Company Level Strategy to Deal with the Yuan Appreication-Buyers' Perspectives

If a company currently buys or is planning to buy goods/services from China , what should it do? Several scenarios need to be considered before a final decision can be made:

1. Stay on course and continue to pursue the China purchase plan. This may sound imprudent. However, JJ Wellesley held extensive discussions with several US based companies on the currency issue earlier this year when the yuan appreciation rumor just started. Most of these companies felt that the cost savings derived from their China purchase programs have been so substantial, a small-scaled upward movement of the yuan will not diminish the economic merits of buying from China . It is also important to realize that a company is likely to incur a slew of switching costs when it changes a large of part of its procurement from one country to another.

2. Re-do the cost-benefit analyses . If a company is not sure about the exact amount of savings achieved from its buying-from-China program (or the company is just planning to buy from China ), we believe that this is a good time to re-do the cost-benefit analysis of the China procurement plan. JJ Wellesley has always advocated to our clients that this analysis should not be just based on a comparison of labor and material costs. Instead, a total acquisition cost approach should be adopted. Costs in areas such as shipping, inventory holding, product quality, and workers' training should all be carefully examined.

3. Consider risk mitigation alternatives. Perhaps, one of the more significant implications of Beijing 's move on July 21 st is the potential of more frequent and larger scaled volatility of the yuan in the future. Earlier this year, several of our clients started to make plans to mitigate potential currency risk. Some of the actions they considered include:

   • Work with Chinese suppliers to eliminate or contain short-term risks . Many Chinese companies (particularly those in the manufacturing sector) are currently operating in a hyper competitive environment (largely due to over-capacities), some of them are likely to be willing to sacrifice a significant amount of profits to gain bigger and/or longer term contracts. A foreign purchaser can certainly discuss the possibility of a short-term (even medium-term) price guarantee with its Chinese suppliers. If no price guarantee can be achieved, one can also try to negotiate for a short-term price increase cap in the event of further yuan appreciation.
     
   • Consider various currency hedging tools. If a company's procurement from China constitutes a significant portion of its overall cost structure, it ought to consider establishing a formal currency hedging strategy. Having a sensible hedging strategy can prevent a company from going bankrupt. Anyone who followed the US airline industry in recent years can certainly attest to this point.

  Read Part Two-Sellers' Perspectives

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