What euro dividend?

Where's the real savings from the European monetary union - and who can expect to get the lion's share?

Don't be misled. The European monetary union has been a movement led by European big business, not a popular movement led by politicians. No politician, American or European, would take on an agenda like the EMU and the stringent social reforms necessary for compliance without strong impetus. European business sees a single currency bringing a "euro dividend," or a tangible savings in business expense, much like the end of the Cold War was supposed to bring America a peace dividend from lowered defense spending.

But our research shows that this euro dividend, like the peace dividend, is more hype than fact. And any dividend that does exist will accrue more to European corporations than to American corporations. Indeed, we calculate that European companies will reap a much healthier return on their investment in euro compliance vis-a-vis American companies. That's why, to maximize their own investment return, American companies must use the EMU to first re-engineer their European financial strategy. Garnering the dividend requires viewing the monetary union as an opportunity for a change in financial management and operational strategy as opposed to simply a compliance issue. Improvement in European competitiveness will not be wholesale, but limited to companies with competent management teams, able to tap the opportunity the EMU presents.

The Direct Benefit - and Stealth Gains

There is really only one direct benefit of the EMU: reduced foreign-exchange transaction charges and reduced currency volatility (which translates into improved valuation). Companies are paying 5 to 10 basis points on European FX trades, depending on the currency and the transaction volume, all of which will be eliminated. Given that 40 percent of the average large European company's business is intra-European, compared to only 15 percent for the average American company, the reduction in FX cost and volatility is three times greater for European companies.

Beyond this one direct effect, there are several second-order effects that will bring tangible savings. First, the EMU allows the creation of an EUwide capital market that will lower price on corporate debt and improve liquidity and valuation for equity. The cost of financing in Europe is expected to decrease by 50 basis points during the transition period (1999-2002). This reduction in overall finance costs will drive American businesses to tap European capital markets more aggressively, but less so than European companies.

Second, the ability to compare price across borders will increase competition, resulting in a net 0.5-1.0 percent price reduction. The price correction will harm American companies exporting to Europe more so than companies manufacturing within the EMU. Local manufacturers will experience reductions in both payables and receivables.

Third, companies will realize savings in administrative processes and the treasury function as a result of streamlining A/P, A/R and foreign exchange activity. We believe the finance function will reduce European headcount by 5 percent as a result of the EMU.

We estimate the total savings for an American company from the combined euro dividend and "stealth" expenses will be approximately $15 million, or 3 percent, of overall European expenses. This makes investment in the EMU compliance a net loss for American firms. European companies are investing the same amount in euro compliance, yet are getting three times the return on their investment as their American counterparts.

Improving the Dividend

The euro dividend, however, is not enough to significantly improve the competitiveness of European companies en masse. To maximize the investment made in euro compliance, companies must use the EMU as the rationale to re-engineer their European financial operations and strategy. This means realigning the treasury from a regional to a functional structure, consolidating bank relationships, centralizing risk and cash-management operations, and re-engineering A/P and A/R.

Several European companies - Siemens, Daimler Benz and Philips - have followed this strategy and reshaped their overall financial management and operational structures. All three companies expect to reduce financial management costs by 15 percent to 20 percent as a result of EMU-related re-engineering. Most of these savings come from innovation surrounding capital-raising activity, which will be the biggest benefit of the EMU. True pan-European markets, and financial service institutions serving these markets, will make Europe a more attractive and cheaper place for financing.

Finally, even if the impact of the EMU won't revolutionize European business and make it competitive with America, it will be an opportunity for competitive improvement left to business managers who understand the EMU is an opportunity, or excuse, to re-engineer their financial and operational strategies.

The bottom line as we see it: U.S. CFOs should adopt currency transition strategies now used by European firms to deal with the advent of the euro in 1999. After 1999, the euro could become the preferred currency for intra-European trade and challenge the global supremacy of the U.S. dollar. That's why U.S. corporations need to Europeanize their operations and learn to adapt to a more level playing field that neutralizes the advantage of the U.S. dollar as the firm's home currency.

The EMU Defense Budget

American companies are in the position of having to identify and execute change to reach euro compliance. This includes preparing systems and procedures to handle a replacement currency in Europe. See the chart below for a profile of the major direct costs of this undertaking.

The Direct Cost of Euro Compliance

                                    Expected Cost ($)

A/P-A/R compliance                          6,500,000
Purchasing process revision                 4,500,000
Marketing update                            2,500,000
IT application compliance                   2,000,000
Report restatement                          1,500,000
Legal review                                1,500,000
Treasury compliance                         1,500,000

Net Cost                                  $20,000,000

Though much is made of system compliance issues in the trade press, major application vendors provide euro-compliance upgrades as part of their service and maintenance contracts. The costs in the table above are those associated with process re-engineering and training.

Source: World Research Advisory

Mr. Craig Macdonald is with the financial advisory service of the World Research Advisory, based in Reston, Va. You can reach him at [phone] or [e-mail].