Hedging is a widely used finance term that basically refers to measures that are adopted by an organization to mitigate or avoid a certain risk. In finance, the main source of risk emanates from 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, it is important that for businesses to come up with strategies to mitigate the impact of the above risks. Hedging is therefore, an investment plan that is prepared with the intent to offset or mitigate business losses that may incur from the operations of an enterprise. Hedging has various strategies that can be implemented which a raise due to 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 is a France based incorporated in 2011. It is a multinational engineering company which seeks to specialize in electric transformation and, automation. Schneider Electric’s hedging strategies are mainly derived from the risks that are faced by the particular company (Kapferer, 2008). It is very evident that business risk is subject to all businesses 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 Schneider Electric
To enhance broad understanding of the risks subject to Schneider Electric, it is important they re categorized into; internal and external risk factors. The internal risk factors include; the company lacks an operating history thus makes it virtually impossible to predict future business performance. This is because, the company recently changed its name and as such cannot predict future business will be successful. The customers of the company have weak credit histories. This implies that the entities which indulge in business with Schneider Electric might have a wanting credit history and hence, fail to pay up their obligations in time (Kapferer, 2008).
Another impending risk is the fact that the company’s revenue is greatly pegged on how efficient and effective the company is. If the company is able to manage the terms of the contract, then profitability will be greatly enhanced. As a manufacturing firm, the firm is exposed to certain risks that cut across many players in the industry as a whole. These would include; difficulty in hiring skilled labour, it is difficult to predict the volume well in advance, the availability to source raw materials at competitive prices is also a great challenge. In addition, immobility f specialized machinery from project to project given the geographical barriers is also a risk combined with the fact that, securing an uninterrupted power source at cost effective rates is also a great risk to the manufacturing firm. The firm deals with large project and hence the insurance covers are exorbitant. At times, the company fails to cover itself from all the economic losses its exposed to (‘Schneider Electric Infrastructure Limited: information memorandum 2011’).
The external risks include; Schneider Electric is a multinational corporation. The first and crucial risk t faces is the exchange rate risk commonly referred to as currency risk. This is the risk that adverse currency fluctuation between the parent currency and the subsidiaries currency will amount to losses. The risk exposure however varies with the kind of transaction that is being undertaken. For instance, when the parent company considers dispo0sing certain assets owned by the subsidiary, translation risk will be present. There is also transaction risk which is the possibility of incurring adverse economic losses from currency fluctuations from dealings between the parent company and the subsidiary. There is also an economic risk comes from a company’s business operations. This the key external risk that faces 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 in the power sector would adversely affect the company. For instance, the company’s growth and development is great pegged on the Indian economy. This hence 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. There hence a raises 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 of the exorbitant cost of business operations which are then transferred to its customers in terms of very expensive commodities and services. Finally, the threat of foreign exchange reserves and their impact to the valuation of the respective country’s currency is present. This is because the liquidity of such reserves dictates the level of prevailing interest rates. To Schneider Electric, interest rates are important as they control the company’s source of funds (Suder, 2007).
Hedging strategies undertaken by Schneider Electric company
Many of the transactions in which Schneider Electric engages in are international in nature. This thus leads to foreign exchange risk. To offset this risk, Schneider Electric usually engages in forward contracts. Forward exchange contracts are governed by company policies and they are a type of financial derivative instrument. 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 basing on the current or spot rates. The locking of a future position seeks to eliminate the eventuality of any adverse change in any participants currency or economy. Hedging against currency risk solely seeks to reduce the sensitivity of earnings to the fluctuating exchange rates. Forward contracts are basically forecasting contracts and expire in short time spans, usually 12 months (‘Financial and Sustainable Development Annual Report: Registration Document, 2011’).
From the numerous amounts of risk that face the company, it will be very important to for Schneider Electric to engage in hedging strategies.
To hedge from the competition risk, Schneider Electric has implemented procedures which include; business reviews to monitor performance and projections to ensure the situation is contained. Also, the forecasts and results to date are adopted to manage these risks. 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 (Kapferer, 2008).
To mitigate the risk posed by failure to meet customer needs, Schneider Electric incurred has the highest research and development cost in the industry. This commitment has enabled Schneider Electric to market its products and even develop strategic alliances within different geographical zones. The success of Schneider Electric largely depends on its ability to meet the customer needs and specifications. The company has thus indulged in creating innovative products that are tailored to coincide with the clients needs and specifications (‘Financial and Sustainable Development Annual Report: Registration Document, 2011’).
In the manufacturing sector, it is quite important to hire and retain qualified staff as the industry is labour intensive. With this realization, Schneider Electric has sought a workforce strategic planning process. This workforce allows the management team to realize of the prevailing workforce needs and, to recruit the qualified personnel as required. Schneider Electric’s success of the labour force 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 the success. Schneider Electric has embarked on training, developing, compensating and managing their employees (‘Financial and Sustainable Development Annual Report: Registration Document, 2011’).
Schneider Electric may engage in partially insured projects. The risk involved in such projects revolves around 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).
To manage interest rate risk, Schneider Electric seeks to indulge in consolidated borrowing at the Group level. The sole aim of interest rate management is to ensure that borrowing costs are maintained at a minimum. For instance; a 1 percent change in the level of interest rate would result in a comparable increase or decrease in the level of expenses. The company thus engages in interest rate hedging by engaging in the swap arrangements (‘Financial and Sustainable Development Annual Report: Registration Document, 2011’).
It is very evident that business risk is subject to all businesses and Schneider Electric is no exception. Measures to mitigate the impact of such risk 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 as it faces stiff competition. Hedging is not all inclusive however, Schneider Electric should seek to offset as much risk as possible as the threat management process enhances company growth. In addition, the risks are very dynamic in the business world. This thus calls for Schneider Electric to continue modifying the hedging strategies to ensure risk levels are maintained at bare minimum.