Daily Archives: April 1, 2012

Can You Endure the Exacerbated Euro?

Greece may be almost taken care of, but now Spain (and Portugal) are threatening to endanger the Euro’s future. Procurement’s problems with the Euro are far from over. But what can a Procurement Professional do?

Be cautions and ever vigilant. As explained by Julian Catchick in this recent article over on CPO Agenda on How to Deal with the Troubled Euro, about the only risk minimization strategies a buyer has available to her are to:

  • hedge,
  • spot buy in bulk to take advantage of a favourable exchange rate movement, and
  • fix the exchange rate with suppliers for a mutually agreed duration.

All of these strategies have their advantages and disadvantages.

  • Hedging on a different currency that tends to fluctuate in a manner opposite to the Euro (going up when the Euro goes down and vice versa) can mitigate the impact of a rapid Euro fluctuation if currency trades are made at appropriate times, but if the performance of the currency hedged in is not what is expected, losses can actually mount.
  • Spot buying can reduce acquisition costs significantly if done at the proper time, but if too much inventory is bought too early, inventory management costs will go up and eat into the savings.
  • A fixed exchange rate will mitigate currency fluctuation risk and allow for predictable purchase costs, but since the supplier will have to assume additional currency risk, a buffer will be built into their costs and the organization may end up paying more than it needs to.

Regardless, one strategy that should not be pursued is pulling out of the countries in question. Even though some banks are minimizing exposure to these countries, it is not the country that poses the risk to the buyer, but the supplier. As Julian states, it is not likely that buyers face a material risk as long as they look into the suppliers’ financials and credit ratings and also establish how balanced their portfolios are across other geographies. Plus, given that the buyer can get much credit better terms than the suppliers in these countries, the buyer has an opportunity to reduce costs further by pre-paying for goods and services (with a stable supplier) at a substantial discount. Suppliers need regular cash flow, and if their terms are 30%, and your terms are 5%, there’s no reason that your Procurement organization couldn’t extract a 20%+ discount due to their cost of capital. That’s a smart Procurement move!

And if there is concern about future risk, build additional break and termination clauses into the contract. If a major currency fluctuation (or collapse) would make the supplier potentially insolvent, give the buying organization the right to terminate the contract, just like you’d do with any insurance or hedging contract. But, as Julian advises, don’t forego long term (strategic) relationships just because there is a potential currency risk.