Baker Adhesives

International Financial Management Case Analysis

Written by:
Florentina Farmasita 15/375488/EK/20189
Maria Devina 16/392626/EK/20708
Julie Vidalia 16/395938/EK/20910
Adyatma S. Pramana

Course:
International Financial Management

Lecturer:
I Wayan Nuka Lantara, M.Si., Ph.D.,

FACULTY OF ECONOMICS AND BUSINESS

UNIVERSITAS GADJAH MADA
YOGYAKARTA
2018
 Introduction
Baker Adhesives is a small company manufacturing specialty adhesives who had
recently enter the international market. Owned by Doug Baker, the international market is a
new territory for Baker Adhesives. The market for adhesives in the United States and global
market was dominated by large firm with international manufacturing and sourcing
capabilities that provided the vast bulk of adhesives. Since the competition was fierce, the
company was only able to gain slim profit margins. Those successful firms relied on
economies of scale, which induce more efficient production systems.
Due to the economies of scale, it opened market for small and technically savvy firms.
The key for this specialty market was the feasibilities to economically produce relatively
small batches with distinct properties. As in the Baker Adhesives, the company was able to
build a flexible production system with a good chemist. This resulted Baker Adhesive to
become successful in attracting a number of capable new employees and acknowledged as
the leader in the specialty markets.
The company had done well financially with high profit margin and steady level of
sales. The company had a line of credit from a local bank and presently owed about
USD180,000 on the credit line. The credit helped the company to provide sufficient funds to
cover short-term needs.
 Statement of Problem
Baker initially made a recent sale to Novo in size at 1,210 gallons which used up the
raw materials that were supposed to be reselled at significant loss. The company has no
problem in fulfilling the order as the company had been running well under the capacity and
the order can be accommodated within the production schedule. Furthermore, the order
would give significant profit to Baker Adhesives to pay down the balance of the firm’s line of
credit.
During the meeting with Baker’s sales manager, Alissa Moreno, he found out that the
order was not as profitable as he thought to be. Novo is a Brazilian company, therefore, the
payment from Novo had to be converted into USD at the current exchange rate. Baker tried to
renegotiate the per-gallon price to adjust to the exchange rate, however, Novo refused. Due to
this, the company had to deal with the exchange rate risk, in which could further change in
the future.
 Industry Analysis
A. S.W.O.T Analysis of Baker Adhesive
1. Strengths:
The strength of Baker Adhesive is its ability to produce specialized adhesives as the
company also manufacture their products based on the specific requirements of the
customers. The strengths they also gain is that due to their customer specification,
they are able to gain loyal customers and also gain steady sales. Also Baker Adhesive
had done well financially for the past few years which resulted for the company’s
margin to be higher compared to large companies’ margin. Moreover, Baker has an
excellent relationship with a local bank that had always provided sufficient funds to
cover the company’s short-term needs.
2. Weakness:
Due to focusing on specialized product/customized product for their customers, they
relatively have a slow sales growth. Furthermore, the weakness of Baker Adhesive is
the lack of overall knowledge of their business where as a new company, they took
the risk to venture into the international market without any proper experience
regarding the industry they venture into, thus, this showcase their lack of inability to
anticipate future risks.

