Thursday, October 9, 2014

Depreciation and Small businesses in Japan. My example.

Here is a nice article on how swings in currency exchange rates are having an adverse affect on small businesses in Japan. Here is an excerpt and below that I do a simple example to show how this works in "real life".  Exchange Rates MATTER!

Data Show More Smaller Companies Succumbing to Weak Yen

"The failed businesses, many of them small, were struck by the higher costs of imported materials such as fuel, minerals and food as the exchange rate shifted from less than ¥80 per dollar two years ago to as high as ¥110 in recent days.(*emphasis mine).
Hit hardest was the transportation industry, including trucking companies, which saw 81 companies go bankrupt. The number of insolvencies totaled 44 in manufacturing, 41 in wholesale and 19 in services, the research company said."

I am a Japanese small business-person.  I produce a "widget" that sells for $100 Yen in Tokyo.

Assume half the cost of producing and selling one widget comes from inputs I must import from the US--50 Yen. Prior to the weakening of the Yen against the dollar, one US dollar exchanged for 80 Yen or, inversely, one Yen exchanged for 1.3 US cents.

So, for me to purchase my inputs from the US I took 50 Yen and sold them for 1.3 cents each for a total of 6.5 US cents. Remember, this is half the cost for me to produce and sell the widget. This means the price for my widget, in US currency, is 13 US cents.

Now, the exchange rate moves to one US dollar exchanges for 110 Yen or, inversely, one Yen exchanges for .9 US cents (9/10ths of a cent/penny).  The Yen does not "buy" as much US currency as it did before.  So I am going to have to give up MORE Yen in order to pay for the 6.5 US cents worth of inputs I need.

How many Yen do I need at the exchange rate of one Yen buys 9/10th of a cent to get 6.5 US cents?

YEN ("X") Times .09 US cents = 6.5 US Cents.  Solve for YEN "X" and you get 72.22 Yen.

Through no fault of my own, events beyond my control, my cost of production using US inputs has increased from 50 Yen to 72.22 Yen, a 44% increase.

Assuming I have little pricing power domestically because of competition and cannot raise the price, it is easy to see how small companies in Japan are under pressure. If they cannot cut costs elsewhere to off-set the currency swing, then they risk going out of business.

I hope this simple example helps you understand better how changes in exchanges rates can affect big AND small businesses.

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