Every business leader is searching for ways to add value and increase profits.
Since most companies do not have the luxury of being able to increase prices, it would seem the only other way to increase profits is to cut expenses. However, companies that sell overseas only in U.S. dollars have another option. Rather than let a wholesaler or distributor make extra profit, these companies can mark up the U.S. goods for foreign currency fluctuations and make the profit themselves.
Large firms with overseas business often quote in foreign currencies, but small to medium-sized companies can be intimidated by the prospect. Although there are risks, the essential benefits to assuming the foreign exchange risk are the ability to penetrate a market more deeply and the potential to mark up your product or service (since you have the foreign exchange risk).
For example, an exporter or seller in Italy may quote a sale to Germany in euros. All things being equal with the product, if your company quotes in U.S. dollars only, the German buyer may be more inclined to purchase from the Italian manufacturer due to the ease of payment and comparable price.
There are inherent risks and ramifications of sales contracts quoted in a local currency. This allocation of risk differs widely between the exporter/seller and the importer/buyer.
The largest risk from quoting in a foreign currency for the exporter/seller is the unknown fluctuation in the foreign exchange market. If a currency rate moves against the exporter/seller in the market, the profit margin may be jeopardized. The exporter/seller now bears the foreign exchange risk that had previously been pushed to the importer/buyer by historically quoting in U.S. dollars.
Conversely, the importer/buyer reaps the most significant benefit from accepting the sales quote in its own currency because it now knows the exact cost of the product. By paying in local currency, the importer/buyer is able to eliminate any unknown currency fluctuations.
Currency markets are moved by many factors, including market perception, government regulations and policies, and the strength of the underlying economy. Generally, higher interest rates attract investment. Investors seek the highest return on their investments while accepting a risk tolerance within certain parameters.
When investments run into a country and its markets, demand for that investment increases and supply tightens, forcing the value of that country’s currency up. Other things can impact currency movements, including how accessible hard currency or world markets are to the local government, inflation rates and economic growth.
One form of risk mitigation an exporter/seller can use to protect itself from currency fluctuation is a forward exchange contract, which allows the exporter/seller to lock in the exact exchange rate today for a given currency for a future payment delivery. Forward contracts are cost control tools, not speculative instruments. The bottom line is that the exporter/seller is not in business to speculate on currency movements but rather to sell its product. By using a forward contract, the exporter/seller knows the profit margin without jeopardizing it in currency movements.
Forward contracts are easy to use. They can be used during a bidding process for indicative quotes by contacting your local bank’s foreign exchange desk. Foreign exchange traders watch the markets and can offer discretionary opinions on what direction a currency may be heading. However, it is important to remember that no one can accurately and consistently predict such a direction.
To succeed in the global marketplace, a little flexibility may expand your customer base while also providing enhanced profits for your company. It certainly provides an edge versus the competition.
To help you determine if quoting in a foreign currency is an appropriate sales tool for your company, discuss with your clients their interest in this option. If your company loses a bid, find out if it was related in part to the choice of currency.
A financial institution with local expertise in foreign exchange can assist you in making this a valuable strategy for increasing your business profits. Justin Kluemper is a vice president of international and corporate banking for Fifth Third Bank. Reach him at (614) 744-5444 or [email protected]