t

os
W14494

Teaching Note

rP
ALLIANCE DESIGN CONCEPTS: FOREIGN EXCHANGE RISK

Ryan Orchard wrote this teaching note as an aid to instructors in the classroom use of the case Alliance Design Concepts: Foreign
Exchange Risk, No. 9B14M116. This teaching note should not be used in any way that would prejudice the future use of the case.

yo
This publication may not be transmitted, photocopied, digitized or otherwise reproduced in any form or by any means without the
permission of the copyright holder. Reproduction of this material is not covered under authorization by any reproduction rights
organization. To order copies or request permission to reproduce materials, contact Ivey Publishing, Ivey Business School, Western
University, London, Ontario, Canada, N6G 0N1; (t) 519.661.3208; (e) cases@ivey.ca; www.iveycases.com.

Copyright © 2014, Richard Ivey School of Business Foundation Version: 2017-07-27

SYNOPSIS
op
Alliance Design Concepts: Foreign Exchange Risk provides a look at the impact that foreign exchange
fluctuations can have on the bottom line of a small Canadian company (based in Edmonton) that sources
most of the equipment that it uses for audio system installations for customers from the United States.
Alliance provides price quotes for prospective customers (such as a local church requiring a new sound
system) in Canadian dollars (CAD). A large proportion (60–80 per cent) of these price quotes is based on
tC

high-quality equipment (speakers, amplifiers, etc.) that is sourced from the United States. Considerable
time (four to 16 weeks) may pass between when the price is quoted to the customer and when Alliance
makes payment to the supplier; during that time, a decrease in the value of the CAD relative to the U.S.
dollar (USD) is a direct loss in the margin on the job for Alliance. Andrew Wagstaff, Alliance’s operations
manager, is looking for strategies for mitigating this risk. Possible courses of action are: changes to internal
processes related to price quotations, procurement of equipment and collections/payment, as well as the
possibility of using tools offered by financial service providers, like a foreign currency bank account or the
purchase of forward foreign exchange contracts.
No

TEACHING OBJECTIVES

This case could be used in an undergraduate or MBA course in finance or international business. Although
the business problem centres around and provides a tangible example for discussion of foreign exchange
risk, the technical context is not complex (unless one wishes to put considerable focus on the concept of
forward foreign currency exchange contracts or other such tools) and thus the case also provides an
opportunity for practice in analyzing and improving the management of business processes and cash. The
Do

case could therefore be used with a primary objective of deepening student understanding of foreign
currency-related concepts (e.g., exchange rates and the impact of fluctuation, as well as tools such as
forward foreign currency exchange contracts), with a secondary objective of practicing the analysis and
improvement of business processes and cash management, or it could be used with a primary objective of
practicing the analysis and improvement of business processes and cash management whilst also gaining
exposure to the concept of foreign exchange risk.

This Teaching Note is authorized for use only by Saad Khan, University of Wah until Mar 2025. Copying or posting is an infringement of copyright. Permissions@hbsp.harvard.edu or
617.783.7860.
 Page 2 8B14M116

t
SUPPLEMENTARY READINGS

os
On currency exchange:

 Chapter 9 (“The Foreign Exchange Market”) of C.W.L. Hill and T. McKaig, Global Business Today,
Canadian Ed., McGraw-Hill Ryerson, Toronto, Canada, 2006.


rP
Chapter 11 (“Terms of Sale and Payment”) of D.F. Wood, A.P. Barone, P.R. Murphy and D.L.
Wardlow, International Logistics, 2nd Ed., AMACOM, New York, United States, 2002.

On cash management:

 R. Lacerte, “Rule #1: Cash Is King,” CPA Practice Advisor, 21:4, 2011, p. 17.
 G.R. Barrett, “How Small CPA Firms Manage Their Cash,” Journal of Accountancy, 176:2, 1993, pp.

yo
56–59.
 J.G. Longenecker, J.W. Petty, L.E. Palich and F. Hoy, Small Business Management, 17th Ed., Cengage
Learning, Stamford, United States, 2014.

