Famous for selling cosmetics door-to-door through ‘Avon ladies’ sales representatives, Avon is the world’s largest direct seller of beauty products, with more than US $11 billion in annual revenues from over 100 domestic and foreign markets.[ii]
Avon was founded as the California Perfume Company by David McConnell in 1886 and named Avon in 1939. In 1914, it opened its first international office in Montreal, Canada. By 1986, more than a third of its US $3 billion sales came from abroad.[iii] By the end of 2011, the foreign share of its total consolidated revenue from outside North America had risen to 81 per cent.[iv]
Extensive cross-border activities expose Avon to all kinds of effects brought about by volatile exchange rates. For example, in the mid 1980s, the dollar reached a peak in 1985. As the dollar rose to its 1985 peak, converting foreign earnings from weakening currencies into dollars reduced Avon’s profits. However, as the dollar fell between 1985 and 1987, conversion from strengthening currencies increased the profits from foreign markets. During the Asian crisis of 1997–8 and the Latin American currency crisis in the 1990s, sharp devaluations of currencies, such as the baht (Thailand), the peso (Mexico) and the real (Brazil), also hit Avon.
Such volatile exchange rates forced Avon to introduce effective tools to reduce the risk of losses resulting from changes in exchange rates. However, with Avon’s key markets being located outside of the United States, the firm will continue to face challenges when attempting to mitigate foreign exchange risk.
Sources of operating exposure
The market position of Avon vis-à-vis its competitors, including the geographic sourcing of its inputs, the geographic dispersion of its outputs and its comparative flexibility at switching locations, largely determines the firm’s operating exposure.
Because of its market position, Avon has sometimes outperformed the competition during currency crises. For example, during the Mexican peso crisis in 1994, when the peso was devalued, Avon’s main competitors in Mexico faced much more expensive imports when expressed in pesos, leading their prices to almost double. Unlike its main rivals, however, Avon relied mainly on domestic producers in Mexico for its supplies. As a result, Avon was able to raise its prices higher than required by inflation rates, but still lower than its competitors.
Managing exposure
Besides using financial options to reduce its transaction exposure risk, Avon has configured its international business activities to reduce the potentially negative effects of volatile exchange rates. More importantly, Avon’s senior financial managers communicate extensively with operating managers and help them to understand the possible impacts of operating exposure.
Financial options
When the dollar declined against the yen in late 1987, John E. Donaldson Jr, then Avon’s treasurer, reduced the transaction risk of losses by using various tools, including purchasing forward contracts from foreign exchange brokers, buying options contracts from brokers and applying stop-loss orders.
To effectively manage the financial risk arising from its international business activities, Avon now utilizes a combination of tools such as forward contracts, swaps and options. These financial instruments help to reduce Avon’s “exposure to fluctuations in cash flows associated with changes in interest rates and foreign exchange rates”.[v]
Although Avon has successfully managed its foreign exchange exposure in the past, the firm has faced many challenges in recent years. In particular, Avon’s operations in Latin America underperformed as compared to expected sales projections, despite being a key market for the company. The situation was exacerbated when Venezuela devalued its currency after a prolonged period of high inflation, which negatively affected Avon’s net profits in 2010 and 2011. This impact is expected to continue into the foreseeable future.[vi]
In 2011, the bulk of the company’s foreign exchange exposure was to “the Argentine peso, Brazilian real, British pound, Canadian dollar, Chinese renminbi, Colombian peso, the Euro, Mexican peso, Philippine peso, Polish zloty, Russian ruble, Turkish lira, Ukrainian hryvnia and the Venezuelan Bolivar”.[vii]
Configuring manufacturing activities
Prior to 2007, most of Avon’s cosmetics were manufactured within the country where they are sold. When viable, Avon would try to source materials from local suppliers, but the company has recently moved to take more advantage of economies of scale. The company’s strategy is to move towards a ‘globally coordinated’ approach to sourcing, rather than one that is locally oriented.[viii] This Strategic Sourcing Initiative (SSI) was implemented in 2007 and had provided a cumulated value of US $300 million by 2010. This initiative allowed Avon to decrease the costs of materials and to select suppliers with complementary capabilities. The SSI and price increases on selected products helped to mitigate the foreign exchange effects faced by Avon in 2010.[ix]
Avon has also shifted production in response to fluctuating exchange rates. For example, during the Asian crisis, Avon replaced its European lace supplier (with the lace being used to make bras) with a Thai company, so as to reduce the negative impact of having to pay for inputs in a strong European currency.
Continuing communication between finance officers and operating managers
In 1997, Avon treasurer Dennis Ling was in daily contact with Jose Ferreira Jr., head of the AsiaPacific region for Avon. Together, the two chose financial options and other reconfiguring activities to manage potential risks. Such communication with finance specialists helped operating managers to understand the threats and opportunities brought by currency volatility.
