Currency fluctuations and Sourcing Decisions

How much do currency fluctuations matter in sourcing decisions? The answer is simple: they matter a lot.

If you are in India and buying from America and your contract is in dollars then you are bleeding money like hell. Rupee was at Rs39.36 in Jan 08 and in Dec 08 it had moved to Rs 49.66, 26% decrease in value of Rupee. Now take an example of a contract of a part worth $100 dollar made in Jan 08, it would have cost the company Rs3, 936. But if you had re-bought the same part at same price of $100 in Dec 08, it would have cost at Rs4, 966. Oops!!! You lost 1000 bucks if you don’t understand the currency fluctuations.

Similarly the weaker Indian Rupee has helped the Indian Outsourcing and IT industry in great deal. Now with Dollar hovering at around Rs 52 in March 09 things have become slightly easy for Indian ITES Industry and exporter.

Dollar being primary currency of trade globally so it is very important to understand what its fluctuation means to the world. Currently dollar is very strong despite of economic uncertainties in the US economy. The main reason for that is flight to safety into U.S. Dollars and U.S. Treasuries by different governments who still perceive the US economy to be the safest.

But Strong dollar is hurting the US industry most right now because it is making American goods much more expensive abroad thus making American industry uncompetitive abroad. Similarly Toyota posted loss for the first time in its history thanks mainly due to huge drop in sales but also due to the fact that Yen has become very strong vis a vis the dollar.

Due to these factors Sourcing decisions are becoming increasingly complex. Anticipated savings can disappear due to currency fluctuations alone. Two equally capable suppliers from different companies who had quoted at same US dollar price equivalent can end up generating significantly different costs for the buyer over along contract period.

But forecasting currency changes is extremely risky and tricky. Companies can go for “Hedging” of currency to offset any high risk associated with fluctuation but this policy can boomerang if the dollar becomes weaker thus leaving you with higher import bill.
It’s important that companies model the possibility of changing currency values when making global sourcing. Too often, those analyses are made using current exchange rate levels, and don’t well vet the impact if those ratios change significantly. Doing different analysis to understand the change in costs under different currency scenarios can lead to more informed and balanced decisions.

On the other hand, fear of exchange rate changes shouldn’t cause companies to abandon outsourcing strategies that have the opportunity to lower costs. This argues for maintaining a maximum level of operational flexibility in terms of sourcing. While this may result in somewhat higher costs versus the optimum strategy at the present moment, the huge swings in currency values seen across the globe in recent years place a premium on flexibility, which should result in overall lower costs over time.

Buyers can also try to secure contracts that lock in a price regardless of currency changes for a given period. This, in a sense, can be a form of hedging, as the overseas supplier may command a higher unit price for this guarantee. They may also negotiate large shipments as the “price” of this guarantee, in which case buyers must weigh the potential increase in inventory holding costs against currency swing protection.

Companies can also sometimes negotiate a risk-sharing clause in offshore contracts. For example, the buyer and seller might agree to split any changes in currency swings, regardless of direction. The downside to this strategy – currency swings that increase the value of the U.S. dollar would result in higher unit costs, not further reductions, as would be the case without such a risk sharing clause.