# Undervalued Currencies, Part II

Editor’s Note: Today’s post is from Dick Locke, Sourcing Innovation’s resident expert on International Sourcing and Procurement. (His previous guest posts are still archived.)

In our last post we discussed the undervaluation of the yuan, introduced the Purchasing Power Parity (PPP) rate as a measure of the relative valuation of a currency, and reviewed the background behind the PPP rate. In this post, we’ll cover the determination of PPP rates, the calculations necessary to determine value against the US dollar, and list some countries with large differences between the PPP rate and the actual rate.

The Determination of PPP rates

You can look them up in a very wordy and meandering World Bank publication. However, the World Bank does not update values very frequently. The most recent data is from 2005. The CIA in the United States publishes an annual World Factbook. It has data that enables an easy calculation of current PPP rates.

The Factbook shows GDP at both PPP and “official” exchange rates. In the case of China in 2009, GDP at PPP rates was 8.789 trillion U.S. dollars. (Note to non-U.S. readers: A trillion in the U.S. is 1,000,000,000,000.) GDP at official rates was 4.814 trillion dollars. Because both GDPs are conversions of the same amount of yuan, if you know the official rate simple algebra will give you the PPP rate.

How can you find the “official” rate? In most cases, it’s the actual rate. If you use the “Historical Exchange Rates” facility at oanda.com, it will give you an average exchange rate over a period of time. The average rate in 2009 was 6.841 yuan per dollar.

That means the PPP rate was 3.74 yuan per dollar. (I left the algebra to you.)

Calculation of Over- and Under- Valuation

There’s a big difference between 6.84 and 3.74. How big? First you need to re-express exchange rates into dollars per yuan. That means simply inverting each value, or dividing it into 1. If there are 6.84 yuan per dollar, each yuan is worth 14.62 U.S. cents. At 3.74 yuan per dollar, each yuan is worth 26.69 cents. The difference between the two values is 11.93 cents. Take that difference (11.93) and divide it by the PPP value and you get .452, or 45.2 percent of the PPP value. That means the yuan is undervalued against its PPP value by 45.2%.

Other Countries

If you do similar calculations on other countries, you get results that will dispel any notion that floating currencies settle near the PPP rate. You will also see that China isn’t different than many of its competitors.

With this method, some countries’ currencies are undervalued against the U.S. dollar. In turn, the U.S. dollar is undervalued against some countries’ currencies

Countries Undervalued against U.S. dollar Countries against which the U.S. dollar is overvalued
 Country Amount India 69% Taiwan 50% Thailand 45% China 45% Malaysia 40% S. Korea 40% Singapore 30% Mexico 29% Brazil 26%
 Country Amount Germany 14% Italy 20% France 23% Japan 26% Ireland 29%

Summary

• PPP rates are calculated based on consumer purchases, not industrial products.
• China is one of several countries that have both currency controls and an exchange rate that is significantly different than the PPP rate. However, removing controls and floating a currency does not guarantee it will reach PPP rates.
• Individual buyers (and sourcerers) should not concern themselves with official PPP rates because these consumer-oriented rates may be very different than the rates for the particular product a buyer is handling.

Thanks, Dick!

# A Hitchhiker’s Guide to e-Procurement: Analysis, Part II

### Mostly Harmless, Part XVIII

Previous Post

In the last post, the analysis process was discussed and some of the basic questions were defined. This post will address the some of the associated challenges of the analysis process, some associated best practices, and the benefits that could be expected from an appropriate e-Procurement solution.

Common Challenges

The literature will claim that there are many challenges with regards to spend analysis, and that these challenges will revolve around data cleansing, data classification, and data enrichment, but the reality is that there are generally only two real challenges: access and analysis.

• Data Access

In order to do data analysis, an analyst needs access to the majority of the relevant organizational data that represents at least 90% of the spend in the categories that the buyer wishes to analyze. Without a centralized e-Procurement system, this can be difficult as some spend will be in the ERP/MRP, some in the accounting systems, some in the P-Card system, and some in various departmental systems.

• Insightful Analysis

Top N reports are not analysis. Spending trends are not analysis. Automated reports are not analysis. Analysis is the ability to slice and dice the data eight ways from Sunday to allow for the identification of unusual spending patterns that represent true savings opportunity.

Best Practices

• Force Every Purchase Through the e-Procurement System

Forcing every purchase through the system not only significantly reduces maverick spend, but it provides a centralized repository of all transactions which provides a solid foundation for spend analysis.

• Force Every Payment Through the e-Procurement System

If the e-Procurement system does not support e-Payments, insure that it supports a record of payment against each invoice and that all payments are loaded into the system and cross-referenced with associated invoices, goods receipts, and purchase orders. This is necessary to take spend analysis to the next level. While many vendors will claim that only AP data is needed for spend analysis, the reality is that AP, invoice, and purchase order data is needed for spend analysis. Without the m-way analysis, it is impossible to tell if overpayments, which could be recovered, were made. Without the m-way analysis, it is impossible to identify all maverick spend, which is the first step in reducing future maverick spend. Etc.

• Do Ad-Hoc Analysis Whenever There is a Possibility for Savings

Traditionally, data analysis was avoided because the cost of analysis was high relative to the savings potential. However, with the right tool, the cost of an ad-hoc analysis is no longer the five or six figures it used to cost, it’s now three or four figures — which makes even a maximum five figure savings opportunity worth analyzing, especially if a preliminary analysis can be done in an hour or two! Even if only one in ten hunches pays off, if it only costs \$1,000 of an analysts time to do an analysis, and the one pay off is \$100,000, that’s a 10X ROI.

Potential Benefits

• Savings

Real analysis will identify overpayments that will lead to immediate savings. Real analysis will identify maverick spending, which will lead to more savings when it is prevented. Real analysis will uncover new savings opportunities, which will lead to more savings. Real analysis is savings.

• Better Procurement

Finding and eliminating maverick spend through better processes leads to better procurement. Understanding spending patterns leads to better procurement. Saving money leads to better procurement.

Once the analysis is complete, it is time to review and update the catalogs and contracts, which is the subject of the next post.

Next Post: Catalogs & Contracts, Part I