Timko Export Management Company: the dynamics of international entrepreneurship.(Instructor's Note)

Thomas, Andrew ; Finkle, Todd A. ; Wilkinson, Tim 等

CASE SYNOPSIS

The story of Timko Export Management Company offers a number of lessons to international entrepreneurs. First, economic risk is a reality that can have an enormous impact on a small to medium-sized business. It is not enough to simply recognize that economic risk is part of the landscape of international business. Businesses must be proactive in dealing with exchange rate fluctuations. They need to integrate safeguards that can mitigate exchange rate risk.

Secondly, payment structures involving cash transactions need to be placed into proper context. Timko should have required a deposit equivalent to the cost of the motorcycles. If a transaction was $100,000, the partners only asked their distributors to send $50,000. As a result, Timko had to make another $50,000 just to cover expenses. Currency swaps should have been used from the beginning as a way to hedge against exchange rate risk put into place early in the process. The firm should also have discounted the Letters of Credit in a much more concerted effort. This did not occur until very late in the business.

Ultimately the problem came down to arrogance. When a company is born out of the success of a previous venture, and is then wildly successful, its managers run the risk of adopting a mindset that says, "We are invincible. No matter what we attempt we will be successful." In 1994, in the wake of the Tequila Effect, Timko experienced what the partners thought to be a one-time event. When they became successful again--successful beyond their wildest imaginations with the opening of Africa and the bringing back of Latin American economies--they became arrogant, and were unable to recognize the media warning about the unraveling of the Asian economies were applicable to their company.

In summary, arrogance is something that an entrepreneur needs to guard against. Markets change and you constantly need to be vigilant in order to manage your activities in those markets.

CASE DESCRIPTION

This case would best be used in an international entrepreneurship class or a strategic management class at the junior or senior level. It should take about three hours of class time and a bit more time outside of class in preparation.

INSTRUCTORS' NOTES

Recommendations for Teaching Approaches

The case can be used in undergraduate or graduate small business, entrepreneurship, international business, and strategic management courses. Students should find the case fascinating due to the focus on the motorcycle industry and the international dynamics involved in the startup and growth of a small business doing business throughout the world. Students should have knowledge of international business and currency risks associated with doing business internationally.

This case is especially valuable due to the growth of emerging economies around the world. It gives students an opportunity to see the risks that are associated with going international.

Readings Recommended

Birely, Sue and MacMillan, Ian (1995). International Entrepreneurship. Thomson Business Publishing.

Dana, Leo (2004). Handbook of Research on International Entrepreneurship. Edward Elgar Publishing.

Fong, Gifford H. (1997). "Currency Risk Management In Emerging Markets." Emerging Markets Quarterly, Vol. 1, Issue 3.

Hagelin, Niclas and Pramborg, Bengt (2004). "Hedging Foreign Exchange Exposure: Risk Reduction from Transaction and Translation Hedging." Journal of International Financial Management & Accounting, Vol. 15, Issue 1.

Katz, Jerome and Shepherd, Dean (2005). International Entrepreneurship. Elsevier Science Ltd.

Markillie, P. (Feb. 12, 2000). "The Tigers That Changed Their Stripes." Economist, Vol. 354, Issue 8157.

InternationalEntrepreneurship.com (2007). http://www.internationalentrepreneurship.com/.

Oviatt, Benjamin, McDougall, Patricia, and Haeberle, William (2007). International Entrepreneurship. Edward Elgar Publishing

Rigobon, Roberto. (2002). International Financial Contagion: Theory and Evidence in Evolution. The Research Foundation of Association for Investment Management and Research (AIMR). Virginia, Charlottesville.

Samuelson, Paul (April 15, 1999). "Major Lesson From Asian Financial Crisis." Business Times (Singapore), Editorial & Opinion; The Bottom Line.

