Microsoft’s Multinational Business: Hedging Risks in China and Russia, Research Paper Example

Abstract

Multinational Corporations often face extra costs for doing business overseas. These costs can be exacerbated by the volatility of exchange rates. In order to remain profitable, multinational corporations often try to hedge their risks in different ways. Often, this involves tailoring one operation to make up for the losses at another. Microsoft’s operations in China and Russia show clearly how risky and how profitable multinational business can be. Microsoft has spent billions of dollars wooing the Chinese government into helping it market its products and to protecting it from piracy. It has benefitted from this by selling its goods to 20 million new customers, but it is trading at such low prices that volatile exchange rates could reduce its earnings to almost nothing. Meanwhile, Microsoft has agreed to a fixed-exchange rate with Russia, which could prove either very risky or very profitable.

Exchange rates are volatile. As each country faces a different set of economic challenges, each currency rises or drops accordingly. This presents a risk for countries which do business abroad (Bodnar and Bartolini). Consider, for instance, the case of a software company which operates in the UK. Currently, 1 British Pound is equal to 1.59 American Dollars (United Nations Treasury). Suppose the company sells their product for $100 in the United States. In order to sell the product at a more or less equivalent price, the company would have to sell their product for around £62. But suppose the dollar rises against the pound. Suppose 1 dollar becomes equal to £1.59. Then, the software company will lose money on the deal, because it will be offering the software, not at an equivalent price, but for a much smaller profit. With the dollar rising and failing on a daily basis, exchange rate risks are very real, but many companies have found methods by which to hedge these risks the Microsoft Corporation has met the challenges of exchange rate volatility in two unique manners. In China, it has simply accepted lower profits, with an eye toward long-term growth.  Meanwhile, in Russia, it has begun doing business in rubles, in order to help eliminate some of the instability caused by changing rates of exchange.

Microsoft in China

When Microsoft first tried to do business in China, it found itself unable to compete against free and low-priced software distributors. Pirated copies of Windows were sold on the cheap, and Microsoft found that it could not sell its products for top dollar. Microsoft’s strategy, then, was to lowers its prices and to work with the Chinese government to produce stable, popular products. The cost of such a move has been enormous. Indeed, Microsoft admits that it has cost billions of dollars. And as exchange rates change, Microsoft could very well lose more. Microsoft Office, which sells for well over $100 dollars in The United States, can be purchased in China for roughly $3 (19.74 Chinese Yuan) (Kirkpatrick). Selling Microsoft Products at such a low price has made Microsoft extremely successful in China, which does not often welcome businesses with open arms. Indeed, Microsoft has sold over 20 billion copies of its software in China already. Microsoft has worked with the Chinese government, rather than opposing its policies, it has ensured that its products are in wide use around the nation. But changing exchange rates could hurt the company (Kirkpatrick).

Microsoft has made Chinese consumers comfortable with paying very little for its top products. If the dollar rises against the Yuan, then it will take more Yuan to buy $3 worth of Microsoft products. Office and other Microsoft products will become more expensive for Chinese consumers. These consumers may not want to pay higher prices.  Microsoft could continue to offer Office for 19 Juan, but if it did so, it would make only $2 a sale. Therefore, if the dollar rises, Microsoft would risk either losing business because of higher pricing or losing profits. On the other hand, if the Yuan rises against the dollar, it would take fewer Juan to equal $3 US Dollars.  If Chinese customers pay 19 Yuan for Microsoft office, and the Yuan is equal to $ 4 USD rather than 6.5, then Microsoft will make approximately $4.5 dollars a sale rather than only 3.

Still, operating in China is risky for Microsoft, so the company must find ways to hedge its risks. One of the ways Microsoft has made up for its losses in China is by increasing the cost of its products in its operations in other countries. Microsoft charges Chinese consumers hundreds less than market value for many of its products, but it charges Japanese customers significantly more than market value. For instance, Microsoft charges American customers $299 for its most basic Xbox 360 Kinect Bundle. It charges Japanese customers 29, 800 yen (roughly $359). In spite of this, it was able to sell approximately 26,000 Kinects within two days (Media Create).  Japanese customers pay higher prices for Microsoft Office as well. While Chinese customers pay 19 Yuan ($3), Japanese customers must pay 36,540 yen ($440) for Microsoft Office Home and Business 2010. American customers only pay $279.99 for the product. Microsoft, then, hedges its risks in the Chinese market by charging hundreds more in some markets than it does in others.This allows it to compete in the Chinese market place, and to market its goods in the fastest growing economy in the world, while at the same time making higher profits elsewhere.

Microsoft is taking another approach to risks tied to the exchange rate in Russia. It has agreed to conduct business in Russia’s currency, the ruble, instead of in dollars. According to The Moscow Times, Microsoft generally signs three-year pricing contracts. If the exchange rate fluctuates during three years, Microsoft risks losing profits because of its price commitments. Therefore, Microsoft Russia will be working with a locked exchange rate of 29-33 rubles per dollar (Razumovskaya).

This is a risky move by Microsoft. Essentially, the company is betting that the ruble will rise against the dollar. Should the ruble rise, then Microsoft will make money. If, on the other hand, the dollar rises against the ruble, Microsoft will lose out. The company is hedging its business risks by working with the Russian government to improve Russia’s technology industry. Indeed, it has given $300 million dollars to a program that would help educate and train prospective tech workers in the country. Still, that $300 million is nothing to sneeze at. And to truly make a profit, Microsoft will need to make that money back in business transactions (Razumovskaya).

Microsoft, in general, prices its revenues and costs according to their value in US dollars. But as it begins working in the currencies of foreign nations, it may, instead, begin to price revenues and costs according to regional denominations. Sales in China, the world’s most populous country, are likely to make up a large portion of Microsoft’s revenues. If every person in China purchased a Microsoft product at even one dollar, Microsoft would make a total of $1,341,990,000.  China, then, could very well make up the main share of Microsoft’s profits. Russia, though not as populous as China, has significant pull in politics and the world economy. While investing in Russia is not likely to be nearly as profitable as investing in China, its contribution to Microsoft’s products may be very large, indeed. Yet, under a negative set of economic conditions, both operations could cost Microsoft millions – if not billions of dollars.

References

Bodnar, Gordon M and Leonardo Bartolini. “Are exchange rates excessively volatile? And what does “excessively volatile” mean, anyway?” 1996s. University of Conneticut Deapartment of Economics IDEAS. 27 January 2011 <http://ideas.repec.org/p/fip/fednrp/9601.html>.

Kirkpatrick, David. “How Microsoft conquered China.” 17 July 2007. CNN Money. 27 January 2011 <http://money.cnn.com/magazines/fortune/fortune_archive/2007/07/23/100134488/>.

Media Create. “Microsoft Japan Sold More than 26000 Kinect Units In A Couple Of Days.” 29 November 2010. Soft Sailor. 27 January 2011 <http://www.softsailor.com/news/52769-microsoft-japan-sold-more-than-26000-kinect-units-in-a-couple-of-days.html>.

Razumovskaya, Olga. “Microsoft Bets Long Term on Stable Ruble .” 19 January 2011. The Moscow Times. 27 January 2011 <http://www.themoscowtimes.com/business/article/microsoft-bets-long-term-on-stable-ruble/429184.html>.

United Nations Treasury. “The United Nations Operational Rates of Exchange.” 14 January 2011. The United Nations Treasury Web Site. 27 January 2011 <https://treasury.un.org/operationalrates/Default.aspx>.