Case Study 4

ORIFLAME S.A.
CASE STUDY
ADVANCED ACCCOUNTING
SUBMITTED TO:
LOUIE ARTH REYES
SUBMITTED BY:
Aquino, Mary Claire C.
Cabaya, Eula C.
Crisostomo, Meryl
Enriquez, Pauline C.
Magno, Franz Catherine S.
Magparok, Catherine
Orate, Rhealy B.
I. BACKGROUND OF THE CASE
Oriflame was founded in 1967 in Sweden by the brothers Jonas and Robert of Jochnick
and their friend Bengt Hellsten, with the dream to "give people the opportunity to benefit
from good skin care and attractive cosmetics products inspired by the natural beauty that
the world associates with Sweden." They started by selling their products directly into the
homes of Swedish consumers, and soon thereafter, abroad, with the help of independent
sales consultants. In 2009, the firm sold around 600 million units of Swedish beauty
products in 62 countries (of which 12 were served via franchising agreements) located in
four geographic regions: "CIS & Baltics" (Commonwealth of Independent States,
including Russia), "EMEA" (Europe, the Middle East, and Africa), Latin America, and
Asia. In 2009 emerging markets accounted for roughly 90% of the firm's €1.3 billion
sales (see Exhibit 1 for Oriflame's 2008 and 2009 financials). According to Oriflarne's
management, the founders' respect for people and nature was still reflected in its
operating principles and its social and environmental policies. Oriflame supported
numerous charities worldwide and was a cofounder of the World Childhood Foundation.
Oriflame's value proposition focused on delivering natural, value-for-money cosmetics
within categories such as Skin Care, Color Cosmetics, Fragrance, Personal & Hair Care,
and Accessories & Wellness (see Exhibit 2 for sales by category). Consequently, the
company was competing in a global cosmetics, personal, and hair market, estimated at
€250 billion in 2009, against large multinationals such as American Procter & Gamble,
Anglo-Dutch Unilever, German Beiersdorf, and French L'Oreal. Oriflame also faced
formidable competition on its direct-selling market segment. U.S.-based Avon was
Oriflame's main competitor across the globe (see Exhibit 3 for both firms' organic growth
figures). The American firm was more than five times4 bigger in revenues than its
Swedish challenger, chiefly due to a broader product offering and geographic reach.
Other direct-selling competitors, also of U.S. origin, were Mary Kay and Amway. In
addition, depending on the location, direct-selling competition also came from significant
local competitors, such as Kalina in Russia, and Natura and Esika in Latin America.
Magnuss BrannstrOxn, Oriflame's CEO, summarized the company's global competitive
position: "In the CIS we are already the No. 1 beauty company selling direct and we are
among the top five to top 10 in most European countries. In Asia, we are in a good
position, but in Latin America we are far away."5 Oriflame reported in compliance with
the International Financial Reporting Standards (IFRS) as adopted by the European
Union. Since 1999 Oriflame reported the consolidated results of its subsidiaries at group
level in euros, mainly because the group was incorporated in the Eurozone and incurred
the majority of its costs in this currency. Each national entity was operating in a local
functional currency that reflected the underlying circumstances relevant to that entity.
According to the lEFRS,6 each subsidiary then translated its results and financial position
to be presented in euros.
II. STATEMENT OF THE PROBLEMS
1. Did Oriflarne's business model shield the company from FX losses or

instead magnify the exposure?
2. Recent investment decisions made by Oriflame's management suggested
that FX volatility could become less of a factor in the future. How long would
it take until these measures would effectively mitigate Oriflame's exposure
and could other financial instruments be used in the meantime to alleviate the
hits?
3. Considering Oriflame's significant FX risk exposure, should its finance unit
make much more systematic and massive use of derivative hedging
instruments? Should they add more sophisticated instruments apart from
forwards? In which areas would these be most effective?
4. Should Oriflame review its internal hedging policies and procedures?
5. Is Oriflame's hedging strategy aligned with the shareholder's interests? To
which of the three types of FX risks are Oriflame's investors mainly exposed?
Can hedging that exposure with financial instruments have adverse accounting
effects, short term and long term?
III. PRESENTATION OF DATA
1. Oriflame regularly used derivatives to manage its countries' FX risk