Stanek, Mary Beth. (2002). "A Review of Exchange Rate Policies and Their Effect Upon Nations And Firms." Management Research News, Vol. 25, Issue 4.

Timmons, Jeffrey and Spinelli, Stephen (2006). New Venture Creation: Entrepreneurship For The 21st Century, 7th edition. McGraw-Hill/Irwin Companies.

TEACHING QUESTIONS/PLAN

The following questions were developed to assist students in learning about the various aspects of the case. The assignment of the case and these questions is estimated to take students a minimum of five hours.

1. The owners took a calculated risk when they set up the payment structure for their business. Why did it succeed initially? Why did it ultimately fail?

2. Together, the owners of Timko Export Management Company had the following assets: cash, experience, and education. What didn't they have, which may have prevented their mistakes?

3. What strategies could Timko have put in place to hedge the potentially damaging effects of rapid or drastic currency value fluctuations within international financial markets?

4. Conduct a SWOT analyses of the Timko's position in the motorcycle market in 1992 and 1997. Do any of the 1992 points remain relevant in 1997?

5. In Behaving Badly: Ethical Lessons from ENRON, Denis Collins provides an ethics decision making framework. The full framework consists of six questions, but ultimately an ethical decision comes down to the answers to two questions:

* Is the action for the greatest good of the greatest number of people affected by it?

* Are the motives behind the action based on truthfulness and respect/integrity toward each stakeholder? (You will need to consider all the people affected by the decision.)

According to Collins, if the answers to both questions are "yes" then taking this action is the most ethical decision. If the answers to both questions are "no" then taking this action is the least ethical decision. If the answers to both questions are mixed, then taking this action is moderately ethical and you may have to consider legal, social, and personal affects. Discuss each of the following decisions made by the Timko partners in terms of Collins' ethical decision making framework:

(a) Selling motorcycles in Argentina which the Japanese OEM designed, built, and intended for sale in the U.S. market.

(b) Selling motorcycles in Argentina for 200 percent to 300 percent over MSRP.

(c) Salvaging the value of motorcycles intended for customers in Mexico by selling them instead to customers in Africa.

(d) Continuing to incur expenses appropriate for a $127 million business in the face of an economic crisis created by unstable currency valuations.

(e) Establishing a payment structure that required distributors (buyers) to put down only 50 percent of the value of what they purchased.

6. What should Timko do now? Why?

1. The owners took a calculated risk when they set up the payment structure for their business. Why did it succeed initially? Why did it ultimately fail?

The payment structure succeeded initially because of several reasons:

* Based on previous ventures in South America, Wilson and Richards were flush with cash. Selling product at 200 percent to 300 percent of the MSRP allowed the partners to create enormous cash flow in a short period of time.

* Either because the Japanese OEM did not know or did not care that Wilson and Richards were selling product meant for the U.S. market in South America, there was no interference in the deal.

* Coincidentally, the Japanese motorcycle manufacturers had also turned their attention to the manufacture of cars and other electronic products. Apparently, they did not notice demand characteristics in South America and elsewhere around the world. Wilson and Richards were "in the right place at the right time."

* Stability of the currency in the South American markets combined with a pent up demand (recently unleashed by government policy in South America) for Japanese motorcycles created an engine of demand the partners exploited.

The payment structure ultimately failed because:

* The currency crisis in Asia choked off the ability of distributors and ultimate retail customers throughout the Timko network to afford the Jaiek motorcycles.

* Cash flow for Timko dried up when the cash sent to China did not release the bikes necessary to keep the business model going.

* There was an over-dependence on the sustainability of long cash-to-cash cycle times. Expenses continue to mount during the three to six months that cash is tied up in the next purchase cycle under the unusual payment structure. Unmet obligations put pressure on the partners which they could not meet.

2. Together, the owners of Timko Export Management Company had the following assets: cash, experience, and education. What didn't they have, which may have prevented their mistakes?

Wilson and Richards lacked knowledge of foreign currency markets, the time value of money, and the ability to stay focused on effective business management.

