Creating a Limited Liability Co. to import coffee into Ukraine directly. Economic and financial analysis

On January 10, 2002 the Ukrainian government lowered the import duty on instant coffee to 10% but not less than EUR 0.5 per kilo for up to 10-kg packages, and to 5% but not less than EUR 0.3 per kilo for above 10-kg packages.

There are more than 40,000 bars and restaurants in Ukraine, most of them sell coffee as a menu product and 40% of them specialize in "Espresso" coffee.  

Number of bars, shops and department stores is steadily increasing in the country while most companies at the market sell only instant coffee. That’s why, having developed a well-organized distribution network, it would be profitable to sell our coffee in stores, shopping-centers, cafes and restaurants as well as to smaller distributors.

Raiffeisenbank Ukraine is chosen to be the bank to work with (exchange UA hryvnas for US dollars).  According to the Association of Ukrainian Banks (AUB), it is the country's seventh-largest bank in terms of total assets (€ 790 million as of 30 June 2005). The bank is also the largest among the country's international banks and has a special focus on structured trade finance products, tailor-made for the complex local environment.   The best variant would be opening of current account in hryvnas and dollars. The bank has also a clear system of international money transfers.

Forward market is possible to be used when selling in Ukraine in order to avoid currency exchange risks in case currency rate suddenly significantly changes.

Now the bid price for 1 USD in cash is 5,03 UAH and 5,02 cashless. The ask makes 5,08 in cash and 5,04 cashless. However, there is a tendency of decreasing cashless bid and ask prices.

During the last year the exchange rate of Ukrainian hryvnas was rather stable. According to Interbank the lowest bid for the last year made 4.73720, the highest - 5.19000.  The average ask price made 5.12421.

During the last three months the ask price has gone down from 5.280 on the 22nd of May to 5.23690 on the 22nd of July. At its lowest points the average ask price was on the 2nd and 3rd of July and made 5.19060 while on the 24th of May it made 5.27570. The bid rate ranged from 4.73720 to 4.86830 during the given time period. 

During the last month the ask price ranged from 5.19060 to 5.27240 and has gone up from 5.23870 on the 20th of June to 5.27240 on the 20th of July. The bid rate ranged from 4.73720 to 4.84820 during the given time period.

National economy of Ukraine is one of the key factors to affect the value of hryvnas. That’s why it is extremely important to consider political and economical situation. Instability or unclearness of some legislative regulations, laws and policies may cause great problems for a foreign company.

However, a domestic firm may also face such problems as state policy changes, increasing taxation, and change of customers’ demands. In such a situation the only way to solve problems is reorientation, transformation, adjusting to newly arisen market conditions. But at the same time a company which has additional markets abroad will lose less in the same situation. The reason for it is the fact that while the domestic office is working on the development of new profitable managing strategies, foreign subdivisions of the company are working and getting profits while a purely domestic company puts all its resources for solving the current problem and has no additional income.

A company operating overseas will certainly get interest and dividends from its international investments and realize capital gains. But the fact is that the firm won’t necessarily gain   a positive , or that the return will be as strong as the return of a company making the same investment with euros, yen, or pounds.

This happens because most currencies have no fixed value — that’s why currencies float one against another. Sometimes the dollar is stronger than other currencies, sometimes it’s comparatively weaker. When the dollar is strong, the company will have to spend fewer dollars in order to get a particular amount of another currency, and, when the dollar loses value; such an operation will be more expensive.

Currency futures are often used to hedge currency exchange risks. It is a futures contract which enables a company to exchange hryvnas for dollars on some certain day in future at a price that is fixed on a last trading day. This can be profitable depending on the rising or falling exchange rate. If we, for example, buy a 25 July CME Hryvnas currency futures at 5.27240 UAH/USD, and the future close at 5.2900 at the end at the day, having bought a contract for 100,000UAH, we get a profit of USD 1,760     because the change in price made 0,0176.

In case the Ukrainian currency rises in price, currency options may used to hedge the currency exchange risks. Currency options allow the company to buy or sell certain amount of hryvnas at a specified price before the specific date. Such an option may help the company to avoid possible results of unfavorable currency movements. 

