Hedge against uncertainty
To many, hedging may seem like the kind of sophisticated, capital-intensive pursuit that is reserved for multinational corporations or wealthy individuals. Not so. Hedging against future uncertainty is something we do in our everyday lives. For instance, event planners might identify indoor and outdoor venues ahead of time in anticipation of inclement weather. Also, the automobile, health and life insurance policies many of us purchase are a hedge against future vehicle loss, health or death events. You do not know if your insurance company will spend more on policy payouts than you do on premiums. On average they pay less, the difference being their profits. Statistically you are playing a losing game. Why do you play anyhow? Because you have replaced the uncertainty of a worst case scenario with the relative certainty of known payments and a safety net. That is a hedge.
Now let’s consider your business. Commodity hedges are an obvious example. If fuel is a primary cost input, such as for a trucking company, you might add a fuel surcharge to your basic pricing schedule. If fuel prices, notoriously volatile, jump all over the place, your fuel surcharge will follow suit, leaving you a stable cost and revenue gap. Mobile phone companies love to lock their customers into long-term deals. Why? It provides for stable revenue and network demand planning in the face of a fickle public. Airlines raise the price of tickets as the flight date gets closer, encouraging travelers to commit earlier. This helps with planning routes and boosting utilization of assets.
What about you? What are the biggest uncertainties your business faces? How can you hedge against them? Maybe it is product mix. You can never tell how many blue versus polka dot versus striped widgets will sell and you always seem to be short on some and long on others. Can you postpone the mix decision until later in the process? Maybe you can keep an inventory of widgets that are ready to go except for the final finish. The total number of widgets sold is likely to be much more stable than the mix between the various options. Alternatively, your business could have high fixed costs and low variable costs, causing profits and losses to swing wildly on variable sales. How can you hedge against such swings? On the cost side, you can convert seemingly fixed costs into variable costs in many cases. Outsourcing certain process steps or skills sets is one way. On the revenue side you can offer steep volume discounts in your pricing, compelling large, long-term orders across which to spread your high fixed costs.
The details of how to hedge will vary from case to case. The important point is that you can and should do it. You should also let MagnaVaria help.