The partners had little interest in or knowledge of international currency markets. Even though they had found an imaginative way out of the collapse of the Mexican peso by shifting sales to another currency, they did not learn from that experience. The broad lesson to be learned was that currency is like any other commodity in that it has value relative to other commodities. Even if they had been savvy enough to put hedge strategies in place to mitigate potential currency fluctuations, they may have missed the difference in the second crisis.

The second crisis involved the currency of their manufacturing partner in China. Labor is paid and materials are procured in local currency, which with the devaluation, meant that cash for the Chinese manufacturer could not cover those additional costs. In 1993 the problem had been on the demand side which could relatively easily be remedied by shifting to currency that was more stable and where demand was roughly equivalent: Africa. In 1997 the currency shift meant that the source of supply would be cut off.

Wilson and Richards also lacked knowledge of the time value of money. When the partners extended themselves to cover 50 percent of the cost of the motorcycles they bought from China, they did not see that for what it was: an interest free loan to their distributors in South America and Africa. Even though they knew demand was high in the selling markets, they assumed distributors would not be willing to put down the full value of the motorcycle 6 months in advance of delivery. They assumed demand needed to be propped up by no-interest loans they provided to their distributors. This assumption never required testing because of the buffer in cash reserves and the partners' lack of understanding that their cash was not working for them in the transactions.

Finally, the partners seem to be unaware of erosions in their own business plan as reflected in their financial statements of the time. These are two men who make decisions based on how much money is in the checkbook today--an ironic result of too much success early on. It might be too much to expect them to assess trends in the financial condition of their business.

At the very time that the business was reaching its zenith in terms of top line sales and bottom line profits, gross margins were eroding significantly. Between 1992 and 1994, gross profit as a percent of sales (gross profit margin) went from 44 percent to 48 percent. But the margin dropped to 41 percent in 1995 and dropped again in 1996 to 38 percent. The cost of travel and offering free use of cash for distributors began to eat away at profits internally. These are fundamental warning signs that executives with less hubris would be paying attention to.

Further, while the increase in sales from 1994 to 1995 is impressive (up 74 percent) the increase in operating expenses over that same period (70 percent) almost entirely offset the revenue generating potential the company was building at the time. Sales were going up but at a high cost.

Finally, once the issue of how serious the financial meltdown in Asia had become, the partners apparently did not take enough cost cutting action to make any significant difference. Sales declined 58 percent from 1996 to 1997 while expenses went down only 4 percent. The partners may have missed the looming crisis, but they had 6 months in 1997 to offset some of their losses by making cuts in operating expenses. Both travel and employee wages went up during the year over the previous year.

3. What strategies could Timko have put in place to hedge the potentially damaging effects of rapid or drastic currency value fluctuations international financial markets?

Timko could have hedged its transaction exposure through the use of various financial contracts. Two of the popular methods are forward market hedging and money market hedging. Strategy Transactions Outcomes Forward market hedge 1. Sell foreign Assured of receiving (the firm sells its currency accounts monies in U.S. dollars foreign currency receivable forward for on payment due date, receivables forward U.S. dollars at the future spot exchange to eliminate foreign forward exchange rate. becomes irrelevant-- exchange exposure eliminating transaction 2. On payment date, exposure. receive payment in foreign currency and deliver it to the counter party of the forward contract. Money market hedge 3. Borrow in foreign Assured of receiving currency today the the discounted discounted sum of the receivable amount now foreign currency in U.S. dollars or the receivable in the full value at the time future. of the payment; future spot exchange rate 4. With proceeds, buy becomes irrelevant-- U.S. dollars on the eliminating spot now. transaction exposure. 4. Lend forward U.S. dollars in time to coincide with timing of collection of receivable at current money market rates. 5. On due date of the receivable, collect payment from buyer and pay of foreign currency loan. Adapted from Madura, Jeff (2003)

Timko could have billed foreign importers in their own currency, with the exchange rate set at time of shipment. This approach exposes Timko to currency exchange risk rather than credit risk. Timko did try to shift this exposure (currency exchange risk) to the buyer by billing with terms for payment in U.S. dollars (operational hedging). If the currency devaluation occurred before the payment date, the possible collection may become a mute issue. For example, if the home (foreign) currency was devalued by 50%, the devaluation would double the payable (receivable for Timko) of the foreign company, a very substantial increase that few firms could absorb.