Unfortunately the Ukrainian hryvnas are not included into the CME futures list; hence, this particular option of hedging currency exchange risk is not available in Ukraine. As for the prevailing spot rate, 1 US Dollar equals

FXCrossRate Results

USD/UAH: 5.00

→

5.06 (next move)

negative for the UAH. However, USD/UAH fell

back to 5.00 last week and there were no inter-

ventions on the market last week. The National

Bank of Ukraine (NBU) said that in the first quarter

Ukraine probably had a current account deficit of

USD 500 mn and capital outflows of around USD

2-3 bn. Therefore it was clear that the NBU had to

intervene on the market to stabilise the currency.

The NBU nearly lost USD 2 bn of currency reserves.

We expect that the UAH will remain under depre-

ciation pressure until a government is formed. We

also see a risk of a renewed gas price hike in the

second half of the year which should generate fur-

ther pressure on the current account. We think that

the NBU will decide to let the UAH depreciate after

a new government is formed. The deterioration of

the competitiveness should be the main argument

for the NBU, because they would have enough cur-

rency reserves to prevent depreciation if they want

to.

Analyst: Gerhard Lechner

[email protected]

http://72.14.221.104/search?q=cache:tgLqE7qXxKcJ:www.raiffeisen.ro/files/rapoarte/3/FocusFX020506_e.pdf+Raiffeisenbank+Ukraine+spot+rate&hl=uk&gl=ua&ct=clnk&cd=7

For example, let’s say 1 USD is worth 1 euro. If the value of dollar increases, the company may get 1 euro for, for example, 90 cents. That’s a good perspective if materials or equipment is bought in Europe. But if the company byes a stock and pays in euros when the two currencies have equal value, and the dollar is growing stronger, the stock will be worth less to your company than to someone’s who invested in euros. As the last example shows, a capital gain of 1,000 euros would be worth just $900.

At the same time, in case when the dollar loses ground against other currencies, the company may make money on its existing investments that are based on those particular currencies. But purchasing of additional amounts of such investments will be more expensive.

In addition, having decided to have business abroad one should also consider the importance of national culture, specific tastes and demands of each nation, for marketing or managing strategies successful in one country may completely fail in another.

And because multinational business is demonstrably beneficial to both investing and host countries and tends to strengthen the forces of world order, host governments try to even encourage its expansion.

So, the most important risks that a multinational company may face are those of political instability/uncertainty and changing in foreign currency exchange rates. As for all the other aspects, risks of domestic firms are basically similar to those of multinational ones and, hence, a decision of the company not to operate overseas may be caused only by these two mentioned above factors.

Surely, political factors are not the only ones which determine the final decision of the firm. But in general political and economic stability of the target country are necessary requirements for a company to start operating in that particular country. Especially important is a profound evaluation of political risk for unstably developing countries. There are many variables which should be taken into consideration when evaluating the country's political risk. However, some of them are more important that others and are to be paid much more attention.

Currency risk

Risk at home

A domestic company may have decided not to operate abroad in order to avoid currency risk, but there are some peculiarities as for this issue too. As an example let’s take a domestic company which has an international competitor in the same industry. Of both companies sell their similar products at same time, the domestic one may gain less profits than its rival.

The reason for it consists in the fact that if the dollar gains 10% in value related to the competitor’s currency, the importer have an opportunity to lower the selling price of his goods or services because it can cover the cost of manufacturing and shipping with fewer dollars. It happens because every dollar the international company takes back to the country it operates in equals a larger amount of that country’s currency than it did before. And of course, if a company has an opportunity to reduce the price, customers will certainly buy imported goods o services eating into the sales and earnings of the domestic company which doesn’t have such an opportunity.

So if it doesn’t cut costs, or persuade the government to tax imports, the domestic company will be in danger to lose market share or even go out of business.

Hence, based on the examples given above, it may be stated that purely domestic companies are to take currency risk into serious consideration as well as multinational companies.

So, currency exchange risk cannot be a reason not to enter a foreign market for any company because it influences both domestic and multinational firms.

However, there are still such serious risks, which are actually independent variables in managing process, as political and national culture risks.

Surely, no company can influence political decisions of the hosting government but, as for the national culture issue, based on experience and achievements of such giants as McDonald’s and using proper market research results and specific strategies, it can be easily managed.

