Ridgeline Instruments Goes to Germany
Ridgeline Instruments builds environmental sensors. Unit variable cost is $42 and the domestic price is $95. A German distributor has offered to buy 8,000 units a year at €78 each, delivered duty paid, meaning Ridgeline pays freight and EU duty. The exchange rate is $1.09 per euro. Ocean freight and insurance run $6 per unit, and the EU tariff is 14 percent of the declared transaction value, which would be the invoice price. The plant can produce 40,000 units a year and currently makes 30,000 against stable domestic demand. The distributor wants 90-day open-account terms. Ridgeline's bank quotes a confirmed letter of credit at 0.8 percent of invoice value plus $350 per shipment; export credit insurance costs 0.55 percent of insured receivables with 90 percent coverage; and a forward contract to lock the euro rate costs about 1.2 percent of the receivable. Ridgeline has never sold outside the United States and has no European office.
1. Compute the unit and annual contribution of the German offer and decide whether to accept it at this price. What qualitative factors could overturn the arithmetic?
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Unit economics. €78 × $1.09 = $85.02 per unit. Deduct freight of $6.00 and duty of 14% × $85.02 = $11.90. Net revenue = $67.12. Less variable cost of $42, contribution = $25.12 per unit, or $200,960 on 8,000 units.
Risk costs. Forward cover: 1.2% × $680,160 ≈ $8,162. Trade finance: a confirmed LC at 0.8% plus $350 per shipment (assume four shipments) ≈ $5,441 + $1,400 = $6,841. Net contribution after these ≈ $185,957. Export credit insurance instead of an LC would cost $3,741 but leave 10 percent uncovered.
Decision. Contribution is positive and the 10,000 units of unused capacity would otherwise earn nothing, so the order is worth taking on a marginal-cost basis - $25 per unit beats zero. But compare the domestic contribution of $53 per unit: the export price is roughly half. That gap is the real question. If domestic demand grows, Ridgeline would be filling capacity with low-margin export volume and could not easily reallocate.
Overturning factors: (1) the DDP term means Ridgeline owns the tariff classification and any duty re-assessment; if the importer is instead made the importer of record, net revenue rises by $11.90. (2) CE marking, local product-liability exposure, and packaging/labeling compliance are unquantified costs. (3) A single distributor taking 8,000 of 10,000 spare units creates dependency and potential price anchoring. Accept, but as a one-year renewable contract with a price-escalation clause and a capacity-reservation clause.
2. Recommend the payment terms and risk-mitigation package for this transaction, and explain why you would not simply accept 90-day open account.
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Why open account is unacceptable at the outset. Ninety days of open credit on $680,160 a year is an unsecured loan to a company Ridgeline has never dealt with, in a legal system where collection is expensive. The exposure is more than a year's net income, and a single default would wipe out several years of margin on this order.
Compare the two instruments.
- Confirmed irrevocable letter of credit: cost about $6,841 (0.8% + per-shipment fees). Payment depends on document compliance, not on the buyer's willingness or ability to pay; a confirming bank in the buyer's country absorbs commercial and political risk.
- Export credit insurance: cost about $3,741, roughly $3,100 cheaper, but covers only 90 percent of the receivable, requires a credit limit approved by the insurer, and leaves Ridgeline to pursue a claim.
If the distributor is a well-capitalized firm with audited statements and the insurer approves the limit, insurance is the better economics. With no trading history, the LC is the better risk transfer for the first year.
Currency. A confirmed LC still pays in euros, so hedge separately. A 12-month forward at 1.2% ($8,162) locks the rate and removes the risk that a 10 percent euro move erases the entire $200,960 contribution. Do not skip the hedge because it looks like a cost - it is the price of removing a risk the business cannot absorb.
Package: confirmed LC for the first two shipments, converting to insured open account after a clean payment record; forward cover on 100 percent of the confirmed order value; freight and duty quoted as separate line items rather than absorbed; and a retention of title clause in the distributor agreement. Also verify the correct tariff heading before shipment - a misclassification can trigger penalties far larger than the duty itself.