Analysis of Tiffany and Co.

The purpose of this article is to discuss the risks of exchange rate exposures that Tiffany is facing.

Tiffany & Co was an internationally renowned retailer, designer, manufacturer and distributor of luxury goods. Tiffany was acquired by Avon Products in 1979 but was then bought back by its own management in 1984. After the company became profitable again, management offered Tiffany stock to the public in 1987 and in 1989, Mitsukoshi was the largest single institutional investor in Tiffany stock. In 1993, Tiffany concluded an agreement with its Japanese distributor, Mitsukoshi to assume management responsibilities in its wholly owned subsidiary, Tiffany & Co. Japan Inc.

I. Exchange Rate Fluctuations in 1993

Tiffany restructured its Japanese operations by selling directly to the Japanese market instead of selling to Mitsukoshi and Mitsukoshi selling it to Japan. Tiffany wanted greater control over its operations in Japan even though demand for Tiffany's products in Japan declined from 23% to 15% in 1992. However, Tiffany will still be required to pay fees of 27% of net retail sales in compensation to Mitsukoshi after this restructuring.

This change in operations exposed Tiffany directly to the exchange rate fluctuations which Mitsukoshi previously bore. Previously, Mitsukoshi ensured that Tiffany never had to worry about exchange-rate fluctuations and guaranteed a certain amount of cash flows to Tiffany in their wholesale transactions. Mitsukoshi bore the risk of any exchange-rate fluctuations that took place between the time it purchased the inventory from Tiffany and when it finally made the cash settlement.

Tiffany should be worried about the exchange rate fluctuations because the yen/dollar exchange rate is very volatile. Tiffany faced an additional risk by restructuring its Japanese operations as Mitsukoshi now no longer controls Tiffany's sales in Japan.

I believe that it is very important for Tiffany to consider the exchange rate fluctuations that it will expose itself to before it decides to assume complete control of its subsidiary store in Japan.

II. Extent of Tiffany's Exposure to Foreign Exchange Risk

• Economic Exposure

Tiffany is now exposed to foreign exchange rate risk. Tiffany has to bear the risk of any exchange-rate fluctuations that will take place when it assumes the responsibility for establishing yen retail price, holding inventory in Japan for sale, managing and funding local advertising and publicity programs and controlling local Japanese management.This may or may not decrease Tiffany's sales and income from their foreign operations. Table 1 below shows Tiffany's foreign operations performance from 1992 to 1993.

Table 1: Tiffany Co Foreign Operations ($000)

1993 Net Sales= $71,838
1994 Net Sales= $52,851

1993 Income/(loss) from operations= $2,381
1994 Income/(loss) from operations = $3,888

Table 1 clearly indicates that income from Tiffany's foreign operations decreased even though net sales increased in 1993. The additional economic exposure that Tiffany is now exposed to may decrease their income even further which will impact their net sales in the long run.

• Transaction Exposure

The restructuring of Tiffany's Japanese operations requires Tiffany to repurchase its inventory which will significantly decrease its net income. As it can be seen in Table 2 below, Tiffany is said to repurchase its inventory for $115 million in 1993.

Table 2: Tiffany Co Second Quarter Income Statements ($000)

1993 Product return for Japan realignment= ($115,000)
1992 Product return for Japan realignment= 0

1993 Net Income/Loss= ($31,513)
1992 Net Income/Loss= $6,992

However, Tiffany only managed to repurchase $52.5 million of inventory in July 1993 and Mitsukoshi agreed to accept a deferred payment on $25 million of this repurchased inventory, which was to be repaid in yen on a quarterly bases with interest of 6% per annum over the next 4.5 years. The remaining $62.5 million inventory will be repurchased throughout the period ending February 28, 1998 and payment for this warehouse will be made in yen.

The exchange rate fluctuation will definitely affect Tiffany's ability to repurchase their inventory. Besides that, this transaction exposure can also lead to major losses for Tiffany. The reduction in net income in Table 2 assumes that Tiffany actually repurchased all of their inventory by July 31, 1993. However, this assumption was not accurate and Tiffany is now only able to repurchase all of their inventory by 1998 which I believe will lead to a bigger decrease in net income as they are then required to make payment in yen from 1993 to 1998.

III. Conclusion and Recommendation

I believe that Tiffany is making the right choice by restructuring its Japanese operations. Tiffany will be able to experience huge profits by gaining more control in Japan if they plan their strategy wisely. It is important for Tiffany to hedge against the volatile exchange rates between the yen and the dollar and they can always buy options and future contracts to reduce this risk. I believe that the profits that Tiffany can earn by gaining control in Japan outweighs the exchange rate risk as this risk can be offset by hedging.