Hewlett-Packard (HP) is a nearly $12 billion company that designs, manufactures, and services electronic products and systems for measurement and computation. Management states in its 1989 Annual Report that "HP's basic bust ness purpose is to provide the capabilities and support needed to help customers worldwide improve their personal and business effectiveness," The California-based company is publicly traded in the United States, as well as on the exchanges in London, Paris, Frankfurt, and Zurich.
Europe is a very important geographic region for HP, In 1989 HP derived 34.7 percent of its revenues and 26.6 percent of its profits from Europe, and 25.1 percent of its identifiable assets were in Europe. HP operates in sixteen countries in Europe, but its largest operations are in the United Kingdom, France, and Germany. HP is the third-largest U.S. computer maker after IBM and DEC, and it was also the third -largest U.S. computer maker in Europe in 1989: 37 percent of IBM's sales and 40 percent of DEC'S sales were in Europe.
HP views Europe as a regional market, although the advent of Europe 1992 is causing management to change to a Pan-European orientation with operations that are going to be far more global as goods and capital move more freely.
HP has established a European headquarters in Geneva, Switzerland, and it centralizes many of its treasury functions there. The Geneva headquarters is a reinvoicing center that buys from supply factories and resells to sales companies Its European subsidiaries purchase up1 to 50 percent of their inventories in dollars but bill in local currencies HP currently sells more than 10,000 products worldwide, making different pricing and hedging strategies necessary. In addition, since many of its sales are intercompany, it must plan around IRS regulations on intercompany transactions.
Pricing StrategyThere are two key pricing issues facing HP. One of them is intercompany and the other is external. In 1990 HP management made the decision that HP would not support the Advanced Determination Ruling (ADR) procedure for any of its intercompany transactions. On the benefit side, management stated: "We have been strongly supportive of the ADR process as an attractive alternative to the current process of worldwide sporadic intercompany audits, litigation, and competent authority appeals as a means to resolve these disputes." However, management felt that the cost of an ADR would be far greater than any possible benefits.
In spite of the decision to forgo any ADRs, HP management identified several criteria that would have to be addressed in order for them to reconsider their decision:
1. The detailed economic analysis required for an ADR would have to be curtailed and abbreviated. Management estimated that the interviews, paperwork, and economics staff would cost between $750,000 and $1,000,000 for each ADR.
2. Assurances concerning the proprietary nature of the information would have to be made. HP management is concerned about two possible groups of users: competitors, who would be able to get access to the information through public disclosure laws. and other IRS agents who are currently auditing HP transfer pricing practices from prior years.
3. Assurances that tax authorities from other countries would accept an ADR and vice-versa.
On the external side, importing products in one currency and selling them in another results in one of three alternatives:
1. Price for the currency swings and hope that demand carries the product;
2. Lose market share but maintain profit margins;
3. Keep market share and accept a lower profit margin.
HP had decided to retain profitability rather than keep market share. However, HP has also promised buyers a three month guarantee on any prices that it quotes. That means that it is exposed to foreign-exchange gains and losses over that three-month period.
In order to hedge the exposure, HP management, during a period of a strengthening dollar, uses forward contracts for the first month and options for the next two months. The use of forwards for a short time is usually less expensive and more predictable, whereas the options are more valuable the further into the future you go. HP has a policy that options cannot cost more than 1.5 percent of the underlying exposure, so it uses that policy to try to hold down its costs. In the case of a weakening dollar, HP takes forward rover for two months and options for the third.
Cash ManagementAs mentioned above, HP has a Geneva headquarters that manages its cash for Europe. By acting as a purchaser and seller of HP products, the Geneva headquarters can net its cash flows more effectively. As noted by their European treasurer, "Several of our subsidiaries generate profits and excess cash. We regularly collect funds in each country and bring them back to Geneva to the in-house bank. Usually we keep the cash in dollars, our natural currency of operations, and then swap into whatever currency we need for financing the subs via the in-house bank." HP uses a proprietary software system called HP Cash to keep track of its cash availability and needs. HP Cash is a fully integrated cash-management system. All cash information from the different subsidiaries is transferred electronically by the subs and their banks to Geneva, and the information is automatically reconciled by HP Cash, When the European Treasurer comes in each morning, he can instantly look at HP's net cash position and determine how to use the funds most effectively.
Each of the larger HP operations in Europe has its own cash installations, and they communicate with Geneva electronically through a private company network. By centralizing the cash information and cash flow, HP has been able to reduce the number of banks that it has to do business with. Bank and other legal regulations meant that they had to do business with several banks in order to get access to the credit and services they needed. Now, however, they can utilize intercompany financing much more effectively.
Questions
1. What do you think are the major factors that are driving HP's centralization strategy?
2. Identify the major foreign-exchange exposures that HP has.
3. Evaluate HP's foreign-exchange exposure strategy. What are some of the things that you would recommend HP consider as it continues to refine its exposure management strategy?
4. Discuss some of the financial considerations that HP has because of its intercompany transactions. Evaluate its response to the ADRs.
New words
litigation – òÿæáà
hedging – õåäæèðîâàíèå, ñòðàõîâàíèå îò ðèñêîâ
identifiable assets – èäåíòèôèöèðóåìîå èìóùåñòâî
treasurer - êàçíà÷åé
proprietary software system – ñîáñòâåííîå ïðîãðàììíîå îáåñïå÷åíèå
currency – äåíåæíîå îáðàùåíèå, âàëþòà
foreign-exchange – èíîñòðàííàÿ âàëþòà
to reconcile - ñîãëàñîâûâàòü
to weaken - ñëàáåòü
transactions - ñäåëêè
network - ñåòü
to evaluate - îöåíèòü