How to help companies to realize the full potential of foreign purchases. For a long time, this issue has been regarded as an easy shortcut or as a sort of standard routine.
1. SELECT AND RETAIN BEST SUPPLIERS
Recently, the scenario has drastically changed. Over the past months, the market globalization has influenced the attitudes, the behaviours and the needs of companies, shifting the focus to a crucial game for their own future: how to select and retain the best international suppliers.
Today, there are new challenges to be faced and, above all, there are new opportunities for the companies able to react promptly. In fact, who will be the first one able to build strong relationships with foreign trade partners, taking advantage of existing transaction arrangements, will have a competitive advantage. In this new scenario, the global supply chain management is a hub where you can engage commercial and manufacturing interests with a seamless integration, taking care and respecting the profitability budget as is the foundation of every economic activity.
What is a necessary tool for trading in order to establish long-term profitable relationships? To manage the exchange rate risk.
2. THE COMPLEXITY OF A MANAGING MULTI-CURRENCY
The currency fluctuation may change dramatically before the expiry of the supply. As an example, we might have a look at what recently happened to the US Dollar against the Euro. As you can see in Figure 1, the US currency strengthened against the Euro.
At the beginning of 2015, we could exchange 100 Euro for 120 US Dollars. Today, with 100 euros we can get 105 US Dollars. In the last 24 months, the Euro depreciated by about 14% against the American currency.
The dollar strengthened due to higher investor confidence. But, a strong Dollar is a problem for US exports. American products are less competitive abroad when buyers have to pay in Dollars. A major competitor in the international trade arena are the exports from China. Over the past 24 months, the Chinese currency (Yuan ¥), depreciated against the US Dollar by 11% (Figure 3).
At the beginning of 2015, with 100 Euros you were able to buy some 740 Yuan. Today, with 100 Euro we can obtain 732 Yuan. Over the last 24 months, the Chinese currency appreciated slightly. In other words, for Eurozone companies, the US dollar imports have become more expensive, and purchases paid in Chinese currency are basically unchanged.
3. THE BEST PRACTICES
In the face of these developments, what should global companies have done? And – most of all – what should they do in the future? Is it appropriate to change the traditional suppliers if they use a less competitive currency, or not? The answers lie in the adoption of three policies for the global supply chain management:
- Avoid choosing suppliers on the basis of an opportunistic short-term currency convenience. The best companies seek to smooth out the uncertainties of currencies with hedging practises. When prices are on the rise, they make forward buys, locking in their price for several times. Companies can lock in an exchange rate for all, or a portion, of their cash-flow activities. On the other hand, if they believe the currency is going to move in their favour, they might reduce the hedge.
- Contracting in your own local currency is not the same as avoiding currency risk. Many companies require foreign suppliers to quote in Euro but then do not address the issue of exchange rate fluctuations in their supply agreements at all. If the possible currencies fluctuation is not in your contractual terms, it does not mean it does not exist; it’s hidden! If the currency moves in your favour, you will miss cost saving opportunities. There are more opportunities to manage risks if the exchange rates and terms are explicit in the agreement.
- Set with accuracy, the contractual terms of the global supplies. Agree on the baseline exchange rate and the up and down boundaries for fluctuations. The price is fixed inside the range, but it will be adjusted when the exchange rate exceeds the boundaries.
Over the course of a supply agreement, foreign exchange rates can fluctuate dramatically and it is crucial to consider their impact upfront.
As the figure above shows, the US Dollar over the past year has appreciated against the Chinese Yuan and the Euro. Large jumps, or long-term trends, will impact prices, regardless of the company’s market power.
On one side, a strong dollar is a big concern for American exports. On the other side, China is a formidable competitor in the global arena. Eurozone companies have become accustomed to trading in Euros. But as globalization continues to expand, international currency markets will open up, spurring increased trade in foreign currencies.
Companies should act to protect themselves against the impact of the currency fluctuations. This is a crucial element of a well-considered strategy for the global supply-chain risk management.
Facing these challenges will single out industry leaders from those who worry daily about increasing costs.
In brief, managing the supply-chain issue, on the basis of the principle “this is what we have always been doing”, might be an easy solution, but is clearly a losing solution. Those companies willing to be competitive and to win their future challenges must be able to turn financial risks into profit opportunities.
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