Timko could have hedged its transaction exposure through the use of various financial contracts. Some of the popular methods are: (1) forward market hedging, (2) money market hedging, and (3) swap market hedging. (Note: although a possibility, swap market hedging is usually available only to large Multi-National Corporations because of the customization, the timing, and the size of the various contracts). An underlying premise of the above hedging techniques is that there are existing markets for the currencies of interest and thus, can be easily executed by a firm to manage its transaction exposure. However, if a firm is transacting in minor currencies such as the Korean Won or the Thai Bhat, it may be either very costly or impossible to use financial contracts in these currencies (Stetz, Finkle, and O'Neil, 2008).

Aggarwal and Demasky (1997) suggest that various exchange rates are highly correlated. For example, the Yen/Dollar exchange rate is highly correlated with the Won/Dollar exchange rate. As a result, if Timko wanted to manage its currency exposure, it might want to consider cross-hedging techniques which involve hedging a position in one currency versus another (Madura, 2003). Thus, Timko could sell an amount of Yen forward against the Dollar thereby cross-hedging its Won exposure (equivalent to Timko's Won receivable).

4. Conduct a SWOT analyses of the Timko's position in the motorcycle market in 1992 and 1997. Do any of the 1992 points remain relevant in 1997? SWOT Elements 1992 1997 Strengths * Management experience * Management experience in international trade in international trade * Management fluency in Spanish * Ready cash brought to the partnership from previous ventures * Vision to take advantage of market opportunities in narrow niches Weaknesses * Lack of appreciation ack of basic financial of the critical role management ability and international currency paying attention to the plays in ventures like nuts and bolts of TimkoLong cycle cash running a business flow drains in the procurement and * Lack of focus on delivery cycle of the international financial business market shifts and trends * Lack of basic financial management ability and * Management hubris and paying attention to the lack of ability to learn nuts and bolts of from previous failures running a business * Long cycle cash flow * Lack of a coherent drains in the procurement business plan and delivery cycle of the business * Lack of a coherent business plan Opportunities Pent up demand in * Growing worldwide demand Argentina for high-end for low-end motorcycles Japanese motorcycles used as a primary means of transport in * Easing of government developing countries restrictions on imports * The existence of * Lack of an existing motorcycle manufacturing Argentine dealership companies in China network * Easy availability of Japanese motorcycles in the U.S. dealer network * No enforcement by Japanese motorcycle OEMs on the re-selling of motorcycles intended for the American market * Growing worldwide demand for low-end motorcycles used as a primary means of transport in developing countries * The existence of motorcycle manufacturing companies in China * Relative economic stability in Latin American markets * The exit of Japanese motorcycle manufacturing companies from the low- end market Threats * The low-end market is * The low-end market is largely in developing largely in developing countries with less countries with less stable currencies stable currencies * The manufacturer of motorcycles Timko would sell was also located in a developing country surrounded by other countries with unstable currencies

5. In Behaving Badly: Ethical Lessons from ENRON, Denis Collins provides an ethics decision making framework. The full framework consists of six questions, but ultimately an ethical decision comes down to the answers to two questions:

a. Is the action for the greatest good of the greatest number of people affected by it?

b. Are the motives behind the action based on truthfulness and respect/integrity toward each stakeholder? (you will need to consider all the people affected by the decision)

According to Collins, if the answers to both questions are "yes" then taking this action is the most ethical decision. If the answers to both questions are "no" then taking this action is the least ethical decision. If the answers to both questions are mixed, then taking this action is moderately ethical and you may have to consider legal, social, and personal affects.

