He could try to raise the dollar price of his products to compensate for the fall In the value of the dollar, but he knew that was unlikely to work. The market for machine tools was very competitive, and manufacturers were constantly pressuring machine tool companies to lower prices, not raise them. Another small German supplier to U. S. Automobile companies, Keeper, was faring somewhat better. In 2001 Keeper, which manufactures metal frames for automobile seats, opened a plant in London, Ontario, to supply the U. S. Operations of Demolisher’s- At the time the Investment was made, the exchange rate.
Management at Keeper had agonized over whether the investment made sense. Some in the company felt that it was better to continue exporting from Germany. Others argued that Keeper would benefit from being close too major customer. Now with the Euro appreciating every day, it looked Like a smart move. Keller has a real hedge against the rising value of the Euro. But the advantages of being based in Canada were tempered by two things; first, the U. S. Dollar had also depreciated against the Canadian dollar, although not by as much as its depreciation against the Euro.
While sales of GE scanners in India did not take off as quickly as expected, GE quickly realized it had found a cheap source of talented engineers and programmers. India has a solid base of technology-focused universities and colleges that turn out many engineers every year. The vast majority speak English. While software programmers in the United States with two to four years of experience make $64,000 a year, similarly skilled individuals in India can be had for as little as $2 an our, and programmers at Wiper on average earn $10,000 a year.
That might not sound like a lot, but in India, where the annual per capita income is still less than $500, it can translate into a very good living. GE quickly set aside $5 million a year to hire Wiper software programmers to write code for Gee’s ultrasound machines and its CT scanners. By the mid-sass, senior GE managers began to encourage other units to follow the medical division’s lead and outsource information technology work to Indian companies. As a result, at one point during the mid-sass Wiper was getting as much as 50 percent of its revenues from General Electric.
However, along the way GE taught Wiper a hard lesson. GE was soon contracting out work to other Indian information technology hold onto its GE business, Wiper found that it had to improve its own operating efficiency, so Wiper looked at what GE was doing, and copied it. Wipers Joint venture with GE helped in this regard, since it gave Wiper a window into Gee’s relentless push for operating efficiencies. Thus, following Gee’s lead, Wiper was one of the first Indian companies to adopt the Six Sigma process for improving operating efficiency made famous by GE.
Today, Wiper executives credit much of their success in the international market to the hard lessons it learned about efficiency as a GE vendor. By the late sass, GE began to turn its attention from simply buying software from India, to using the country as a base for data entry, processing credit card applications, and other clerical tasks that could be performed over the Internet. About this time, other Western companies such as American Express and British Airways began doing the same thing.
GE estimates that it cut operating costs $300 million a year by shifting such work to India. Wiper was a major beneficiary. Today Wipers 39,000 technology employees write software, integrate back-office lotions, design semiconductors, debug applications, take orders, and field help calls for some of the biggest companies in the world. Its customers still include General Electric along with Hewlett-Packard, Home Depot, Monika, Sony, and Weyerhaeuser. By using the Internet, Wiper can maintain and manage software applications for companies all over the world in real time.
Typical is Wipers relationship with Weyerhaeuser, one of the world’s largest timber companies. Wiper’s involvement with Weyerhaeuser began in 1999 when two employees conducted a modest on-site analysis at Weyerhaeuser U. S. Headquarters Just south of Seattle. By 2003, Wiper was supporting a broad array of Weyerhaeuser information systems including logistics, sales, and human resource applications from Bangor, India. Overall, Wiper estimates it can save clients as much as 40 percent of the cost of maintaining such systems.
In a highly competitive global economy, the imperative for companies such as Weyerhaeuser to outsource is compelling. Wiper, however, is not content to remain in the low-margin end of the software business. The company increasingly is moving upstream into high value-added applications. For example, in 2002, Wiper signed a deal to design and engineer tape outrage devices for Storage Technology. In 2004, Wiper took over responsibility for all development work on this product line from 200 employees in Minneapolis.
Wiper is also moving rapidly into high value-added software services, such as establishing global supply chain or billing systems for large corporations, a business that is currently dominated by Western consulting outfits such as MM, DES, and Accentuate. As Wiper expands its business, it is also taking steps to become a more global push. The company now has a direct sales presence in 35 countries, most of which are staffed by local nationals. By 2005, the company hopes that three-quarters of the employees that customers see will be local nationals;in Europe the figure is already 90 percent.
According to a Wiper spokesman, using locals “provides the cultural and linguistic ties that make clients smile, and help us build stronger relationship. ” Wiper is also buying local companies to give it instant industry presence. In November 2002, Wiper paid $26 million for American Management Systems, buying not Just credibility but also 90 consultants and 50 existing client relationships in the energy business. While these consultants will manager contact with U. S. Customers, much of the software development work will be moved to Bangor.
