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Three Card Monte and the Currency Risk

December 6th, 2006 · by Tim Minahan · 2 Comments · LCCS and trade, best practices, sourcing

A few weeks ago, I asked Supply Excellence readers to send me your favorite supply management tactics and strategies. I’m glad to say that you were more than up to the challenge.

I have received dozens of responses, to date, which I will be sharing in the coming weeks and months. (There’s still time to submit your favorite supply management approach to tminahan@supplyexcellence.com)

I wanted to pass along one submission that is top of mind for most supply managers today: how to manage the currency risk.

The weakening U.S. dollar against other currencies has supply management executives second-guessing or, at least, recalculating the impact of their global sourcing strategies. (See “Is the U.S. is the next low-cost country?”) And company executives are blaming missed profit targets on the softer dollar.

While the costs of pulling up newly planted stakes with suppliers in far-reaching, low-cost regions are prohibitive (and impractical) for most companies. There are ways to minimize your currency risk. One savvy supply management practitioner suggested the following strategy for mitigating currency risk during supplier negotiations:

The first question you typically ask when currency is a consideration is “Do I force suppliers to bid in my preferred currency or do I allow them to bid in their own?” One party, in a relationship where multiple currencies are in play, will be required to take the risk of currency fluctuations. Of course this could work in favor of either party but the question you should ask is “Why would I take a high risk option if I can take a no-risk option?”

When a supplier bids in their own currency as opposed to the buyer’s they are simply passing the risk of currency fluctuations to the buyer. Ask yourself “Why would they do that?” If you do allow suppliers to bid in a different currency you have to agree an exchange rate with them. This requires a degree of forecasting or “hedging” on behalf of the buyer and this can often end in tears – even for those experienced in currency markets. 

Best practice suggests forcing the suppliers to bid in the buyer preferred currency, if at all possible. If this cannot be managed ensure that you engage with your in-house experts before agreeing an exchange rate with the supplier. There are two reasons for this precaution: First, they are the experts and will be better positioned to advise you. Second, if the decision proves costly at least you have someone else to share the blame! 

Great tip. Although, some might argue that passing the currency risk to suppliers is the business equivalent of three-card monte. Others may claim that the better sourcing solutions manage currency conversion with at least daily updates of currency exchange rates. However, currency rates fluctuate throughout the day — particularly in today’s volatile market. Locking in an exchange rate to use throughout your negotiation can cause you to stress over and miss out on a few points in either diection.

Acknowledging that most of lack the skills or time to become currency market experts, the above advice is an easy to use tip that can help you minimize risk in global sourcing projects. 

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2 responses so far ↓

  • 1 Mark Usher // Dec 7, 2006 at 11:32 am

    Tim, your practitioner’s advice is certainly pragmatic and easy to implement but in my opinion unnecessarily places all the risk on one of the parties (depending upon who has the power, buyer or seller). A “half-way house”, and an approach I have used successfully in the past, is to negotiate tiered pricing (typically in the seller’s currency)around a “mean price” which is set at an agreed exchange rate. As exchange rates fluctuate during the term of the agreement a delta is applied to the resultant dollar price (reduction for unfavorable rate change, increase for favorable rate change). This effectively shares risk between buyer and seller. The “whole way house” approach is of course to utilize a number of potential financial instruments such as futures contracts and options. These require specialized financial knowledge to implement, however, and can lead to disaster in the wrong hands. My advice to the average sourcing professional engaged in global sourcing would be to at least utilize the half way house approach.

  • 2 Tim Minahan // Dec 8, 2006 at 10:07 am

    Mark:

    Sage advice from an experienced supply chain expert. Sharing risk (although tougher to manage) has benefits beyond just the currency risk. It engages buyers and suppliers in a true partnership at the outset and sets a tone for collaborative risk and benefit sharing for the relationship going forward.

    The “half-way house” approach is indeed within the capabilities of most supply management organizations.

    Tim

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