Discuss each of the following decisions made by the Timko partners in terms of Collins' ethical decision making framework:

(a) Selling motorcycles in Argentina which the Japanese OEM designed, built, and intended for sale in the U.S. market.

The people affected by this decision include Timko, Argentine distributors, Argentine retail customers, and the Japanese OEM.

Clearly, Timko and the Argentine distributors benefited from this decision. Argentine retail customers got the motorcycles they demanded, but at prices beyond what those who were able to pay for a trip to the United States they often paid.

The Japanese OEM, however does not benefit from this decision. Basically, Timko cut out its trading partner's ability to access Argentine markets by taking motorcycles the OEM expected to sell in the U.S. for one price and reselling them in another market at a premium which the OEM did not enjoy. Even if the selling agreement with the Japanese manufacturer did not strictly prohibit further export of its bikes, Timko had an ethical responsibility to inform their trading partner as to what they planned to do. The obvious reason why Wilson and Richards did not make their intent known to the OEM was to keep the OEM from reaping any portion of the gain found in Argentina. Their motive was untruthful. This is not an ethical decision.

(b) Selling motorcycles in Argentina for 200 percent to 300 percent over MSRP.

The people affected by this action are the same as in (a) above and the ethical issues are an extension of the discussion in (a) above. Retail customers able to get to the U.S. were paying 30 percent to 40 percent over MSRP. By delivering the bikes directly to Argentina, Timko served a market that could not afford to travel to the U.S. Clearly, again, the distributors in Argentina and Timko benefited from this decision. The Japanese OEM did not benefit. Because the answer to question 1 is clearly no and the answer to question 2 may be disputed, this is a more unethical than ethical decision.

(c) Salvaging the value of motorcycles intended for customers in Mexico by selling them instead to customers in Africa.

The people involved in this action include Timko, the Chinese manufacturer, the distributors and retail customers in Mexico, and the distributors and retail customers in Africa.

The people in Africa got access to additional bikes beyond what they would have access to otherwise. Clearly, they benefit. The distributors and retail customers in Mexico, however, had a right to those bikes (they had put down at least 50 percent of the value with the order). The fact that the value of the peso declined did not mean they gave up their legal right to the bikes. Employees at Timko benefited because the company did not have to take a loss on the value of the bikes intended for Mexican customers. The Chinese manufacturer was not effected one way or the other since the bikes had already been sold to Timko. This action is not in the greatest interest of all those involved (particularly Mexican customers) and was done without respect for the impact on Mexican customers. This is clearly an unethical decision.

(d) Continuing to incur expenses appropriate for a $127 million business in the face of an economic crisis created by unstable currency valuations.

The most significant group of people affected by this decision are the employees of Timko, though to the extent Timko's value chain (from suppliers to customers) is effected by the failure of the company, others are marginally involved.

The decision that Wilson and Richards made to continue to incur expenses may have been made in a desperate attempt to salvage the business model they had created. To the extent that is true, the answer to both questions is likely to be yes--Wilson and Richards attempted to preserve the business and the jobs of the greatest number of their employees.

However, the partners knew that there was a crisis in June 1997. There is no indication they significantly slowed their cash outlays during the last six months of that fiscal year. By the end of 1997 they were spending at a rate much more appropriate for a $100 million business than a $50 million business. Perhaps there is no ethical lapse here, but this is certainly an indication of bad judgment and poor business management sense.

(e) Establishing a payment structure that required distributors (buyers) to put down only 50 percent of the value of what they purchased.

The people affected by this decision include the Chinese manufacturer, Timko and its employees, and distributors. Retail customers are buffered from this decision by their transactional relationship with distributors.

