Most supply chains have a global component. One of the key risks of global supply chains is the risk posed by uncertain and unpredictable foreign exchange rate. Exchange rates can fluctuate significantly over the course of a transaction, creating uncertainty and significant financial risk. Although currency fluctuation can ripple through an entire supply chain, the effects for importers are the most obvious and help to explain the flow on effects for other businesses throughout the supply chain.
How do exchange rate fluctuations create risk?
When importers and exporters move goods between different countries (that do not share a currency), either the importer or the exporter will need to buy or sell the goods in the other party’s home currency. An Australian-based company buying apparel from a Vietnamese supplier might purchase stock priced in Vietnamese dong. The Australian dollar price of Vietnamese dong (the exchange rate) is set by supply and demand for both dollar and dong and, within certain bounds, tends to be in a constant state of flux. Although the Australian business can be relatively certain that an Australian dollar will buy many Vietnamese dong, the exact exchange rate constantly varies and makes the effective price of the stock in Australian dollars difficult to predict. The purchaser will have likely relied on a certain margin to make the stock worthwhile purchasing. If the price of dong increases, the purchaser’s margin becomes smaller, eating away at the purchaser’s profit.
Businesses who source locally are not immune from foreign currency risk simply because they produce or procure their products in one country. For example, if the price of dong sharply decreases, the Australian firm that imports apparel can now more easily beat the steady prices charged by a local producer.
Can currency fluctuation risk be mitigated?
In a complex, highly globalised market, currency fluctuation risk can never be entirely eliminated, especially in the long term. However, a prudent approach can insulate your business from the most volatile fluctuations.
- Negotiate to transact in your home currency
One approach to manage currency fluctuation risk is to negotiate sales agreements in your own currency. This solution effectively shifts the risk of adverse exchange rate fluctuations onto the other party. The other party now has to factor additional risk into their margins, so expect an increase in the quoted price to reflect this.
- Factor currency fluctuation risk into your own margins
Only one party involved in a transaction between currencies can have the ‘home ground’ advantage. If your business is forced to buy or sell in a foreign currency, it is important to count on and assume some degree of adverse currency fluctuation. This involves making sure any deal is reasonably economic, even in the face of an adverse shift.
- Share the risk by agreeing on a stable exchange rate
By agreeing that the exchange rate at the time of quotation is to exist regardless of subsequent fluctuations, each party can be sure that they will not have to pay or receive a worse price for the goods should their local currency depreciate in value.