3. Opportunities
The opportunity Adhesive took was capturing the market through specializing in
adhesives that would fit into customer’s specifications while other companies focused
on large economies of scale by producing general or producing adhesive in bulks. The
company also took opportunity by offering different product line compared to other
companies by supplying to toy manufacturers and toiletries etc. Another opportunity
they took was that they impose lower costs as the company did not need to invest on
large machinery as their system was made to order system, thus, they do not require
large amount of capital nor labour intensive.
4. Threat
Being relatively a small company that focuses on specialty adhesive markets, the
company is still threatened by larger companies who have a higher economic of scale
and larger capital and labour. The larger company can easily switch to making
specialized order with their high economies of scale, which in turn will be a threat to
Baker Adhesive.
B. Porter’s Five Forces Analysis of Baker Adhesive
1. Bargaining Power of Supplier (LOW)
There are relatively large amount of suppliers for adhesives but these suppliers are
only gaining small market share, thus, they do not have enough power to exert to
companies. Therefore, there are no high prices that supplier can demand to the
companies in the industry. As a result, in return, the company can easily switch to one
supplier after the other.
2. Bargaining Power of Customers (SIGNIFICANT)
Usually, customers will buy on larger volume and lower price giving them the power.
Although there are consumers who consider quality as a priority in choosing supplier
which is an advantage for Baker Adhesives which is already well known for
providing this type of products. For those who are looking for small scale companies,
there are also these type which are newly entering the market and favors the
consumers. This brings to a significant bargaining power of consumers.
3. Threat of New Entrants (MODERATE)
Since the market of Baker Adhesives is dominated by few large firms that provide
bulk of adhesives globally, there is a small chance that some companies will enter this
industry. Given that the competition is fierce, these firms already owned a stable
market share which new entrants would not be able to get since this will cost them a
large investment. In this type of industry, efficient production system is highly
required to be successful. These production systems must be flexible since they must
be able to produce relatively small batches with distinct properties feasibly and
economically. The key driver of success is also having good and brilliant chemists
which will lead them to marketable products that can make them acknowledged by
customers globally. Due to these factors the duration of the newly entered companies
in this market must be considered although they can attract small consumers. Out of
this, it can be concluded that there is a moderate threat of new entrants.
4. Threat of Substitutes (MODERATE)
Substitutes for adhesives are sometimes done by consumers which find this lowly
needed where in they can be made at home with little efforts. These are consumers
who are usually on rural areas or place wherein this market is not feasible. But since
Baker Adhesives is a company of specialty adhesives with high quality this cannot be
easily substituted for consumers who buy this in bulk. Given that adhesives are used
 in many aspects like automotive# construction and electronics there are a great
number of consumers who find this product highly needed to sum up there is a
moderate threat of substitutes.
5. Threats of Existing Rivalry (HIGH)
Some of the existing competitors of Baker Adhesives in market share are BASF, Dow
Chemicals Henkel, Bayer, H. B. Fuller, Acucote Inc., Ashland Inc., Beardow Adams
(Adhesives) Ltd., Creative Materials Inc., and Franklin International Inc.which are all
large firms that provide bulk of adhesives for consumers. Given that they are large
firms, it can be concluded that this industry has a fierce competition. To become
successful, these companies invested in efficient and flexible production system as
well as good chemists which are all also possessed by Baker Adhesives. The
competitive advantage of the others is they were able to dominate international market
and sourcing capabilities while Baker Adhesives is experiencing issues in entering
international market. This leads to high threats of existing rivalry.
 Decision Analysis

Original Order (February 2006)

Order (in gallons) 1,210

Price per gallon BRL 90.15

Total payment from Novo to Baker BRL 109,081.50

Exchange rate (USD/BRL) 0.45294*

Total payment from Novo to Baker USD49,407.32

*USD to BRL February 1st, 2006 = 2.2078. BRL 1 = USD 0.45294 (Source =
https://tradingeconomics.com/brazil/currency)

Meeting with Moreno (June 5, 2006)

Order (in gallons) 1,210

Price per gallon BRL 90.15

Total payment from Novo to Baker BRL 109,081.50

Exchange rate (USD/BRL) 0.4368*

Total payment from Novo to Baker USD47,646.80

*Exchange Rates for the Real as of June 5, 2006 (USD/BRL), Bid on real = 0.4368
Through this calculation, we can see that the payment received is lower by
USD1,760.52 (USD49,407.32 - USD47,646.80) than it should be. This indicates that Baker
Adhesives occurred loss of profits.