In something of a departure from its historic strategy, since 2000 Wiper has also been moving some product development work out of India to developed nations. It now has nine development centers in Europe and the United States. These centers focus on product development work where more communication between Wiper engineers and the client is required than with the typical outsourcing contract, and where language is an issue. In Germany, for example, Wiper has found that it can win more business if not only its salespeople are German, but also some development ark is done locally by German engineers.
Questions: 1 . How did outsourcing work to Wiper improve General Electrics ability to compete in the global economy? Does such outsourcing harm or benefit the American economy? 2. Did General Electric help to create Wiper? How? 3. If Indian’s information technology companies continue to prosper, over time what do you think will happen to the income differential between software programmers in the United States and India? What are the implications for the American Economy? 4. Since 2000, Wiper has moved abroad, establishing sales officers in 35 nations ND design centers in nine.
Why is Wiper doing this? What would happen to the company if it did not follow this strategy? 5. What does the rise of Wiper teach you about the nature of the global economy in the first decade of the 21st century? CASE Ill FINANCIAL GOLD Brazier’s Gold Lineal Areas Intelligence is a tropical version of Getable Airways and 2001, Gold adopted the low-cost model pioneered by Southwest Airlines, and refined by the likes of Getable and Ryan. Gold sells discount tickets, mainly over the Internet. It targets price-sensitive business travelers, who account for 70 percent of traffic in
Brazier’s rapidly growing market for air travel (demand for air travel in Brazil is growing at roughly twice the rate of growth in the country’s gross domestic product). Gold is also going after Brazier’s large bus market;in 2001, some 130 million people in Brazil traveled by interstate bus companies. Gold has standardized its fleet on a single aircraft model, Boeing’s 737 series. There are no airport clubs or frequent-flier programs, cabins are a single class, and light snacks and beverages replace meals. The airline also offers Internet check-in and delivers a reliable product, with 95 recent of flights arriving on time.
Sol’s service has elicited a remarkable response from customers, with an independent market research survey finding that more than 90 percent of customers would continue to use the airline and recommend in to others. From a standing start in January 2001 , this business model enabled Gold to capture a 22 percent share of the Brazilian market by mid-2004. By then, Gold had a fleet of 25 aircraft and was already ranked as one of the fastest growing and most profitable airlines in the world, but its aspirations are much bigger. Gold wants to be the low-cost carrier in South America.
To get to that point, it plans to expand its fleet to some 69 aircraft by 2010. To help finance this expansion, Gold decided to tap into the global capital market. In mid-2004, the privately held company offered nonvoting preferred stock to investors on the SEES Paulo Paves and the New York Stock Exchange. The simultaneous offering was oversubscribed, with the underwriters lifting the offering price twice, and raised some $322 million. In explaining the decision to offer stock through the New York Stock Exchange, Sol’s chief financial officer noted, “We wanted to get a solid group of long-term investors that understood the business.
We’ve got that. We also wanted to get a solid group of research analysts that understood this sector, and we now have seven analysts covering the stock. Southwest, Getable, Ryan, and Weakest are considered the tier one in terms of operating profitability and successes. We were able to put Gold right up in that group. Doing both the NYSE and Paves was part of our strategy to sell shares to investors that have familiarity with low-cost carriers. The strategy works. If you look at the list of major investors in the company, the majority of them have high positions in trade of the equities of
Getable, Southwest, and Ryan. For them, it was a very easy analysis to understand Sol’s business model and how it makes money. ” 1 . What were the benefits to Gold of a listing on the New York Stock Exchange in addition to the SEES Paulo Paves? 3. Do you think Gold would have raised as much money if it had Just listed on the SEES Paulo exchange? 4. How might the Joint listing of the New York and SEES Paulo stock exchange affect Sol’s ability to raise additional capital in the future?
For decades the rich countries of the developed world have lavished subsidies on heir farmers, typically guaranteeing them a minimum price for the products they produce. The aim has been to protect farmers in the developed world from the potentially devastating effects of low commodity prices. Although they are small in numbers, farmers tend to be politically active, and winning their support is important for many politicians. The politicians often claim that their motive is to preserve a historic rural lifestyle, and they see subsidies as a way of doing this.
This logic has resulted in financial support estimated to exceed $300 billion a year for farmers in rich nations. The European Union, for example, has set a minimum price for butter of 3,282 euros per ton. If the world price for butter falls below that amount, the EX. Will make up the difference to farmers in the form of a direct payment or subsidy. In total, EX. Dairy farmers receive roughly $1 5 billion a year in subsidies to produce milk and butter, or about $2 a day for every cow in the EX.;a figure that is more than the daily income of half the world’s population.
