How can firms reduce the effects of currency fluctuations?
Exporters should use cost-modelling techniques to remain competitive, while exploring opportunities that shifts in exchange rates may present in international markets
The UK’s most successful firms operate in an increasingly international marketplace. With continued uncertainty surrounding the future of Greece in the eurozone and a weakening euro, firms are battling to remain competitive in the UK’s largest export market. With this currency depreciation set to continue in the coming months, businesses must act now to mitigate risks and increase the agility of their supply chains to secure a profitable future.
When currency valuations fluctuate, one of the main problems for exporters arises when they are buying in a currency with a relatively high valuation, the pound sterling or the US dollar, for example, and selling product or services in a much weaker currency, such as the euro. Any strong movement affecting either currency, in any direction, would have significant consequences for profit margins.
To remove this variable, the business should try to match the currencies it is buying and selling in. For example, if a business has significant sales revenue in euros, it makes sense to balance this with a similar level of goods and services bought in euros and doing so acts as a ‘natural hedge’. Taking this approach, companies can reduce the effect of currency fluctuations; profit margins are protected and costs remain directly proportional to the end price, irrespective of whether the euro weakens against the sterling.
Another solution that may be used is traditional hedging, whereby firms with major commodity spends in areas such as plastics, metals, currencies or fuel secure a proportion of their requirements via futures, with the aim of utilising these resources when their market price has inflated. The same approach can be used with currency hedging to protect a business from future adverse currency movements. This strategy does, of course, carry additional risks if commodity prices drop or currencies move in the wrong direction. Air Asia, for example, purchased large quantities of jet fuel in the expectation its value would rise, but was caught short when the market price of crude oil fell by almost 40% at the tail end of 2014. When investing company assets in hedging, it is vital that the business partners with an expert that possesses extensive industry experience and a track record of success.
There are other strategies that can be employed within the supply chain to manage adverse currency movements and even take advantage of advantageous ones.
The first step is to determine the genuine effect of the currency or commodity swing on the supply chain. Although a business might be based in a certain country and affected by the currency swing, it is likely that part of the cost is based in another currency. For example, sourcing from a Swiss supplier (with prices set in Swiss francs) would obviously be costly in today’s climate. On deeper investigation, however, the business might find that its supplier is sourcing a proportion of its raw materials and subcomponents from a country in Europe and paying for them in euros. Knowledge of this could give the business some room to renegotiate costs and protect its profit margin.
Increased understanding about where costs come from in the supply chain can also lead to greater agility. Forging a relationship with a supplier that operates in a number of international locations means that a firm can request the movement of production from a base where costs are high (for example, the UK or US) to a country where costs are more competitive.
Similarly, if a suitable multinational supplier cannot be found, businesses may opt for a dual-sourcing strategy by engaging two different supply partners, one within and one outside of the EU. As long as strong relationships are formed and the business is confident that both vendors can provide a quality product, order volumes can be easily switched between the two depending on which represents the best value, as governed by fluctuating exchange rates.
Coping strategies aside, businesses should also aim to grasp the opportunities that currency fluctuations present. Although a weak euro reduces the affordability of British goods to companies in the EU, the strong dollar and Swiss franc increase the attractiveness of UK imports within Switzerland and America. Increasing the focus of business development in these areas could prove fruitful and may offer firms a more profitable route to market.
With Greece still reluctant to commit to a debt reduction programme and a number of EU states struggling to strengthen their economic prospects post-recession, it looks as though a weakened euro is here to stay. However, if Greece decides to exit the EU, the effect this could have on the euro in the short to medium term is less certain. UK exporters must work to strengthen the agility of their supply chain and utilise cost-modelling techniques to remain competitive, while exploring the opportunities that shifts in exchange rates may present in other international markets.
Phil Bulman is managing consultant at Vendigital, a leading firm of procurement and supply chain specialists