adopted are yet to take effect (“Financial and Sustainable Development Annual Report: Registration Document,” 2011; Kapferer, 2008).
In an effort to mitigate the risk posed by failure to meet customer needs, Schneider Electric incurred the highest research and development cost ever recorded in the industry. This commitment has enabled Schneider Electric to market its products and even develop strategic alliances in different geographical zones. The success of Schneider Electric largely depends on its ability to meet the customer needs and specifications. The company has indulged in creating innovative products that are tailored to coincide with the clients’ needs and specifications (“Schneider Electric Infrastructure Limited: information memorandum,” 2011).
In the manufacturing sector, it is quite important to hire and retain qualified staff as the industry is labor-intensive. With this realization, Schneider Electric has sought a workforce strategic planning process. This workforce allows the management team to realize the prevailing workforce needs and recruit qualified personnel as required. Schneider Electric’s success is backed by its unanimous support for diversity with regards to gender and nationality. In addition, the creation of a motivational working environment has also promoted success. Schneider Electric has embarked on training, developing, compensating, and managing their employees (“Schneider Electric Infrastructure Limited: information memorandum,” 2011).
Schneider Electric may engage in partially insured projects. The risk involved in such projects covers the production of defective products. The company mitigates the risk caused by such defects by recalling the products. For instance, in 2009, the company engaged in a recall campaign for defective capacitors that had been developed between 2004-2008. A portion of the expenses incurred in the recall program is compensated by the liability insurance (“Schneider Electric & International electro-technical commission,” 2007).
Schneider Electric seeks to indulge in consolidated borrowing at the Group level in an effort to manage the interest rate risk. This will ensure that borrowing costs are maintained at a minimum. For instance, a 1 percent change in the level of interest rate would cause a similar increase or decrease in the level of expenses. Thus, the company engages in interest rate hedging by engaging in the swap arrangements (“Schneider Electric Infrastructure Limited: information memorandum,” 2011).
It is evident that business risk affects all businesses, and Schneider Electric is no exception. Measures to mitigate the impact of such risks should be adopted to enhance profitability and business survival. Schneider Electric has engaged in remarkable business hedging over the years. This has enabled it to retain relevance in the market despite stiff competition. Schneider Electric should seek to offset as much risk as possible since the threat management process enhances company growth. In addition, the risks are very dynamic in the business world. This calls for Schneider Electric to continue modifying the hedging strategies to ensure risk levels are well managed.
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Financial and Sustainable Development Annual Report: Registration Document, 2011. Web.
Jaeger, L 2005, The new generation of risk management for hedge funds and private equity investments, Institutional Investor Books, New York, NY.
Kapferer, J 2008, The new strategic brand management: creating and sustaining brand equity long term, Kogan Page, London [u.a.].
Schneider Electric & International electro-technical commission 2007, Electrical installation guide: according to IEC international standards, Schneider Electric, France.
Schneider Electric Infrastructure Limited: information memorandum 2011. Web.
Suder, G 2007, Doing business in Europe, SAGE Publications, Los Angeles.