SUGGESTED ASSIGNMENT QUESTIONS

1. How do exchange rate fluctuations directly affect the bottom line (profit) of a small business, and thus
op
present a risk to be managed? Can Alliance Design Concepts share the foreign exchange risk that it
experiences with others in its supply chain (e.g., suppliers, customers)?
2. (Optional) Discuss the importance of cash to a small business, and general “levers” for managing cash
(such as receivables and payables) that are relevant in this case.
3. What are the relative strengths and weaknesses of the proposed risk mitigation strategies, in the specific
business context of Alliance Design Concepts? (Feel free to bring in any other strategies that may come
to mind, as well.)
tC

4. Propose an implementable mitigation strategy for Alliance Design Concepts. The strategy can include
a combination of any of the strategies mentioned in the case, and/or other strategies that you may have
come up with. Your strategy should explicitly address the business process regarding
quotation/sourcing/payment.

CASE DISCUSSION AND ANALYSIS

No

1. How do exchange rate fluctuations directly affect the bottom line (profit) of a small business,
and thus present a risk to be managed? Can Alliance Design Concepts share the foreign
exchange risk that it experiences with others in its supply chain (e.g., suppliers, customers)?

A change in the exchange rate results in a proportional change to any foreign currency expense (cost of
goods sold, in this case), and thus changes the pre-tax profit by that amount. In the example provided in the
case, the “exchange rate fluctuation represented a direct 8.2 per cent decrease in the pre-tax margin on the
equipment” due to a change in the CAD–USD exchange rate from 0.97 USD to 0.89 USD. The calculation
of the loss on the margin on the equipment was as follows: ([0.97 – 0.89] / 0.97) × 100 = 8.247%.
Do

Obviously, if the change is large and goes against the favour of Alliance, it will eliminate some of the profit
margin on the sale, which already might be slim. While it is also true that over the long run the company
should be an exchange rate winner as often as it is an exchange rate loser (note that it does not track net
exchange rate gains/losses over longer time periods such as a year), this does not seem to be a consolation
to Alliance — a significant exchange rate loss tends to be a short-term problem even if it is preceded or
eventually followed by a comparable gain, partly due to the fact that Alliance is not “saving” the gains to

This Teaching Note is authorized for use only by Saad Khan, University of Wah until Mar 2025. Copying or posting is an infringement of copyright. Permissions@hbsp.harvard.edu or
617.783.7860.
 Page 3 8B14M116

t
pay for future losses and, like many small businesses, is confronted with short-term cash flow challenges.

os
In other words, it sees exchange rate fluctuation as a risk that it wants to mitigate, since over short to
medium time intervals (a few months to a year) it may not have the total sales volume to overcome even a
few major setbacks caused by a decrease in the value of the CAD relative to the USD.
Alliance is probably going to need to manage this issue without the assistance of other members of its

rP
supply chain. As described in the case, Alliance does not have the ability to pass the risk on to the supplier,
since it is the convention for the seller to receive payment in their home country’s currency. Also, given the
relative size of the two organizations (Alliance and its supplier), it is very unlikely that the supplier would
even consider a change to this.

In terms of the customer, it does not seem that the typical type of customer, who is working with a specific
budget and requires pre-approval from a committee, would be happy about taking on the currency risk if
the contract were to require that they pay according to the exchange rate at the time of job completion.

yo
However, there do seem to be some other process-related options that do not create any additional risk for
the customer, but would help Alliance out; these will be discussed with Question 3.

2. (Optional) Discuss the importance of cash to a small business, and general “levers” for
managing cash (such as receivables and payables) that are relevant in this case.

This question may or may not be relevant, depending on the course. The management of cash is inherent in
op
the same processes that affect exchange rate risk, so this makes for a good opportunity to include the
important concept of cash management in the objectives for this case. (However, it would be easy enough
to leave it out and focus only on other concepts as well.)
Cash is a fundamental part of working capital, which is required for funding the day-to-day operations of a
business. Longenecker, Petty, Palich & Hoy (2014) point out that “a firm cannot survive without adequate
working capital” (p. 265). In the context of the Alliance case, working capital (cash) is primarily affected
tC

by the timing of the payment (deposit and balance) received from the customer, and the timing of payment
made to the supplier. The sooner the payment can be collected from customers and the later the payment
can be made to suppliers, the better off the cash position of the business. (Note that this could be at the
expense of others in the supply chain, which arguably affects the whole chain at some point. However, it
would seem that in this case the very large and successful supplier organization is more likely than Alliance
to be in a strong cash position, which implies that stretching the payment terms is beneficial to all members
of this supply chain in the long run.)
No

3. What are the relative strengths and weaknesses of the proposed risk mitigation strategies, in
the specific business context of Alliance Design Concepts? (Feel free to propose any other
strategies that may come to mind.)