Baker Adhesives Profit Calculation

Expected revenue USD49,407.32

Total costs 44,500.00

Expected profits USD4,907.32

Realized revenue USD47,646.80

Total costs 44,500.00

Realized profits USD3,146.80

 Loss (Realized - Expected Profits) USD1,760.52

Seeing that Baker Adhesives would further receive loss of profit when they receive
new order, the company consulted to the bank to find ways to mitigate the exchange risk. The
bank offered three options to Baker Adhesives to mitigate the exchange risk from any new
order. It consisted of not hedging the transactions, hedging in the forward market, and
hedging in the money markets.

a. Unhedged Transactions
New Order (June 2006) to be paid in September 2006

Order (in gallons) (1.5 x 1,210) 1,815

Price per gallon BRL 90.15

Total payment from Novo to Baker BRL 163,622.25

Exchange rate (USD/BRL) (Forecast bid 0.4234

in September 2006)

Total payment from Novo to Baker USD69,277.66

Effective interest rate over three months 2.1452%

Present value of the total payment USD67,082.73

As written in the case, Baker agreed to deliver 1.5 of the original amount in
June 2006. However, payment will be settled three months after delivery, which is in
September 2006. The USD69,277.66 is assumed to be paid in 3 months if Baker
agreed not to hedge its payment. The line of credit annual percentage rate (8.5.2%)
was based on monthly compounding with the effective 3 months rate of 2.1452%.
Assumed to be paid immediately, Baker would receive USD67,082.73 after
discounting the total payment by the 3 months effective rate.

Baker Adhesives Profit Calculation

Revenue (NPV) USD67,082.73

Total costs (USD44,500 x 1.50) 66,750.00

 Profit USD332.73
The calculation above shows that profit would be cut significantly when Novo
renew the contract by ordering more, resulting in only USD332.73 net profit for
Baker. This is a very dramatic decline in profit compared to the original order. Baker
would suffer almost 90% profit cut with this new order.

b. Forward Market Hedge

New Order (June 2006) to be paid in September 2006

Order (in gallons) (1.5 x 1,210) 1,815

Price per gallon BRL 90.15

Total payment from Novo to Baker BRL 163,622.25

Exchange rate (USD/BRL) (Forecast bid in 0.4227

September 2006)

Total payment from Novo to Baker USD69,163.13

Effective interest rate over three months 2.1452%

Present value of the total payment USD67,710.59

In the forward market hedge, the exchange rate used is the forecast bid of
0.4227 on the month of September 2006. From that, we deducted the amount with the
effective interest rate over three months of 2.1452%. Then, the present value of the
total payment is USD67,710.59.

Baker Adhesives Profit Calculation

Revenue (NPV) USD67,710.59

Total costs (USD44,500 x 1.50) 66,750.00

Profit USD960.59

Deducted form the total costs of the new order, the company would gain
profits of USD960.59. This profit is significantly higher than the other 3 options.
c. Money Market Hedge

New Order (June 2006) to be paid in September 2006

Order (in gallons) (1.5 x 1,210) 1,815

Price per gallon BRL 90.15

Total payment from Novo to Baker BRL 163,622.25

Interest Rate of Reals 0.065

Reals to Borrow (BRL) 152,986.57

Exchange rate (USD/BRL) (Bid on Real as 0.4368

of June 5, 2006)

Total payment from Novo to Baker USD66,824.53

Baker Adhesives Profit Calculation

Revenue (NPV) USD66,824.53

Total costs (USD44,500 x 1.50) 66,750.00

Profit USD74.55

Surprisingly, hedging through the money market resulted in the lowest realizable
profit of only around USD75. This indicates that choosing this option would not be
wise.
 Conclusion

Profit Calculation Summary

Unhedged Transactions USD332.73

Forward Market Hedge USD960.59

Money Market Hedge USD74.55

Based on the finding, it is in our professional opinion that Baker Adhesives should
choose the hedging in the forward market to mitigate the international currency exchange
risk. Based on the calculation, it shows that the NPV from the forward market is higher than
if they should choose to do the money market hedging since the bank guarantee a forward
rate. This resulting in the firm will be able to anticipate their profits from the sale in advance.
Baker Adhesives should choose the Forward Market Hedge as it is the most profitable option
compared with unhedged transactions and money market hedge. If Baker Adhesives opts to
do the forward hedging, then they will get USD960.56 of profit. On the contrary, there’s
bigger potential for gains if they choose to do money market hedging. But, Brazillian
currency is characterized by high inflation and interest rates, as well as volatile exchange
rates. Therefore it is not the best option for the firm as has an uncertainty factor to it.