CASE STUDY: Managing Foreign Currency Exposure at 3M 3M is one of America’s oldest and most venerable diversified industrial corporations. The company is known for its strong consumer brands, such as Scotch, Scotchgard, Post-it, Scotch-Brite, and ACE Bandages, but in truth its consumer business only constitutes a small part of its activities. The company also has many product offerings with applications in industrial areas such as automotive, health care, electronics, and energy, as well as safety and graphics. 3M has a well-earned reputation for being an innovation machine, plowing 6 percent of its annual revenues back into R&D. A long history of innovation has given 3M a portfolio of 55,000 products, many of which command high margins. Some 30 percent of its sales come from products introduced in the last five years. In addition to being an innovation machine, 3M is also one of the most international of all U.S. companies. The company generates around 60 percent of its $32 billion in annual revenues from sales outside of the United States. This large global business has sales in 200 countries and operations in 70. The company has 200 plants around the world; manufactures many of its own inputs in addition to final products; and has built up networks of regional supply chains to better manage inventory, improve customer responsiveness, achieve economies of scale, and realize the productivity gains that come from manufacturing products in the optimal location. Like many companies, 3M tries to reduce its exposure to such adverse effects by hedging its foreign exchange risk. The company enters into what are known as foreign exchange forward contracts, in advance of a foreign transaction, to “lock in” the exchange rate. The company may lock in exchange rates as much as 36 months in advance. For example, if 3M is exporting a product to the euro zone with payment in euros expected in three months, and it thinks that the U.S. dollar might appreciate against the euro over the next three months but it’s not sure about this, 3M might purchase a three-month forward contract that locks in a certain dollar–euro exchange rate. By doing this, 3M knows what revenue it will get from the sale at that time in terms of dollars, and dollar sales are not reduced by a rise in the value of the dollar against the euro over the next three months. Of course, such forward contracts are not free, nor are they perfect. In the face of uncertainty, the company may bet incorrectly and lose out. If the dollar falls against the euro over the next three months, instead of rising as 3M expected, 3M would have been better off not hedging because the unhedged dollar value of its euro sales would have increased. As circumstances warrant, 3M also uses foreign currency forward contracts and foreign currency debt as hedging instruments to protect the value of portions of the company’s net investments in foreign operations. For example, in 2018, its European operations were partly financed by €4.1 billion in euro-denominated debt. If that debt were denominated in U.S. dollars, but had to be serviced by 3M’s European operations, then the cost of servicing that debt in euros for the European subsidiaries would go up if the euro declined in value against the dollar, thereby reducing 3M’s euro-zone profits when denominated in U.S. dollars. It is by actions such as these that 3M reduces its exposure to the unpredictable movements in currency exchange rates over time. Case Discussion Questions If the dollar appreciates in value against most other countries over the next year, what will the impact of this be on 3M? If the dollar depreciates in value against most other countries over the next year, what will the impact be on 3M? Should 3M hedge against adverse movements on foreign exchange rates? How should it do this? Should it hedge all of its foreign exchange transactions, or just a subset?
CASE STUDY:
Managing Foreign Currency Exposure at 3M
3M is one of America’s oldest and most venerable diversified industrial corporations. The company is known for its strong consumer brands, such as Scotch, Scotchgard, Post-it, Scotch-Brite, and ACE Bandages, but in truth its consumer business only constitutes a small part of its activities. The company also has many product offerings with applications in industrial areas such as automotive, health care, electronics, and energy, as well as safety and graphics. 3M has a well-earned reputation for being an innovation machine, plowing 6 percent of its annual revenues back into R&D. A long history of innovation has given 3M a portfolio of 55,000 products, many of which command high margins. Some 30 percent of its sales come from products introduced in the last five years.
In addition to being an innovation machine, 3M is also one of the most international of all U.S. companies. The company generates around 60 percent of its $32 billion in annual revenues from sales outside of the United States. This large global business has sales in 200 countries and operations in 70. The company has 200 plants around the world; manufactures many of its own inputs in addition to final products; and has built up networks of regional
Like many companies, 3M tries to reduce its exposure to such adverse effects by hedging its foreign exchange risk. The company enters into what are known as foreign exchange forward contracts, in advance of a foreign transaction, to “lock in” the exchange rate. The company may lock in exchange rates as much as 36 months in advance. For example, if 3M is exporting a product to the euro zone with payment in euros expected in three months, and it thinks that the U.S. dollar might appreciate against the euro over the next three months but it’s not sure about this, 3M might purchase a three-month forward contract that locks in a certain dollar–euro exchange rate. By doing this, 3M knows what revenue it will get from the sale at that time in terms of dollars, and dollar sales are not reduced by a rise in the value of the dollar against the euro over the next three months. Of course, such forward contracts are not free, nor are they perfect. In the face of uncertainty, the company may bet incorrectly and lose out. If the dollar falls against the euro over the next three months, instead of rising as 3M expected, 3M would have been better off not hedging because the unhedged dollar value of its euro sales would have increased.
As circumstances warrant, 3M also uses foreign currency forward contracts and foreign currency debt as hedging instruments to protect the value of portions of the company’s net investments in foreign operations. For example, in 2018, its European operations were partly financed by €4.1 billion in euro-denominated debt. If that debt were denominated in U.S. dollars, but had to be serviced by 3M’s European operations, then the cost of servicing that debt in euros for the European subsidiaries would go up if the euro declined in value against the dollar, thereby reducing 3M’s euro-zone profits when denominated in U.S. dollars. It is by actions such as these that 3M reduces its exposure to the unpredictable movements in currency exchange rates over time.
Case Discussion Questions
If the dollar appreciates in value against most other countries over the next year, what will the impact of this be on 3M?
If the dollar
Should 3M hedge against adverse movements on foreign exchange rates? How should it do this?
Should it hedge all of its foreign exchange transactions, or just a subset?
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