Overall, EX. Farmers receive $53 billion a year in subsidies. The EX. Is not alone in this practice. In the United States, subsidies are given to a did range of crop and dairy farmers. Typical is the guarantee that U. S. Cotton farmers will receive at least $0. 70 for every pound of cotton they harvest. If world cotton prices fall below this level, the government makes up the difference, writing a check to the farmers. Some 25,000 U. S. Cotton farmers received some $3. 4 billion in annual subsidy checks. Total agricultural subsidies in the United States amount to some $19 billion a year.
One consequence of such subsidies is to create surplus production. That surplus is sold on world markets, where the extra supply depresses prices, making it much order for producers in the developing world to sell their output at a profit. For example, EX. Subsidies to sugar beet producers amount to more than $4,000 an acre. With a minimum price guarantee that exceeds their costs of production, EX. Farmers plant more sugar beet than the EX. Market can absorb. The surplus, some 6 million tons per year, is dumped on the world market, where it depresses world prices. Markets, sugar prices would increase by 20 percent.
That would make a big difference for developing nations such as South Africa, which exports roughly half of its 2. 6 million tons of annual sugar production. With a 20 percent rise in world prices, the South African economy would reap about $40 million more from sugar exports. American subsidies to cotton farmers have a similar effect. Brazilian officials contend that by creating surplus production in the United States that is then dumped on the world market, U. S. Cotton subsidies have depressed world prices for cotton by more than 50 percent since the mid-sass.
Low cotton prices cost Brazil some $600 million in lost export earnings in 2001-2002. India, another big cotton producer, has estimated that U. S. Cotton subsidies reduced its export revenue from cotton by some $1 billion in 2001. According to the charitable organization Sofas, the U. S. Government spends about three times as much on cotton subsidies as it does on foreign aid for all of Africa. In 2001, the African nation of Mali lost about $43 million in export revenues due to plunging cotton prices, significantly more than the $37 million in foreign aid it received from the United States that year.
Overall, the United Nations has estimated that while developed nations give about $50 billion a year in foreign aid to the developing world, agricultural subsidies cost producers in the developing world some $50 billion in lost export revenues, effectively canceling out the effect of the aid. As one UN official has noted, “It’s no good building up roads, clinics, and infrastructure in poor areas if you don’t give them access to markets and engines for growth. Similarly, Sofas has taken the unusual position for a charity of coming out strongly in support of the elimination of agricultural subsidies and price supports. If world prices were increased and production was shifted from high-cost, protected producers in Europe and America to lower-cost producers in the developing world, Sofas claims that consumers in rich actions would benefit from lower domestic prices and the elimination of taxes required to pay for the subsidies, while producers in the developing world would gain from fairer competition, expanded markets, and higher world prices.
In the long run, the greater economic growth that would occur in agriculturally dependent developing nations would be to everyone’s benefit. Although subsidies have been against the spirit of World Trade Organization rules, under the terms of a 1995 “peace agreement,” WTFO members agreed not to take each other to court over agricultural subsidies. However, that agreement expired December 31, 2004. Signs are growing that unless rich countries take steps to cut their subsidies soon, a number of efficient agriculture exporting countries will launch an assault on farm subsidies.
Brazil did not even wait for the “peace agreement” to expire; in late 2003 it filed a complaint with the World Trade Organization, claiming that the United States had retained its position as the second largest cotton grower cotton farmers between August 1999 and July 2003. Brazil argued that in 2001-2002, the U. S. Funneled nearly $4 billion in subsidies to its cotton farmers for a crop worth just $3 billion, which depressed world prices and cost Brazil $600 million in lost sales. In an interim ruling issued in mid-2004, the WTFO agreed that U.
S. Subsidies, by encouraging surplus production, had lowered cotton prices and harmed Brazilian exporters. The United States appealed, and it may be two more years before the issue is resolved. 1 . If agricultural tariffs and subsidies to producers were removed overnight, what would the impact be on the average consumer in developed nations such as the United States and the EX. Countries? What would be the impact on the average farmer? Do you think the total benefits outweigh the total costs, or vice versa? 2.
Which do you think would help the citizens of the world’s poorest nations more, increasing foreign aid or removing all agricultural tariffs and subsidies? 3. Why do you think governments in developed nations continue to lavish extensive support on agricultural producers, even though those producers constitute a very small segment of the population? 4. The current Doth Round of talks organized by the World Trade Organization is trying to reduce barriers to free trade in agriculture. So far, however, the talks have dad little concrete progress on this issue.
