CASE STUDY 4 Revised

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ORIFLAME S.A.

CASE STUDY
ADVANCED ACCCOUNTING

SUBMITTED TO:
LOUIE ARTH REYES

SUBMITTED BY:
Aquino, Mary Claire C.
Cabaya, Eula C.
Crisostomo, Meryl
Enriquez, Pauline C.
Magno, Franz Catherine S.
Magparok, Catherine
Orate, Rhealy B.
I. BACKGROUND OF THE CASE

Oriflame was founded in 1967 in Sweden by the brothers Jonas and Robert of
Jochnick and their friend Bengt Hellsten, with the dream to "give people the
opportunity to benefit from good skin care and attractive cosmetics products
inspired by the natural beauty that the world associates with Sweden." They
started by selling their products directly into the homes of Swedish
consumers, and soon thereafter, abroad, with the help of independent sales
consultants. In 2009, the firm sold around 600 million units of Swedish beauty
products in 62 countries (of which 12 were served via franchising agreements)
located in four geographic regions: "CIS & Baltics" (Commonwealth of
Independent States, including Russia), "EMEA" (Europe, the Middle East,
and Africa), Latin America, and Asia. In 2009 emerging markets accounted
for roughly 90% of the firm's €1.3 billion sales (see Exhibit 1 for Oriflame's
2008 and 2009 financials). According to Oriflarne's management, the
founders' respect for people and nature was still reflected in its operating
principles and its social and environmental policies. Oriflame supported
numerous charities worldwide and was a cofounder of the World Childhood
Foundation. Oriflame's value proposition focused on delivering natural, value-
for-money cosmetics within categories such as Skin Care, Color Cosmetics,
Fragrance, Personal & Hair Care, and Accessories & Wellness (see Exhibit 2
for sales by category). Consequently, the company was competing in a global
cosmetics, personal, and hair market, estimated at €250 billion in 2009,
against large multinationals such as American Procter & Gamble, Anglo-
Dutch Unilever, German Beiersdorf, and French L'Oreal. Oriflame also faced
formidable competition on its direct-selling market segment. U.S.-based Avon
was Oriflame's main competitor across the globe (see Exhibit 3 for both firms'
organic growth figures). The American firm was more than five times4 bigger
in revenues than its Swedish challenger, chiefly due to a broader product
offering and geographic reach. Other direct-selling competitors, also of U.S.
origin, were Mary Kay and Amway. In addition, depending on the location,
direct-selling competition also came from significant local competitors, such
as Kalina in Russia, and Natura and Esika in Latin America. Magnuss
BrannstrOxn, Oriflame's CEO, summarized the company's global competitive
position: "In the CIS we are already the No. 1 beauty company selling direct
and we are among the top five to top 10 in most European countries. In Asia,
we are in a good position, but in Latin America we are far away."5 Oriflame
reported in compliance with the International Financial Reporting Standards
(IFRS) as adopted by the European Union. Since 1999 Oriflame reported the
consolidated results of its subsidiaries at group level in euros, mainly because
the group was incorporated in the Eurozone and incurred the majority of its
costs in this currency. Each national entity was operating in a local functional
currency that reflected the underlying circumstances relevant to that entity.
According to the lEFRS,6 each subsidiary then translated its results and
financial position to be presented in euros.

II. STATEMENT OF THE PROBLEMS

1. Did Oriflarne's business model shield the company from FX losses or


instead magnify the exposure?
2. Recent investment decisions made by Oriflame's management suggested
that FX volatility could become less of a factor in the future. How long would
it take until these measures would effectively mitigate Oriflame's exposure
and could other financial instruments be used in the meantime to alleviate the
hits?
3. Considering Oriflame's significant FX risk exposure, should its finance unit
make much more systematic and massive use of derivative hedging
instruments? Should they add more sophisticated instruments apart from
forwards? In which areas would these be most effective?
4. Should Oriflame review its internal hedging policies and procedures?
5. Is Oriflame's hedging strategy aligned with the shareholder's interests? To
which of the three types of FX risks are Oriflame's investors mainly exposed?
Can hedging that exposure with financial instruments have adverse accounting
effects, short term and long term?