exposure caused by FX rate movements between committing to euro-
denominated intragroup liabilities and actually paying them. Karapanchev
gave the rationale for such an approach: "These payables are constant in
amount and they don't change dramatically from month to month, so we
can hedge them on the group level by entering into forward contracts in
the opposite direction.
Oriflame's sales and distribution model resulted in a short cash-to-cash
cycle and highly variable cost structure. With its dispersed creditors and
frequent, catalogue-driven transactions, Oriflame had a cash turnover
cycle of five to six months. In addition, lack of physical outlets and the
consultants' flexible remuneration structure resulted in variable costs being
about 80% of the total costs. Karapanchev observed, "If something
happens, if the sales do not get through, then also the 80% of the costs do
not come through. Out of this 80%, the costs of sales account for about
40% to 45%, and are incurred in euros. The other part is variable in local
currency, so at the end of the day, I would like to emphasize how agile
Oriflame is as a business concept against the downturns.
2. Oriflamme employed financial instruments to selectively mitigate its FX

risk exposure that the firm divided into strategic, transaction, and
translation exposures. Regarding to recent decisions made by Oriflame’s
management, it would take for a maximum of five to six months until
these measures would effectively mitigate Oriflames exposure if they
hedge cash flow. Oriflame has short cycles that in six months they are
back again with the problem.
3. Companies are exposed to different hazards in their normal day-to-day
operations, for some of the hazards, however, These hazards include
hazards connected with changes in the price of an input, a reduction in
price of a commodity the company sells, an increase in the cost of
borrowing investments, and an unfavorable movement of exchange rate.
The tools that can be applied to present these securities are identified as
derivative tools, so called because they obtain their importance from
whatever the agreement is based on. These tools comprise futures
agreements, forward agreements, alternative agreements, swap contracts,
and floor and cap contracts. The management can achieve security from
these derivatives. The utilization of positive and negative attributes,
moreover the speculative purposes in trading purposes. The important
reason of these devices is to provide firm promises to charges for futures
charges for future date for giving protection against the harmful events in
future charges, to reduce the quantum of economic hazards. Not only this,
they further provide more opportunities to get profit from earnings for
those entrepreneurs who are prepared to take higher risks. In other words,
these devices really help to move the risk from those who desire to bypass
it to those who are ready to accept the similar. Currently, the economic
derivatives have become progressively well liked and most routinely
Derivatives as a Tool of Risk Management utilized in the world of
economics. This has developed with so phenomenal pace all over the
world that currently it is identified as the derivatives rebellion.
4. Oriflame should review its internal hedging policies and procedures
periodically to enable them in aligning their decision with the
organizations management standards. It can help the company to identify
risk at an early stage and come up with procedures to be undertaken. As
changes also happen, fluctuation will likely to occur that might result in an
economic uncertainty.
5. Yes, Oriflame’s hedging strategy is aligned with the shareholder’s interest.
The type of foreign exchange risk that investors mainly exposed is the
transaction exposure. Hedging that exposure with financial instruments
does not have an adverse accounting effect, `oriflamme developed an
indirect hedging approach where the currencies correlated with more
liquid markets were identified. The company’s unwritten rule for the
indirect dollar hedges was to cover 30% to 40% of the exposure. Even
though, it cannot cover 100% of the risk, it helps to mitigate the gains or
losses.
IV. CONCLUSION
Business is all about taking risk. What matters is how the risk is handled.
Often, there are so many permutations of risks that can affect the business that
it will take away most of the profits if one were to reduce/eliminate all of
them. Ultimately, it is the organizational cultural and its appetite for risks that
will determine risk management policies. Risk management is an important
part of corporate planning; it envisages a systematic approach for
identification, measurement and control of a variety of risks faced by an
organization. The top management is also becoming more cost conscious and
more aware of how should risk management helps to minimize expenses. The
organizations are learning to cope with a rapidly changing environment with
hedging strategies which provide buffers to the bottom line. Thus the
organizations are having many strategies to focus on the managing on the risk
that are facing in every way of its business life.

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ORIFLAME S.A.

1. Did Oriflarne's business model shield the company from FX losses or

III. PRESENTATION OF DATA

1. Oriflame regularly used derivatives to manage its countries' FX risk

2. Oriflamme employed financial instruments to selectively mitigate its FX

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