Transferring knowledge to manage exposure
In countries throughout Latin America, such as Brazil, Venezuela, Mexico and Argentina, senior managers have developed specific knowledge to cope with economic crisis, political crisis and hyperinflation. Avon has used this knowledge to develop a set of responses to deal with volatility. Further, Avon can also move these experienced managers to help Avon managers in other countries in crisis. For example, when Russia experienced a currency crisis in 1998, Avon called in Miguel Salbitano and Richard Foggio to give a hand. The former was the head of the Central America region, and the latter spent eight years in Latin America. Similarly, a team of Latin American executives was brought to visit Avon’s Asian units country by country to help them out in 1997 during the Asian crisis.
Future outlook
With the impact of the 2008 recession still felt across the globe, Avon has had a difficult time trying to turn around its operating performance since 2009.[x] Avon’s strong presence in emerging markets continues to be a key driver in its success, which opens the company up to significant operating exposure.[xi] Avon must continue to manage its foreign exchange risks to ensure these markets continue to contribute to their growth.
Avon has faced an uphill battle since 2008 with allegations coming forth regarding participation in bribery in China. Numerous executives were fired and an investigation by the Securities and Exchange Commission was imposed for many of Avon’s international operations, costing the firm millions of dollars. In 2012, Avon’s debt rating has also been downgraded from a triple-Bplus to a triple-B by Standard and Poor’s. Weak operating results and bribery allegations have negatively affected the firm.[xii]
In December 2011, the company announced that its current CEO, Andrea Jung, would be stepping down to take on the sole position of executive chairman. This move created significant debate amongst employees, ex-employees and the public. Past CEOs made public statements disagreeing with Mrs Jung staying on as executive chairman as they felt a new direction needed to be taken.[xiii] Former executives indicated whom they felt should have been appointed, signalling to the public that dissatisfaction had existed with the internal functioning of the firm.[xiv] After a five-month search, Avon announced that Sherilyn S. McCoy, a former executive of Johnson & Johnson, would replace Andrea Jung as CEO, effective 23 April 2012.[xv]
On 2 April 2012 Avon was presented a buyout offer from Coty Inc., a ‘global beauty company’ for US $10 billion.[xvi] The offer was priced at a 20 per cent premium from the closing price on March 30th. However, Avon rejected the offer stating that the company was undervalued. Avon hopes the appointment of a new CEO will help to revive and realign the struggling firm.[xvii]
QUESTIONS
- How do volatile exchange rates affect Avon’s operations? What are the major risks and benefits?
- Explain Avon’s position in Mexico as described in the case. Please explain the effects of both Mexican inflation and the peso devaluation on Avon Mexico and its competitors, who rely on imports to service the Mexican market. (Note: to answer this question, you have to know the inflation rates in both Mexico and the US, and the exchange rate between the peso and the dollar.)
- Please apply your understanding of location-bound FSAs and non-locationbound FSAs to describe the Avon case.
- Can you provide an update on Avon’s management of its operating exposure, using materials available on the Web?
NOTES
[i] Fred R. Bleakley, ‘How U.S. firm copes with Asia crisis – Avon moves to protect against volatile currencies’, Wall Street Journal (26 December 1997), 1; Thomas C. Hayes, ‘Puzzling out foreign profits’, New York Times (12 September 1987), D.1; David Whitford, ‘A currency drowns – can you stay afloat?’ Fortune 139 (1999), 229–35.
[ii] Avon, company information, 2012.
[iii] Avon, company information, 2006.
[iv] Avon, Annual report (2011), 29.
[v] Avon, Annual report (2011), 42.
[vi] Avon, Annual report (2010) 10.
[vii] Avon, Annual report (2010).
[viii] Avon, Annual report (2010), 6.
[ix] Avon, Annual report (2010), 28.
[x] ‘S&P cuts Avon Products Inc’ Thomson Reuters (16 March 2012).
[xi] M. Gottfried, ‘Avon needs more than lipstick’, Barron’s (19 December 2011).
[xii] Emily Glazer, Gina Chon and Anupreeta Das, ‘Scarred Avon is takeover target’, Wall Street Journal (Online) (3 April, 2012).
[xiii] Joann S. Lublin and Emily Glazer, ‘Corporate news: Avon ex-CEOs push alumnus for post’, Wall Street Journal (Eastern Edition) (30 March 2012), B.4.
[xiv] Ibid.
[xv] Jenna Goudreau, ‘Avon names Sherilyn McCoy as new CEO’, Forbes (9 April 2012).
[xvi] Coty Inc., ‘About Coty’, (2012).
[xvii] Phil Wahba, ‘Wanted: one makeover; Avon ladies looking for a new look amid executive changes, bribery probes’, National Post (19 March 2012), FP.5.