Kilgore Custom Milling
RICK NASON, PHD, CFA
Partner, RSD Solutions Inc., and Associate Professor of Finance, Dalhousie University
STEPHEN McPHIE, CA
Partner, RSD Solutions Inc.
This case study provides a broad spectrum of issues – both opportunities and potential threats – that arise from creating growth opportunities. Many risks can be explored and debated as part of various approaches to enterprise risk management (ERM), including using strengths, weaknesses, opportunities, and threats (SWOT) analysis and risk profiles. In particular, this case focuses on financial risk management as taught in Chapter 14, "Market Risk Management and Common Elements with Credit Risk Management," in Enterprise Risk Management: Today's Leading Research and Best Practices for Tomorrow's Executives, edited by John Fraser and Betty J. Simkins (John Wiley & Sons, 2010). Thus, teachers of ERM can focus at the corporate level and include all risks, or delve more specifically into financial risks, or go even more specifically into liquidity or foreign exchange risks.
"Hope is not a risk strategy! Wishful thinking is not the best we can do, and furthermore we can't repeat the mistakes of the past if we want to move to the next level. We need to think this through more carefully!" Cathy Williams was growing ever more tired and frustrated. She and her four-person treasury team had been struggling with various aspects of the new supply contract for weeks, and all that remained was how the company would hedge the resulting currency risk. This issue had been highlighted as part of the management team's discussions about risk management generally, and it was still an issue as to how this aspect of currency hedging would fit into the firm's attempt at creating an enterprise risk management framework. As she sat with her boss, Steve MacLinden, and the rest of the company's senior management team, it was clear that they were not any further ahead than they had been when the financial hedging strategy meeting began over two hours ago.
Kilgore Custom Milling was a small private manufacturer of power window assemblies for automobile manufacturers' plants based in southern Ontario, Canada. Just over a year ago, as part of a strategic planning session, the company made a decision to seek out contracts to supply plants in the United States. Due to the successful efforts of the entire management team, they were in the final stages of finalizing a contract to supply a Japanese car company that was expanding its operations in Michigan. The deal included a possible extension to supply a plant in Tennessee and one in Mexico that would be coming on line in nine months. Supplying plants in the United States was a major move for the company, a move it had tried before but which had produced results that almost bankrupted the company.
The process of securing the contract had been an exhausting exercise. The Japanese manufacturer involved was very thorough in its due diligence of its supplier agreements. Additionally, in the current economic manufacturing environment, the competition was tough. The five-year contract, with an option to extend to eight years, could potentially mean the difference between a supplier such as Kilgore staying in business and it failing. The operational and technical demands of the Japanese manufacturer were high, but the main point of competition was price, as several different suppliers had the necessary track records and operational platforms to satisfy the conditions and standards necessary to win. In the 1990s, Canadian manufacturers such as Kilgore could rely on the relatively weak Canadian dollar to help them win price-based contracts. That advantage was now gone with the Canadian dollar near parity to the U.S. dollar, and thus it was manufacturing ability and geographical placement that were key determining factors – along with the bottom-line pricing, of course.
The prospect of selling to a U.S.-based manufacturer for the first time in almost 25 years was very exciting, but also scary. Kilgore had supplied a U.S.-based plant in the late 1980s for a while, but exchange rate volatility had caused Kilgore trouble and had led to significant losses. As a result, Kilgore made a decision to stick with supplying Canadian-based manufacturers. Many of its competitors in the automotive supply industry continued to focus on supplying the large U.S. manufacturing plants. Over this period of time, the focus on Canadian sales had provided Kilgore with a stable and profitable stream of business. However, with the changing manufacturing strategies of global manufacturers after the 2008 financial crisis, Kilgore needed to rethink its own strategy.
The contract was to be finalized in less than a week, with shipments to begin in six months, but exactly how Kilgore Custom Milling was going to be able to deliver profitably on the contract was still in doubt. To be sure, the operational and manufacturing details were set, but the contract was finely priced based on the competition. Any hiccups in production or in managing the exchange rate risk could turn the five-year, and possibly eight-year, contract into a guaranteed loss for Kilgore.
"Okay, I think we should all take a break for the weekend and tackle this with fresh minds on Monday," said Steve MacLinden, the CEO and cofounder of the company. "That's just great," thought Cathy. "What he really means is that I have to spend the weekend coming up with a solution for first thing Monday!" With that the meeting broke up with pleasantries exchanged for everyone to have a nice weekend – a weekend that Cathy knew she would be spending coming up with a workable plan for managing the currency risk that Kilgore would be taking on with this new phase of the company's evolution.