Conclusion

Entering an international market requires any company to use certain specific and unique for each country strategies to gain an immense success.

Having discussed and analyzed some of the most important risks a multinational company may face, we can come to a conclusion that even if there is only one serious competitor in the country’s market, the company should never forget that it is a guest in the country and, hence, should first of all study the country’s internal political and economical situation, some national culture features, tastes and demands of its citizens before offering any product or service.

The mistake of some companies entering foreign markets consists in using the same strategies that were used in their home countries. Yes, they were successful, but one must consider that a foreign market is a completely different thing: different culture, different legislative regulations, laws and policies, different tastes. National culture – a concept which includes a great number of specific issues – is also one of the first factors to be evaluated when starting business abroad.

        And, notwithstanding the fact that purely domestic company faces less number of risks, it is as risky as a multinational one. Besides that, I think a multinational company, despite larger number of risks, has more advantages in comparison with a domestic one. And the most serious issue for a company to consider when starting operating in a foreign country is actually inner political and economical situation of the given country which are to be deeply analyzed.

Hence, I believe, in situation when a company is deciding whether to start operating abroad the most important issue is the political and economical climate of the target country because all the other risks may be either managed or even be of some positive use for the company.

In summary, based on everything stated above I would conclude that domestic companies face not less different risks than multinational ones, and if a company takes a decision not to work overseas, such a decision may have been caused mostly by independent political and economical risks in the particular country.

Advantages of Using an EMC/ETC

• Faster entry into the overseas market in terms of first recorded sales.
• Better focus on exporting, because most firms give priority to their domestic problems.
• Lower out-of-pocket expenses.
• An opportunity to study the methods and potential of exporting.
• Expertise in dealing with the special details involved in exporting, as well as its strategies.

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Sales Representatives

The representative uses the company's product literature and samples to present the product to potential buyers. The sales representative works on a commission basis, assumes no risk or responsibility, and is under contract for a definite period of time (renewable by mutual agreement). The contract defines territory, terms of sale, method of compensation, reasons and procedures for terminating the agreement, and other details. The sales representative may operate on either an exclusive or a nonexclusive basis.

Foreign Retailers

A company may also sell directly to foreign retailers. The growth of major retail chains in markets such as Canada and Japan has created new opportunities for this type of direct sale. This method relies mainly on traveling sales representatives who directly contact foreign retailers, although results might also be achieved by mailing catalogues, brochures, or other literature. The direct mail approach has the benefits of eliminating commissions, reducing traveling expenses, and reaching a broader audience.

The firm should investigate potential representatives carefully before entering into an agreement. Besides that the firm also needs to know the following points about the representative firm:

• Current status and history, including background on principal officers;
• Methods of introducing new products into the sales territory;
• Trade and bank references;
• Data on whether the firm’s special requirements can be met.

Marketing strategy

 Use low service charges to attract suppliers and retailers. Once our organization, via our low cost service, has established a relationship with suppliers and retailers, our organization will operate on a commission basis, then – sell higher-margin coffee products and services. This is also the way to come to vertical integration in future.

The EMC would be profitable for there are several ways for it to charge:

1. EMC operating on a commission basis will usually want a commission that equals - or even exceeds - the best domestic commission. This might range from 10% to 15% or more.
2. EMC functioning on a buy-sell basis will ask for the best discount plus an extra discount. EMC that do accept the manufacturer’s best price will usually have to mark up the product more than a distributor in order to make a profit.
3. In addition to commissions or discounts, the EMC may charge for other items, for example, for “special event” contribution such as a 50/50 sharing of costs to exhibit in a foreign trade show. EMC may require a contribution for advertising and other promotional activities, usually on a shared basis.

Cultural Factors

Understanding and respecting cultural, social, and business customs will prepare the company for the flexibility needed to adapt to profitable international business ethics and practices. Lack of cultural awareness can be detrimental to the success of a company’s position in the foreign market. Wells (Exporting from Start To Finance, 1995) suggests a quick, in-flight review of the Culture Grams, developed by Brigham State University’s Center for International Trade. Over 100 countries and their special cultural considerations are identified in separate leaflets. Bookstores and libraries are also an excellent resource for historical and cultural information.

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