SCDigest Editorial Staff

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Given the growth in offshore volumes, and total net savings that are often measured in just a few percent, these currency swings and/or price increases can reduce or even eliminate the expected savings from global sourcing strategies.   What do you say? Send us your comments here

The continued fall of the U.S. dollar against most currencies across the globe is adding complexity to the current global sourcing and offshoring landscape, both for U.S. companies and their international product and service providers.

In the past year, the dollar has lost substantial value against the Japanese yen, the British pound, the Euro, the Canadian dollar, British, and Indian rupee, as well as many minor currencies.

Two notable exceptions: the Mexican peso, which has not changed much in value in relation to the dollar, and the Chinese yuan, which (for now) maintains a fixed value against the greenback.

When buying goods offshore, this means that for contracts committed in foreign currencies, the effective price of imported products has risen dramatically – though many suppliers in Europe and elsewhere have been forced to reduce prices to remain competitive. When contracts are priced in dollars, suppliers have their profit margins significantly reduced from the falling greenback – and will certainly look to reprice contracts upward at the next opportunity.

Contract manufacturing agreements, for example, between U.S. companies and outsourcing providers have typically been priced in dollars – and many are predicting that in the next round of contract negotiations, CMs in Asia and elsewhere will insist that pricing be denominated in the more stable Euro.

Rethinking Sourcing Strategies

Whether for goods or services, the falling value of the dollar will inevitably make most offshored sourcing more expensive – and in many cases, change the optimal decision. Many experts believe that even without China floating or revaluing its currency, Chinese suppliers will be forced to raise prices substantially for sales to the U.S. in order to maintain profitability.

Given the growth in offshore volumes, and total net savings that are often measured in just a few percent, these currency swings and/or price increases can reduce or even eliminate the expected savings from global sourcing strategies.

Consider contract manufacturing in the electronics industry. In the age of a strong dollar, many U.S. companies began relationships with Canadian CMs to lower costs while operating what, in effect, could act like a domestic supply chain. That’s changed.

As blogger Charlie Barnhart recently noted, “For the first time since I started measuring more than five years ago, and most likely for the first time ever, the labor cost for assembling printed circuit boards (PCBs) is lower in the U.S. than in Canada. No, you did not misread that statement. By my recent calculations, the average U.S. cost for fully burdened direct labor for PCB assembly is $39.10 per hour. The comparable figure in Canada is $45.80 - 17 percent higher.”

It’s obviously more than just procurement costs, of course. Changes in cost of goods sold have a direct impact on overall profitability, cash flow, and competitiveness.

In a recent report, consulting company Deloitte cited the example of an automotive company that manufactured some models exclusively in Europe but with substantial sales in the U.S. The hit to the bottom line as a result of the dollar’s fall against the Euro was estimated at more than half a billion dollars.

How Can Companies Respond?

This situation makes sourcing decisions increasingly complex. Anticipated savings can disappear due to currency changes alone. Two equally capable suppliers from different countries who quote the same U.S. dollar equivalent price at a particular point in time can end up generating significantly different costs for the buyer over the extended life of a requirements contract depending on currency changes. But in general, procurement professionals are not well versed in the complexities of exchange rate changes and cost impacts.

Forecasting currency changes is extremely tricky, however, and the track record of currency forecasting services is spotty at best.

In some cases, companies can look to hedge currencies, so that the dollar’s fall is offset by gains in currency trading. But this is a high risk strategy that has a cost of its own if the dollar stays flat or changes direction, and requires expert financial help. It is generally only used by large companies that source a very large amount of product sourced from an individual country.

It’s important that companies model the possibility of changing currency values when making global sourcing or make-buy decisions. Too often, those analyses are made using current exchange rate levels, and don’t well vet the impact if those ratios change significantly. Using sensitivity 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 offshore strategies that have the opportunity to lower costs now or present other supply chain advantages. This argues for maintaining a maximum level of operational flexibility in terms of sourcing and distribution options. 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.

Has your company been impacted by the falling U.S. dollar in its global sourcing strategies? What do you think are the most effective strategies in the dynamic currency environment? Let us know your thoughts at the Feedback button below.