Treasury & Risk's 7th Annual Alexander Hamilton Best Practices Summit — October 1 and 2, 2002
2002 — Financial Risk Management Winners: Gold—McDonald’s; Silver—Sun Microsystems; Bronze—Cisco Systems
SEIZING OPPORTUNITY OR SAVING MONEY
McDonald’s captures the gold
GOLD FINANCIAL RISK MANAGEMENT WINNER—When the purchasing department of the world’s biggest fast-food chain looked at the menu of a typical McDonald’s restaurant, it saw hundreds of different items that needed to be bought to make that restaurant function. Treasury, meanwhile, saw a diversified portfolio of risk. And therein lay the problem. As the purchasing department did everything it could to hold the line on the costs of beef, fries and hamburger buns, treasury’s goal was to do whatever it could to limit the company’s risk exposure—which sometimes meant actually spending money rather than saving it.
Until the middle of 2000, those competing philosophies put the Oak Brook, Ill.-based McDonald’s Corp. at a disadvantage as far as managing risk went. Purchasing agents would only focus on the commodities that they were responsible for and hedged accordingly. The problem was that there were several instances when a hedging strategy for one commodity may have actually boosted the company’s overall risk because the commodity hedged had acted as a natural hedge against another exposure. What McDonald’s needed was a way to view its commodity risk in its entirety.
To gain that kind of perspective, McDonald’s risk management team, headed by director Michael Irgang, didn’t have to look far. Already, the company had been using a basket option pricer to manage the currency risk associated with McDonald’s international business. Irgang and his team figured if they replaced the Deutsche mark with beef and the Japanese yen with hamburger buns they might be able to create a model with which to view McDonald’s commodities risk in aggregate.
First, the company asked the suppliers of its top 30 purchase items to detail the different ingredient commodities and components used to create the products. For instance, the company that supplies the famous sesame seed buns clearly has to worry about the price of flour and then the price of grain—and of course the price of sesame seeds. Armed with that information, treasury created a matrix with the top 30 purchase items on one axis and on another axis the different commodities that went into creating the purchase items (for example, hamburger bun commodities included prices for wheat, soy oil and the fuel required to bring the buns to the restaurants). This gave McDonald’s a more accurate idea of which commodities could be hedged using exchange-traded futures.
With this knowledge, McDonald’s created a commodity risk strategy, the crux of which was based on a dynamic relationship between cost and risk. “You could be increasing risk to save money or spending money to lower risk,” Irgang says. This clearer view has enabled treasury to identify several opportunities to take advantage of favorable prices, including buying coffee at a 35-year low and locking in the cost of diesel fuel before energy prices rose. In addition, the company has been able to pass on more stable food costs, which has helped stores protect operating margins.
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SILVER FINANCIAL RISK MANAGEMENT WINNER—The tech sector meltdown was already in full swing and the treasury department at Santa Clara, Calif.-based Sun Microsystems needed updating. During the go-go Internet boom days, a 20% growth rate at Sun meant few paid close attention to foreign exchange exposure; the goal was to sell computer servers. But when the party ended, the shortcomings in treasury quickly came to light, particularly as the company moved to become more proactive in managing foreign exchange risk.
The solution came with a Web-based FX tool called Crystal Ball that was developed in-house and enabled field finance staff to submit exposure forecasts in a consistent format that would interact with Sun’s trading platform from FXall. The end result is a seamless link that allows trade information to be aggregated in Crystal Ball for trading via FXall. From there the executed trades are uploaded into Sun’s Quantum treasury system to be populated into the general ledger.
The moves to a Web-based system have yielded an estimated $1.2 million in annual pre-tax savings and have extended Sun’s hedge duration without costing the company more. Also, rather than using two-month options, the company is now able to utilize three layers of option hedges, permitting more exchange rate flexibility.
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BRONZE FINANCIAL RISK MANAGEMENT WINNER—In just 5 1/2 years, this San Jose, Calif.-based telecommunications giant’s cash and investment portfolio had grown tenfold to $21 billion, but the treasury department’s ability to put its arms around its ballooning portfolio hadn’t kept pace. Risk management reporting was piecemeal and cumbersome, while accounting for assets proved to be a chore in large part because it was a manual process that required the meshing of disjointed systems. When Cisco and its external portfolio asset managers decided the company needed to expand its investment operations both domestically and internationally, it was clear that the time had come to bring some clarity to Cisco’s risk management.
The company identified three areas of risk that it faced in managing its mammoth portfolio: operational risk, accounting risk and investment risk. It then looked for vendors that could provide straight-through processing for trades done internally and could be consolidated with the external asset management positions. Cisco chose Bloomberg’s Portfolio Trading System to manage the operational risks, State Street Corp. to tackle accounting issues, and RiskMetrics to handle the task of providing Cisco treasury with a true picture of its investment risk.
The upshot: Treasury was able to streamline its accounting processes, enabling staff to spend more time analyzing data rather than focusing on clerical duties like data entry. What’s more, the task of closing the investment books each month has been slashed to a 90-minute process from what once took 120 people- hours to accomplish.
—As seen in the October 2002 issue of Treasury & Risk magazine