Performance Measurement in Multinational Companies

Learning Objective 5 Indicate the difficulties that occur when the performance of divisions operating in different countries is compared

• adjustments needed for differences in inflation rates and changes in exchange rates

Our discussion so far has focused on performance evaluation of different divisions of a company operating within a single country. We next discuss the additional difficulties created when managers compare the performance of divisions of a company operating in different countries. Several issues arise.^*

• The economic, legal, political, social, and cultural environments differ significantly across countries. Operating a division in an open economy like Australia is very different from operating in a closed economy such as Venezuela, where the government controls prices and threatens to nationalize industries.
• Import quotas and tariffs range widely from country to country, and it’s not unusual for countries to impose custom duties to restrict the imports of certain goods.
• The availability of materials and skilled labor as well as the costs of materials, labor, and infrastructure (power, transportation, and communication) also differ significantly across countries. Companies operating in Indonesia, for example, must spend 30% of their total production costs on transportation, whereas these costs account for just 12% of total spending in China.
• Divisions operating in different countries account for their performance in different currencies, and inflation and fluctuations in foreign-currency exchange rates affect performance measurement. For example, economies such as Argentina, Myanmar, and Nigeria suffer from double-digit inflation, which dampens the performance of divisions in those countries when their results are measured in dollars.

As a result of these differences, adjustments need to be made to accurately compare the performance of divisions in different countries.

Calculating a Foreign Division’s ROI in the Foreign Currency

Suppose Hospitality Inns invests in a hotel in Mexico City. The investment consists mainly of the costs of buildings and furnishings. Also assume the following:

• The exchange rate at the time of Hospitality Inns’ investment on December 31, 2019, is $20 \text{pesos}=\mathrm{\$}1\mathrm{.}$
• During 2020, the Mexican peso continues its steady decline in its value. The exchange rate on December 31, 2020, is $30 \text{pesos}=\mathrm{\$}1\mathrm{.}$
• The average exchange rate during 2020 is $[(20+30)÷2]=25 \text{pesos}=\mathrm{\$}1\mathrm{.}$
• The investment (total assets) in the Mexico City hotel is 30,000,000 pesos.
• The operating income of the Mexico City hotel in 2020 is 6,000,000 pesos.

What is the historical-cost-based ROI for the Mexico City hotel in 2020?

To answer this question, Hospitality Inns’ managers first have to determine whether they should calculate the ROI in pesos or in dollars. If they calculate the ROI in dollars, what exchange rate should they use? The managers may also be interested in how the ROI of Hospitality Inns Mexico City (HIMC) compares with the ROI of Hospitality Inns New Orleans (HINO), which is also a relatively new hotel of approximately the same size. The answers to these questions yield information that will be helpful when making future investment decisions.

HIMC’s ROI of 20% is higher than HINO’s ROI of 17% (see section Return on Investment). Does this mean that HIMC outperformed HINO based on the ROI criterion? Not necessarily. That’s because HIMC operates in a very different economic environment than HINO.

The peso has declined in value relative to the dollar in 2020. This decline has led to higher inflation in Mexico than in the United States. As a result of the higher inflation in Mexico, HIMC will charge higher prices for its hotel rooms, which will increase HIMC’s operating income and lead to a higher ROI. Inflation clouds the real economic returns on an asset and makes historical-cost-based ROI higher. Differences in inflation rates between the two countries make a direct comparison of HIMC’s peso-denominated ROI with HINO’s dollar-­denominated ROI misleading.