Clearly, the distribution businesses benefit from this decision. They can order merchandise with half the risk of a regular deal. To the extent that the partners' belief of the need to fill the distribution pipeline was dependent on this kind of payment structure, Wilson and Richards were probably acting in the best interests of their company and its employees. After all, Timko took all the risk in this deal. There does not seem to be any lack of truth or integrity in the decision. Again, this is more of a bad business decision than one lacking an ethical basis.

6. What should Timko do now? Why?

As the Asian Flu of 1997 spread across all of Timko's customer base, the partners were confronted with what to do next. Unlike 1995, when they saved their business by entering the African market, there were no worlds left to conquer. The company, while still viable, was severely wounded by this second currency blow. Fear, uncertainty, and doubt within the company and amongst the partners were on the rise. Given the current state, options were few.

After carefully analyzing their precarious financial situation, the partners took stock of what they had, beyond the cost ratios and balance sheets. It occurred to them that the most valuable part of their business was in fact the relationships they enjoyed with their distributors around the world. Many of their customers were incredibly wealthy and some of the richest persons in their country. It was these relationships which had sustained the business through the good and bad times.

Initially, their Chinese manufacturing partner had little knowledge of who the local distributors were. The Chinese built the units for Timko and let them handle the rest. Timko also kept the Chinese at an arm's length when it came to the local markets. However, as the business evolved, the Chinese began to express more and more of an interest in the distributors.

In the midst of this second crisis, the partners began to formulate an exit strategy of the company, in which they would sell their interest to the Chinese, while continuing to export the Japanese motorcycles from Los Angeles. They calculated that their removal from the value chain would enable the Chinese to sell directly to the distributors at a lower price --and, therefore, lower the risk exposure in the market.

In early 1999, the partners traveled to China and began discussions about a buy-out. The Chinese were receptive and within a year the deal was done.

EPILOGUE

The partners, faced with their second foreign currency crisis in less than two years, became more and more melancholy as time went by. They had made millions of dollars between them. Despite the current downturn in Southeast Asia and the threat to their business, the partners were not as stressed out as they might have been. Much of this was due to some big changes in each of their personal lives. Richards was going through his second divorce, a very difficult and ugly one. Wilson, who at this time was traveling more than 250 days per year, was exhausted. He was feeling increasingly detached from his wife and young son and his health was not very good. He decided to move to the Midwest to be closer to his family.

Without much debate and fanfare, the partners decided to wait out the "Asian Flu". They sat on the inventory, believing that the markets would eventually correct themselves. And they did. By mid-1999, orders from around the world began to flood in once again.

Beat-up and tired, the partners lacked the earlier enthusiasm to seize the initiative. Instead, they began talks with their Chinese partner to discuss a buy-out. Over the next six months, the negotiations intensified, and, by early 2000, a deal was reached. The partners cashed out and each went their separate ways. Richards remained in Southern California and continued operating his successful dealerships. Wilson did move to the Midwest, where he started a successful home-based management consulting firm, helping companies who want to take their firms global. Both partners walked away with enough money to gain them financial security for life.

AUTHORS' NOTE

The case is based on an actual company that was started and sold by one of the co-authors. All of the information is based on the facts as they actually happened, except for some of the financial information.

REFERENCES

Aggarwal, R and Demaskey, A. (1997), "Cross-Hedging Currency Risks in Asian Emerging Markets Using Derivatives in Major Currencies," Journal of Portfolio Management, 88-95.

Madura, Jeff. (2003). International Financial Management, 7th Edition. Thompson South-Western.

Stetz, Phil and Finkle, Todd A., and O'Neil, Larry (2008), "Teaching Notes for A-1 Lanes and the Currency Crisis of the East Asian Tigers," Entrepreneurship Theory and Practice, 32(1), 369-384.

Andrew Thomas, The University of Akron

Todd A. Finkle, Gonzaga University

Tim Wilkinson, Montana State University