The IM Triangle focuses on three elements of international diversification, with income being one of the three key components.
For the true internationalist, the Income Element naturally leads to having one's own business, whether that be a one-man shop or a larger firm with hundreds of employees.
A common issue for would be cross-border businesspeople is that of currency. The differences between currency exchange rates have made and broken many businesses and introduces an element of uncertainty that makes it difficult to plan effectively.
However, at the same time, if managed well, can also offer the sharp manager a potential new source of revenue.
Ed Marsh explains…
FX – Important or Background Noise?
How many times have you heard that currency exposure is one of the big risks of internationalization? Probably a lot! And how many times have you heard that currency diversification and arbitrage are one of the great benefits of internationalization? Not so often!
The reality is that both are true. But with an open mindset you can reduce the risk, leverage the benefits, and create a competitive advantage by working comfortably with customers in their own currency.
Looking quickly at foreign exchange (FX) markets is a good place to start. Why? Well because they are complex markets about which many myths and misconceptions prevail. From the macro view:
- These markets are humongous — at approximately USD $4Trillion/day, just one week's global FX transactions are equal to nearly two times the US GDP!
- Fortunes are made or lost on movements of a few “pips” (.000X of a unit of currency).
- Daily changes in value of the USD vs. another currency rarely approach 1%.
- An annual move of 10-20% in a year is unusually large, and trends tend to be pretty clear and have traditionally occurred in cycles of 7-10 years.
- Short-term trends are harder to identify, but that is more of a trader's perspective.
But your business perspective is different than a trader's. FX exposure should be viewed according to business imperatives. For most companies, that means the biggest FX-related concern is avoiding any erosion of margins. And keeping costs appropriate for developing markets requires diligence.
Therefore, short-term and medium-term exposure (weeks to a year) requires some proactive management. Common situations include:
- Decisions on when/whether to exchange foreign currency cash receipts.
- Implications of manufacturing and shipping lead-times, and the time between setting prices and receiving payment.
- Budgeting and forecasting (reporting of foreign subsidiary profits) and tactical decisions on repatriation of subsidiary profits.
With the right strategies, these exposures can be easily and inexpensively hedged. If your driving motivation is complete predictability of income and profit from each order, then you can simply use window (swap) forward contracts that will allow you to “lock in” values. But if you are open to some downside risk, you will find that these situations offer an upside opportunity which isn't available in domestic business.
In contrast, longer-term trends are important to consider but difficult to hedge. As long-term trends evolve, your product competitiveness could wax and wane just as the value of your foreign corporation holdings, your personal assets overseas, or your franchise value change as well. While there is no feasible hedging strategy for these long term trends, they do introduce a different opportunity – feasibility of leveraging different currency “pairs” to your competitive business advantage!
One of the great benefits of real internationalization is that you are no longer constrained by a “home currency.” Although any given currency tends to move in the same direction against a variety of others, the magnitude of those movements isn't necessarily the same. Further, if you develop operations in various regions (e.g. EU, ASEAN, LatAm) to complement your North American base, you open up greater opportunity to leverage other currency relationships (crosses) between various pairs.
And business owners should always consider the insurance and diversification opportunity available in balancing assets across various jurisdictions and various currencies.
Now some of you are saying “big deal – old news.” Good, you're already realizing the benefits. But others are intrigued (yet worried) about the complexity and expense of hedging strategies. “You said it was easy and cheap… but I've heard that before.”
So let's quickly explore the mechanics and details. (Obviously a short article is no substitute for proper study and professional advice. But remember that your commercial banking relationship isn't necessarily the best place to start.)
What should you know to get started?
There is a difference between banks and brokers. Banks in the US can often hold funds for you (although technically these will be held overseas) in a variety of currencies using a Multi-Currency account (MCA). Brokers, in contrast, will often require that any incoming funds are converted to your home currency. Your relationship with either will be subject to a variety of contractual and regulatory considerations, including, for American companies, Patriot Act requirements.
FX brokerage is a competitive industry. You should acquaint yourself with transaction rates and fees just as you would with any other business service. There are big differences in rates and service. I have personally found differences of more than 2% on the transaction itself and accesorial charges like foreign wire fees may vary by factors of 2-4X.
In order to execute simple hedging and spot transactions, you will need to establish an account and normally deposit some minimal collateral against forward contracts. If your commercial lender is capable of providing competitive international banking, you can often draw on an existing credit facility to provide deposits.
Like many aspects of business, this can initially feel intimidating. But just a couple transactions will clarify the solutions and process. A good banker will easily demystify the details and establish an MCA for your use. If you are a particularly “hands-on” type, there are online trading platforms that you can readily use yourself and as well as no frills Internet banks, which provide competitive FX services.
But what if you don't want to deal with it? You want to begin expanding internationally, but you're not yet ready to diversify assets, open foreign subsidiaries, or worry about currency. You can certainly proceed by pricing and selling in USD/CAD only. That will save you concern about FX, but at what cost?
Think about vendors with whom you deal who offer limited trade terms or require payment in cash. They're not as convenient or attractive as partners. Overseas buyers will view your hesitancy in a similar light. You will limit your prospects. But many companies do just that… and therein lies another opportunity for you. A small additional effort will let you competitively distinguish your business – at a negligible cost.
The bottom line is that companies around the world do business across cultures, continents, borders, languages, AND CURRENCIES every day. Only in the US is a typical businessperson concerned. FX is an important macro-business consideration to be weighed in your diversification strategy, but it is only background noise from a day-to-day perspective.
Ed Marsh has in-depth experience on a number of continents, in various capacities and industries. He founded and managed a start-up in India; successfully built channels throughout Latin America; leveraged his German birth and marriage to a German national in his extensive work in Western Europe and has deep cultural experience with Vietnam. Ed's B2B and B2G pan-global experience has involved a variety of products and services including capital equipment, industrial automation, distribution services and homeland security and defense technology. He is a Founder and Principle at Consilium Global Business Advisors.
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