Why do you think this is the case? What other solutions can you think of for the problems created by barriers to trade in agriculture? CASE V CHINA’S PEGGED EXCHANGE RATE Since 1994 China has pegged the value of its currency, the Yuan, to the U. S. Dollar at an exchange rate of $1 = 8. 28 Yuan. Consequently, the value of the Yuan has moved in lockstep with the value of the U. S. Dollar against other currencies. As the dollar rose in the sass, so did the Yuan, and as the dollar fell in 2002-2004, so did the Yuan.
To maintain the exchange rate of the Yuan against the dollar, the Chinese entree bank regularly bought or sold dollars. China also has much stricter controls than most countries, which makes it very difficult for private citizens or companies in China to move money out of the country and exchange it for foreign currency. This too, helps to preserve the value of the Yuan against the dollar. By early 2005, however, pressure was building for China to alter its exchange rate policy and let the Yuan float freely against the dollar. Egged exchange rate undervalues the Yuan by as much as 40 percent. In turn, the cheap Yuan is helping to fuel a boom in Chinese exports to the West, particularly the United States where the trade deficit with China expanded to a record $160 billion in 2004. Job losses among American manufacturing companies have created political pressures in the United States for the government to push the Chinese to let the Yuan float freely against the dollar. Some American manufacturers complain that they cannot compete against “artificially cheap” Chinese imports. In mid-2003, 16 U. S. Mentors from both parties sent a letter to the George W. Bush administration complaining that the cheap Yuan was harming American manufacturers, leading to job losses and threatening the case for free trade. Others have painted the Chinese policy as a kind of neo-mercantilism, whereby an artificially cheap currency is used to boost exports and limit imports. Keeping the Yuan pegged to the dollar is also becoming increasingly problematic for the Chinese, too. The trade surplus with the United States and strong inflows of foreign investment has led to a surge of dollars into China.
To maintain the exchange rate, the Chinese central bank regularly buys dollars from commercials banks, issuing them Yuan at the official exchange rate. As a result, China’s foreign exchange reserves has risen to more than $600 billion in early 2005, and the Chinese were purportedly buying some $1 5 billion each month in an attempt to maintain the dollar/ Yuan exchange rate. When the Chinese central bank issues Yuan to mop up excess dollars, the authorities are in effect expanding the domestic money supply. The Chinese banking system is now awash with money.
Excessive lending could create a financial bubble and a surge in price inflation, which might destabilize the economy. In 2004, the annual inflation rate rose above 5 percent for the first time in seven years. So why don’t the Chinese simply move to a floating exchange rate regime? Easier said than done! Moving quickly to a free float raises the possibility of destabilize the economy even more. According to the chairman of the U. S. Federal Reserve, Alan Greenshank, the Chinese banking system is very weak. As much as 50 percent of all bank loans are nonperforming.
Many of these loans were made at the bequest of the government, often to state-owned companies which can no longer repay them. The only way that the banking system can operate with such a high proportion of nonperforming loans is if depositors don’t pull their money out. But moving to a floating exchange rate would require the Chinese to abandon their capital controls. If this were to occur, many Chinese might change their Yuan into other currencies and move capital out of the country. The resulting outflow of capital from the Chinese banking system could cause it to collapse, plunging China into a deep economic crisis.
Thus, before China moves to a floating exchange rate regime, Greenshank believes that the country must first fix its banking system. The Chinese seem to be going down this road. They are taking steps to restructure their banking system, increasing the loan loss reserves of banks and removing political influence from lending policies. They are also actively debating a gradual approach toward changing which the Yuan is allowed to fluctuate against the dollar within a presidencies range, which might itself change over time.
Another alternative is to make a small change in the current exchange rate, with other small changes to follow. 1 . Why do you think the Chinese government originally pegged the value of the Yuan against the U. S. Dollar? What were the benefits of doing this for China? What were the costs? 2. Over the last decade, many foreign firms have invested in China and used their Chinese factories to produce goods for export. If the Yuan is allowed to float freely against the U. S. Dollar on the foreign exchange markets and appreciates in value, how might this affect the fortunes of these enterprises? . How might a decision to let the Yuan float freely affect future foreign direct investment flows into China? 4. Under what circumstances might a decision to let the Yuan float freely destabilize the Chinese economy? What might the global implications of this be? 5. Do you think the U. S. Government should push the Chinese to let the Yuan float freely? Why? 6. What do you think the Chinese government should do? Let the Yuan float, maintain the peg, or change the peg in some way?
