Exchange-rate windfall, wage costs and an export price demand
A Yangon garment exporter sells 50,000 units a month to a single foreign buyer at USD 12 per unit. Variable cost is 18,000 MMK per unit and monthly fixed cost is 300,000,000 MMK. When the contract was signed the exchange rate was 2,100 MMK per USD. The kyat has since depreciated to 2,600 MMK per USD. At the same time, a new minimum wage raises the firm's variable cost by 10%. The foreign buyer says it will cut the USD price by 8% unless the firm holds the price; if the firm refuses the cut, the buyer will reduce volume by 20%. The firm has spare capacity and no other buyer in the short run. Assume no tax and no other costs.
1. Calculate monthly profit under the original exchange rate and costs, and under the new exchange rate and wage cost if the USD price and volume stay unchanged.
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Original position: Revenue = 50,000 x USD 12 x 2,100 = 1,260,000,000 MMK. Variable cost = 50,000 x 18,000 = 900,000,000 MMK. Fixed cost = 300,000,000 MMK. Profit = 1,260,000,000 - 900,000,000 - 300,000,000 = 60,000,000 MMK.
New position with unchanged USD price and volume: New exchange rate = 2,600 MMK per USD. Revenue = 50,000 x USD 12 x 2,600 = 1,560,000,000 MMK. New variable cost per unit = 18,000 x 1.10 = 19,800 MMK. Variable cost = 50,000 x 19,800 = 990,000,000 MMK. Profit = 1,560,000,000 - 990,000,000 - 300,000,000 = 270,000,000 MMK. The depreciation more than offsets the wage increase. The gain is not necessarily permanent, because imported inputs, debt or future wage claims may rise, but on these assumptions the firm has a much larger cushion for negotiation.
2. Evaluate the two options: accept an 8% price cut with volume 50,000, or refuse and sell 40,000 at USD 12. Which gives the higher monthly profit?
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Option A: accept the 8% cut. New USD price = 12 x 0.92 = USD 11.04. Revenue = 50,000 x 11.04 x 2,600 = 1,435,200,000 MMK. Variable cost = 990,000,000 MMK. Contribution = 445,200,000 MMK. Profit = 445,200,000 - 300,000,000 = 145,200,000 MMK.
Option B: refuse and lose 20% of volume. Volume = 40,000 units. Revenue = 40,000 x 12 x 2,600 = 1,248,000,000 MMK. Variable cost = 40,000 x 19,800 = 792,000,000 MMK. Contribution = 456,000,000 MMK. Profit = 456,000,000 - 300,000,000 = 156,000,000 MMK. Refusing gives the higher monthly profit by 10,800,000 MMK. The reason is that the price cut costs 2,496 MMK per unit on 50,000 units, while the volume loss saves 19,800 MMK variable cost on 10,000 units but loses 31,200 MMK revenue per unit. The answer is sensitive to the buyer's threat being credible and to the assumption that no other buyer can use the spare capacity.
3. The buyer claims demand is highly elastic. Explain how elasticity, contribution margin and non-price factors should influence the firm's negotiating position beyond this one-month calculation.
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Elasticity tells the firm how volume responds to price. If demand is highly elastic, a price cut can protect or increase revenue, but it can still reduce profit if the extra contribution from volume does not cover the price concession. The relevant test is contribution margin, not revenue alone. Here the price cut costs 2,496 MMK per unit; the firm must gain enough extra units to recover that. The buyer's threat of a 20% volume loss for an 8% price change implies a strong response, but the firm should check whether the threat is credible and whether the buyer has alternative suppliers.
Non-price factors also matter. The firm should consider the long-term relationship, reliability of delivery, penalty clauses, exchange-rate risk, future wage inflation, the risk of relying on one buyer, and the possibility of finding another customer for spare capacity. A short-term profit-maximising refusal may damage a relationship that provides stable orders. A good negotiating position separates the exchange-rate windfall from the wage-cost issue, asks for a temporary price adjustment rather than a permanent cut, and ties any concession to volume or payment terms.