Question

BLADES, INC. CASE Consideration of Direct Foreign Investment For the last year, Blades, Inc., has been exporting to Thailand in order to supplement its declining U.S. sales. Under the existing arrangement, Blades sells 180,000 pairs of roller blades annually to Entertainment Products, a Thai retailer, for a fixed price denominated in Thai baht. The agreement will last for another 2 years. Furthermore, to diversify internationally and to take advantage of an attractive offer by Jogs, Ltd., a British retailer, Blades has recently begun exporting to the United Kingdom. Under the resulting agreement, Jogs will purchase 200,000 pairs of Speedos, Blades' primary product, annually at a fixed price of £80 per pair. Blades' suppliers of the needed components for its roller blade production are located primarily in the United States, where Blades incurs the majority of its cost of goods sold. Although prices for inputs needed to manufacture roller blades vary, recent costs have run approximately $70 per pair. Blades also imports components from Thailand because of the relatively low price of rubber and plastic components and because of their high quality. These imports are denominated in Thai baht, and the exact price (in baht) depends on prevailing market prices for these components in Thailand. Currently, inputs sufficient to manufacture a pair of roller blades cost approximately 3,000 Thai baht per pair of roller blades. Although Thailand had been among the world's fastest-growing economies, recent events in Thailand have increased the level of economic uncertainty. Specifically, the Thai baht, which had been pegged to the dollar, is now a freely floating currency and has depreciated substantially in recent months. Furthermore, recent levels of inflation in Thailand have been very high. Hence, future economic conditions in Thailand are highly uncertain. Ben Holt, Blades' chief financial officer (CFO), is seriously considering DFI in Thailand. He believes that this is a perfect time to either establish a subsidiary or acquire an existing business in Thailand because the uncertain economic conditions and the depreciation of the baht have substantially lowered the initial costs required for DFI. Holt believes the growth potential in Asia will be extremely high once the Thai economy stabilizes. Although Holt has also considered DFI in the United Kingdom, he would prefer that Blades invest in Thailand as opposed to the United Kingdom. Forecasts indicate that the demand for roller blades in the United Kingdom is similar to that in the United States; since Blades' U.S. sales have recently declined because of the high prices it charges, Holt expects that DFI in the United Kingdom will yield similar results, especially since the components required to manufacture roller blades are more expensive in the United Kingdom than in the United States. Furthermore, both domestic and foreign roller blade manufacturers are relatively well established in the United Kingdom, so the growth potential there is limited. Holt believes the Thai roller blade market offers more growth potential. Blades can sell its products at a lower price but generate higher profit margins in Thailand than it can in the United States. This is because the Thai customer has committed itself to purchase a fixed number of Blades' products annually only if it can purchase Speedos at a substantial discount from the U.S. price. Nevertheless, since the cost of goods sold incurred in Thailand is substantially below that incurred in the United States, Blades has managed to generate higher profit margins from its Thai exports and imports than in the United States. As a financial analyst for Blades, Inc., you generally agree with Holt's assessment of the situation. However, you are concerned that Thai consumers have not been affected yet by the unfavorable economic conditions. You believe that they may reduce their spending on leisure products within the next year. Therefore, you think it would be beneficial to wait until next year, when the unfavorable economic conditions in Thailand may subside, to make a decision regarding DFI in Thailand. However, if economic conditions in Thailand improve over the next year, DFI may become more expensive both because target firms will be more expensive and because the baht may appreciate. You are also aware that several of Blades' U.S. competitors are considering expanding into Thailand in the next year. If Blades acquires an existing business in Thailand or establishes a subsidiary there by the end of next year, it would fulfill its agreement with Entertainment Products for the subsequent year. The Thai retailer has expressed an interest in renewing the contractual agreement with Blades at that time if Blades establishes operations in Thailand. However, Holt believes that Blades could charge a higher price for its products if it establishes its own distribution channels.

Identify and discuss some of the benefits that Blades, Inc., could obtain from DFI.

Do you think Blades should wait until next year to undertake DFI in Thailand? What is the tradeoff if Blades undertakes the DFI now?

Do you think Blades should renew its agreement with the Thai retailer for another three years? What is the tradeoff if Blades renews the agreement?

Assume a high level of unemployment in Thailand and a unique production process employed by Blades, Inc. How do you think the Thai government would view the establishment of a subsidiary in Thailand by firms such as Blades? Do you think the Thai government would be more or less supportive if firms such as Blades acquired existing businesses in Thailand? Why?

Answer 1

Ans 1: First, since Blades’ growth potential in the United States is limited, it could utilize Thailand in order to attract new sources of demand, especially since the growth potential in future years is high. Second, Blades is able to generate higher profit margins in Thailand than in the U.S. Third, raw materials are less expensive in Thailand than they are in the U.S. Fourth, by expanding its operations to Thailand, Blades is more diversified and reduces its exposure to the U.S. economy

Ans 2: If Blades undertakes the direct foreign investment now, the initial outlay required will be relatively low due to the recent economic conditions in Thailand and due to the depreciation of the baht. However, if economic conditions do not improve within the next year, Blades may not generate the expected return on its Thai investment and may have to sell its Thai operations at a loss. If Blades waits until next year to make its decision, economic conditions may have improved and there may be less uncertainty associated with the investment. However, if economic conditions in Thailand do improve, the initial outlay required to invest in Thailand will have increased. Furthermore, Blades’ competitors may already be established in Thailand next year, which would make it harder for Blades to gain market share there

Ans 3: If Blades renews the agreement with the Thai retailer, it will have to maintain the relatively low prices it charges the Thai retailer. It may be able to charge higher prices by establishing its own distribution channels. If economic conditions in Thailand improve, demand for Blades’ products in Thailand will likely be strong, and Blades would probably generate higher profit margins by using its own distribution channels. However, if economic conditions in Thailand continue to deteriorate, the agreement would be an advantage for Blades, as it guarantees the sale of a minimum number of products sold each year.

Ans 4: Given a high level of unemployment in Thailand and a unique production process employed by Blades to manufacture roller blades, the Thai government would be faced with a tradeoff if Blades would like to establish a subsidiary in Thailand. On the one hand, locally owned businesses in Thailand may lose business because of the new competition, which may increase the level of unemployment in Thailand.

Conversely, if a firm such as Blades acquires an existing business in Thailand, the level of unemployment in Thailand may be reduced if the firm employs local labor. Furthermore, if the Thai government requires Blades to share its technology, other Thai firms may benefit. Thus, the Thai government would probably be more supportive of firms that acquire existing firms as opposed to those establishing a subsidiary in Thailand, assuming that the acquisition was not intended to downsize the target.