Involving the Customer

The typical customer, who is working with a specific budget and requires pre-approval from a committee,
Do

would not be happy about taking on the currency risk if the contract were to require that they pay according
to the exchange rate at the time of job completion. This option, and the option of padding the margin in
order to reduce the risk for Alliance, may make the Alliance quotation less competitive relative to
competitors. However, it does not seem unreasonable that Alliance could ask the customer for other
concessions, such as shorter quotation acceptance times and/or larger deposits, that the customer might be
more easily agreeable to since they do not affect the ultimate cost of the project. (Some suggestions will be
proposed in Question 4.)

This Teaching Note is authorized for use only by Saad Khan, University of Wah until Mar 2025. Copying or posting is an infringement of copyright. Permissions@hbsp.harvard.edu or
617.783.7860.
 Page 4 8B14M116

t
os
Internal Process Changes

There does seem to be opportunity here. Essentially, Alliance needs to reduce the amount of time between
when it quotes a price, which is based on the spot exchange rate on that day, and when it converts cash for
equipment payment from CAD to USD, which is based on a new spot rate. (Note that this holds regardless

rP
of whether it actually makes payment to the supplier at this time, as long as the currency is exchanged.)
There are many factors that Alliance has control over, including the quotation process (e.g. it does not have
to use the standard 30-day acceptance clause and the standard 50 per cent deposit, if neither fits the business
circumstances) and the payment process (e.g., it does not have to wait until it pays the supplier to convert
the cash from CAD to USD).

yo
Foreign Exchange Services

A foreign currency bank account (with a Canadian bank) does not seem to have any drawbacks beyond the
service charges the bank would levy. Based on a call to TD Canada Trust (Small Business Services), it was
found that deposits in CAD would be converted to USD at the going rate (without the 2.5 per cent premium
that the credit cards generally charge) and that payments could be made to the supplier from the account,
by way of cheques, direct deposit or email transactions, with no service charge as long as a minimum
balance was maintained. There would be a monthly fee for this type of account, which ranges from
op
$5/month up to $100+/month and is based on the number of transactions required; exceeding the number
of transactions of the account type would result in additional service charges. The main benefit of a foreign
currency account would be the ability to keep USD on hand so that Alliance would not have to wait until it
intends to pay the supplier before converting cash — it could do so when it receives deposit payment from
the customer, which significantly shortens the time window for potential exchange rate fluctuation. It could
still keep the money in the account for as long as possible (before paying the supplier) in order to have a
tC

stronger cash balance and to accrue interest (i.e., when it pays the supplier has not changed, but when it
converts the cash from the customer to USD has).

In terms of forward exchange contracts, they are certainly a useful tool, but perhaps not for a smaller
organization like Alliance. The reason that they might not fit well is that they would require an
administrative step, beyond the use of a bank account, that is not conventional for small business managers.
In other words, Alliance would need to purchase foreign exchange contracts at one point in time, execute
No

the deal at another point of time, and connect this to a process for paying the supplier at another point in
time. This might not have enough advantages over a foreign currency bank account to warrant the extra
attention needed.

