Tiffany & Co Case Solution
Key Issue
In July 1993 Tiffany & Company entered in a new agreement with its Japanese distributor, Mitsukoshi Limited. This established that operations in Japan which were previously handled by Mitsukoshi along with the responsibility of the inventory would now be in charge by Tiffany & Co.’s management. As per the previous agreement Mitsukoshi purchased inventory on a wholesale basis and sold it in the Japanese market on retail basis. Along with that the Yen/USD exchange rate fluctuations were borne by Mitsukoshi keeping Tiffany unaffected by the exchange rate risk. Now with the new agreement Tiffany must bear the risk associated with the exchange rate fluctuations whilst handling the inventory in Japan. Yen/USD exchange rates will have significant impact on Tiffany’s future financial performance hence the management of Tiffany & Co. must now make a financial decision to tackle the foreign exchange risk the company is now exposed to.
Alternatives
To address the current issue, Tiffany’s set of alternatives are outlined below:
No hedging instruments, use spot rates to convert currency
Enter a Forward Agreements to sell Yen for Dollars (June 3 Month Forwards @ 106.33 Yen)
Purchase a Yen put Option (93.5 Yen @ Premium of 0.000206)
Criteria
Tiffany is required to adapt a strategy that effectively reduces the foreign exchange risk (Yen depreciating against USD) at the optimal level in regards to amount that should be hedged and costs of using hedging instruments. The company’s new sales strategy is to reduce retail prices of goods 20 to 25%, this necessitates a strong Yen to dollar exchange to reap benefits of the predicted sales growth. The company faces several types of risk, first, due to the restructuring of operations in Japan which requires a buyback of inventory ($115 million) previously sold to Mitsukoshi, this is recognised as a Transaction Risk. Translation Risk also increases as the firm is required to prepare their consolidated balance sheet taking the “Foreign Currency Translation Adjustment” into consideration (FASB #52). As per the new agreement Tiffany now bears the exchange rate risk and is held responsible for the inventory in Japan, selling retail price for sales in Yen which exposes Tiffany to Economic Risk. In this case if the currency is not hedged, earnings will fluctuate significantly depending on spot rates. Operational risks are scaled to be most pivotal as a long term risk the strategy adapted will be based on mitigating this weakness.
External Size-Up
Leading up to the contractual change, the Japanese economy had experienced a slump resulting in reduced