Operational Exposure Occurs at the

Operational exposure occurs at the first moment of market entry into a foreign country. For Laker Airways, the entry into the United States starts when they started cross-continental flights. Laker has several levels of operational exposure. The first level occurs when they purchase fuel. Since they must refuel themselves in the United States in cross-continental trips, they must make all purchases of fuel in the United States in USD.

The risk they expose themselves in fuel is that they are subject to currency fluctuations on a daily basis, whereas other operational decisions can be anticipated and made periodically thus reducing overall currency exposure, fuel is a constant expense that cannot be minimized through carefully playing the currency market. Fuel is perhaps their greatest operational exposure because it is such a consistent and non-negotiable commodity. Their second area of operational exposure is within advertising and booking within the United States itself.

This exposure is more anticipatory because they can incur these costs through company control more so than fuel costs. However, booking costs are once again subject to customer demand rather than corporate control, and therefore they receive significant exposure in this area as well. Their advertising exposure is less so than their other operational expenses because advertisement is company dictated rather than market dictated which makes it much easier to negotiate based upon fluctuations within the currency market.

The final area of operation exposure comes from the one-off costs of purchases U.S. made aircrafts. This cost presents the least operational exposure because purchasing is in the direct hands of corporate control since they can decide when to purchase to provide them with the most favorable currency rates. Overall, it would appear that operational exposure occurs most when the company must pay costs associated with consumer demand and continuing costs such as fuel and booking costs.

Operational costs that are one-off costs or costs that can be controlled and dictated by the company offer the least amount of operational exposure. Other hidden costs that are not discussed within the example would have been through their distribution network. Creating relationships with airports throughout the United States, as well as hiring a U.S. director of operations, developing relationships and branding from U.S. travel agents would all be part of the distribution network. Since these costs are all within the U.S.

market it would seem that they were exposed to currency fluctuations. Laker must have suffered either from lack of corporate foresight into how to negotiate the costs of currency risk, or they were hit hardest by the daily operational expenses that are dictated by market forces rather than corporate strategy. There are several opportunities for Laker to hedge their currency risk. They could have obviously gone through a third party currency player that would willingly hedge their risk in order to play the currency market.

Since the United States is part of the "Major Eight" they could no doubt have found many different currency brokerages to hedge their currency risk. However, since their cross-continental trips are no doubt low margin operations since they must implement such a large infrastructure to support their operations; this could have been too costly or might even have reduced the company to negative margins in their cross-continental trips.

Another method they could have hedged their risk was to use rolling currency conversion, by converting chronically through a long period, they reduce currency risk because they will not having a long position at any given time. However, this strategy will mean they fluctuate based upon the day-to-day movements of the market. This strategy would have been effective in the windfalls from the depreciation of the Pound because they would have reduced their risk on a periodic level and would never have had a very large inventory of foreign currency.

They could also have created OTC contracts that would have dramatically reduced their risk over the long-term. This option would have been particularly attractive since some of their operational exposure are consistent, while some are not, therefore they could have hedged the part of their operational exposure that would have been the most risky, while retaining for their personal investment the stable or consistent aspect of their currency hedge.

Another option they could have pursued was to relocate more operational facilities to the United States, perhaps even open up an independent subsidiary branch within the U.S. The result would be that they operation wholly within U.S. currency, and thus they would work independently of the British headquarter. This would be the optimal way to reduce currency risk, but operationally this is a large investment that the majority of companies are not willing to make.

Since Laker is a relatively small player within the market they would no be able to fully implement such a strategy. Another way they could have hedged their risk is through shifting pricing paradigms towards the currency market. Since there are only a limited number of airways that flies cross-continental from England to the U.S., it would seem that price elasticity would be relatively low.

If customers would be willing to pay slightly more, they could tie their currency exposure to their pricing thus allowing the customer to take on part or all of their currency exposure. Either way, hedging in this case would have been a very good idea, because in order to correctly analyze the currency market and make smart decisions, Laker would have had to hire many currency analysts just to decide what to do with their currency situation.

It is most likely because of their poor planning in association with the currency market that ultimately led to their downfall. The natural dollar liability exposure of Laker Airway could have been hedged although the logistics of this hedging would have been difficult. Since they are not making one-off purchases but incurring liability exposure through operational expenses it is very hard to find a currency broker.

They would not be able to go through for instance the British Bank because they would have to continually borrow and repay money, which is not a feasible method of currency hedging. The only way they could have hedged their operational risk is if they borrowed enough money in sterling on a yearly basis to cover their operational expenses and treated their yearly or monthly expenses as one-off costs. This could have worked, but such a formula would probably be extremely expensive.

Another good hedging method is to allocate even more resources and manpower to the United States and create a self-sustaining service within the U.S. alone that would operate wholly in U.S. currency. This method would make the natural dollar liability an obsolete concern. However, as discussed above this strategy is very dangerous purely because a large financial investment must be made at the outset. If Lakers bought their DC 10 through a loan on sterling from the British bank, it would have several implications upon their overall currency risk.

First, the bank would assume to a certain degree the currency risk associated with the aircraft purchase, since they are now carrying the sterling cost. This means that Laker Airway would shift their current risk over to the British Bank since they would purchase the DC 10 outright using sterling at the going currency rate. The Bank in turn must play the currency market to ensure a return on investment. When Laker Airways borrows money from Eximbank however, they gain.