4. Propose an implementable mitigation strategy for Alliance Design Concepts. The strategy can
include a combination of any of the strategies mentioned in the case, and/or other strategies
that you may have come up with. Your strategy should explicitly address the business process
regarding quotation/sourcing/payment.
Do

It would seem that the most important considerations are: (1) Alliance should attempt to shorten the time
between when it provides the price quote to the customer and when it converts cash (hopefully the
customer’s!) into USD and (2) Alliance should be sure to continue to employ smart cash management
practices that are important for small businesses (e.g., expedite receivables and extend payables,
simultaneously). It could likely achieve these by doing the following:

This Teaching Note is authorized for use only by Saad Khan, University of Wah until Mar 2025. Copying or posting is an infringement of copyright. Permissions@hbsp.harvard.edu or
617.783.7860.
 Page 5 8B14M116

t


os
Open a USD account with whichever bank has the plan that fits Alliance best, in terms of daily interest,
reasonable service charges for currency conversions, and direct payment ability to the supplier with
reasonable transaction fees.
 Ask the supplier if a direct payment (versus credit card payment) would be afforded any discount, since
the supplier is likely charged a 1.5–3 per cent “merchant discount fee” on credit card transactions (and,
of less interest to the supplier, Alliance is charged a small fee by the credit card company for the

rP
currency conversion). Although a discount may be unlikely given that Alliance is a “small fish” to the
supplier, it is worth asking for since it is a direct 1.5–3 per cent cost saving for the supplier.
 Ask customers for a quotation acceptance period of two weeks for jobs with high USD equipment costs,
in order to reduce the risk of currency fluctuation during the quotation and project cycle. Hopefully,
the customer will be sympathetic if Alliance explains that it orders the equipment from the United
States.
 Require the deposit at that time (two weeks), as well; if the equipment cost is more than the deposit

yo
amount, ask for a larger deposit to cover the equipment costs. (Again, hopefully the customer will
understand the reason for this.)
 Upon receiving the deposit, immediately convert this cash into the USD account, where it can sit (and
accrue a bit of interest) until payment to the supplier is required. This will have effectively caused the
time period between quotation and conversion of cash to be shortened to only two weeks, and currency
fluctuation risk during two weeks is generally not going to be a major factor. This may also allow for
the consolidation of invoice payments to the supplier if it reduces service fees from the bank (this
op
depends on whether there are fixed service charges for making payment). Hopefully, the interest gained
by managing the cash cycle will offset fees.
 Note that Alliance should not change the timing of when it orders from suppliers or pays suppliers; the
goal is simply to reduce the time between quotation and conversion of the customer’s cash to USD, but
actual payment to the supplier does not have to be completed immediately once the currency is
converted (see Exhibit TN-1).
tC

WHAT HAPPENED

At the time of the writing of the case, the company was reviewing the suggestions made by the case author
and considering a course of action. For the most part, Alliance “have continued just upping the margin for
the products [from the U.S. suppliers]. In the last month or so [they] have started looking at merging with
a similar-sized firm based in the United States, both to pool resources and to increase market range. With a
No

U.S. [partner they] would be able to use U.S. funds to buy the equipment.”
Do

This Teaching Note is authorized for use only by Saad Khan, University of Wah until Mar 2025. Copying or posting is an infringement of copyright. Permissions@hbsp.harvard.edu or
617.783.7860.
 Page 6 DRAFT

EXHIBIT TN-1: MODIFIED QUOTATION AND EQUIPMENT PROCUREMENT PROCESS (ASSUMES SUCCESSFUL QUOTATION)
Do
Customer requests quotation for
audio system solution.

Alliance does site assessment, retrieves

No
equipment pricing from supplier (in USD),
converts dollar amount based on current
exchange rate, and generates quotation in CAD.
tC
Customer agrees to quotation and pays
deposit; installation work is planned.

Alliance converts currency as per current exchange rate

and deposits cash in foreign currency account.

617.783.7860.
op
Equipment is ordered from supplier such that
it arrives when needed for installation. Installation
completed.
Customer to pay
yo
Equipment ships from U.S., Alliance is invoiced (in balance within
USD); payment to supplier required within 60 days. 30 days.

Supplier paid at end of 60 days.

rP
Alliance is subject to exchange rate fluctuation
over elapsed time of only two weeks.

Source: Case author’s rendition of proposed process, which is a modification of the original process that is presented as Exhibit 1 in the case. This exhibit was created based
on interviews with Alliance management on June 2, 2014, and follow-up email correspondence.
os
t

This Teaching Note is authorized for use only by Saad Khan, University of Wah until Mar 2025. Copying or posting is an infringement of copyright. Permissions@hbsp.harvard.edu or