III. PRESENTATION OF DATA

1. Oriflame business model magnified their FX exposure. It regularly used


derivatives to manage its countries' FX risk exposure caused by FX rate
movements between committing to euro-denominated intragroup liabilities
and actually paying them. Since the profit are set in euros their sales and
cost will be exposed to foreign exchange risk because more than half of it
is incurred in currency other than euro. Therefore, as the foreign exchange
risk decreases, the cost incurred increases and vice versa.
2. Oriflame could use other financial instruments such as currency options
aside from forward contracts to selectively mitigate some types of FX risk
exposure. Regarding decisions made by oriflame, it would take a
maximum of 5-6 months until these measures would effectively mitigate
the risk. It has short cycles that in six months they are back again with the
problem.

3. Companies are exposed to different risks in their normal day-to-day


operations. These risks include currency exposure, transaction exposure,
and translation exposure. FX exposure in transaction is usually associated
with imports and exports and happens when a business makes or receives
payments in a foreign currency. The risk occurs when the exchange rate
changes between the date of the business transaction and the settlement of
the payment. While, translation exposure happens when a company has
assets in another currency and has to translate them for the purposes of
accounting and reporting. If there are changes to the exchange rate this can
affect the value of the company’s assets and must be reported. Entering
forward contract can help both of the party to help businesses from the
risks associated with market volatility to lock in the prices, exchange rates,
and interest rates. Furthermore, the tools that can be applied to present
these securities are identified as derivative tools; these tools comprise
futures agreements, forward agreements, alternative agreements, swap
contracts, and floor and cap contracts. The management can achieve
security from these derivatives. Using them in commodity prices, market
risk, foreign exchange rates, credit risk, etc. will benefit the company, By
locking input prices, firms are able to protect themselves against the rising
operating costs, and therefore, make concrete plans on capital formation
and expansion, in which the Oriflame raises firms’ value and lowers their
capital cost, is indeed an inimitable strategic resource.

4. Yes, Oriflame’s internal hedging policies needs to be reviewed. Since


some of their internal hedging policies do not align with various situations
and economic conditions, reviewing the internal hedging policies shall
help them to reduce risk of unexpected fluctuations arising in the market.
They should also consider other types of derivatives that are suited for the
company. As Oriflame is one of the main direct sales companies in many
of its markets and the largest direct sales company. The company,
Oriflame, by developing a procedure in which decision are made jointly
by head office and subsidiary staff, in which, The head office would need
to come out with a standard pricing policy and allows its subsidiaries to
have certain amount of pricing authority. This is to ensure that the
company would have better knowledge and information about what is
happening in each local branch. The head office would then evaluate each
branch as individual and make necessary changes when needed to avoid
substantial losses. And help the company to identify risk at an early stage
and come up with procedures to be undertaken.

5. No, Oriflame’s stock is undervalued because of some financial decisions


that were made by Oriflame. This is a conflict to the shareholder’s interest.
The type of foreign exchange risk that investors mainly exposed is the
transaction exposure. Hedging that exposure with financial instruments
does not have an adverse accounting effect, `oriflamme developed an
indirect hedging approach where the currencies correlated with more
liquid markets were identified.

IV. CONCLUSION
Oriflame is a globally traded company. As it continues to look across
borders to be the best among its competitors, it is more exposed to FX
volatility. Its business model magnified it from FX losses exposure. More
than half of its cost is incurred other than euros. It could use other
financial instruments such as derivatives to alleviate the hits as it would
take quiet some time to effectively mitigate its exposure. It must review its
internal hedging policies and procedure in that way it can be certain that it
could mitigate its exposure. There are other types of derivatives that
Oriflame may use to hedge the FX exposure aside from forward contract
which includes future contract, option, swap, and the like. Since the
potential translation gains and losses were never hedged, investors in
Oriflame are mainly exposed in translation exposure. It is better to hedge
this potential translation gains and losses to mitigate the risks that the
investors are exposed to.

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