While taxes alone are not damning, as taxes, like death, are one of the only two certainties in life, tariffs, on the other hand, are one of the ongoing nightmares of the Procurement world. Tariffs make the complete personal income tax code of the United States look like a kindergarten book.

For example, the current HTS (Harmonized Tariff Schedule) of the United States is 3,536 pages. And that’s just the US HTS code. The 2007 LIGIE for Mexico is 684 pages, and there have been hundreds of pages of amendments since then.

With 196 countries in the world today, extrapolating, that’s over 200,000 pages of HTS / HS (Harmonized System Code) classifications that an organization needs to be on top off to determine international import and export duty rates. But that’s just the tip of the iceberg. It’s not just keeping track of rates, it’s figuring out the rates that apply. For example, let’s say you want gloves, is it:

    4007.11.70 Leather - full grains   - glove and garment
    4017.12.70 Leather - split grain   - glove and garment
    4107.19.70 Leather - whole hide    - glove and garment 
    4017.91.70 Leather - other         - glove and garment
      ..
    4023.10.40 Apparel - articles      - gloves, mittens and mitts
    4203.29.XX Apparel - cowhide       - gloves
      ..
    6116.10.08 Gloves  - coated        - other
      ..
    6116.92.08 Gloves  - cotton        - other
      ..
    6116.93.08 Gloves  - synthetic     - other
      .. 
    6116.99.35 Gloves  - other textile - other
      ..
    6216.00.08 Gloves  - impregnated   - other
      ..

there are so many (dozens upon dozens of) classification of gloves, that it’s hard to find the right one – and if you pick the wrong one, and especially if you pick the wrong one with a lower tariff rate, then your organization is at risk of significant fines and penalties.

So how do you deal with this? There’s only one way — get a trade market intelligence solution which is kept up to date by people around the globe as classification updates and rate changes come up and easily searchable by the average Procurement professional who is not an expert in H(T)S code structures. There aren’t a lot of options, but SI recently covered one company, Integration Point, that has been building such a solution for almost 10 years. Why do you need a third party? Integration Point, which maintains a global content team, made over 2 Million updates to their global H(T)S code database in 2014 in an attempt to keep up with the never ending string of updates that are regularly released by countries around the globe. (Some countries release updates on a weekly basis. For example, Brazil once updated its HS code 80 times in one year.)

As indicated in the prologue to this series, there are dozens upon dozens of challenges being thrown at you as a Procurement professional on a daily basis. Causing you nothing but grief and agony, these damnations collectively do nothing but divert your attention from critical strategic planning, (should-cost) modelling, and supply assurance.

Today we are going to discuss damnation #05, currency strength — one of the ten economic damnations that we will cover before this series is over. This damnation is particularly relevant with the recent volatility in the Ruble, Renminbi (Yuan), and the petro-dollar — which might be used as a hedging strategy in some organizations.

Currency fluctuations can quickly destroy the best laid sourcing plans when sourcing internationally from countries that use a different currency, even if the contract is being executed in the currency used by the buyer.

In the situation where the contract is being executed in the currency used by the buyer, if that currency devalues against the currency being used by the supplier, then the supplier may not be able to afford to honour the contract without risking bankruptcy (as the supplier’s costs would exceed their sales). In this case, the supplier may simply cease to honour the contract.

In the situation where the contract is being executed in the currency used by the supplier, and if that currency increases significantly in value compared to the buyer’s currency, then the buyer may not be able to afford to buy from the supplier (as the buyer’s costs would exceed what the customers are willing to pay) and may be forced to break the contract (and risk the ramifications).

In either situation, there is a disruption in supply and the potential for significant financial and legal ramifications down the road. And this is one damnation that is never going away as currencies never remain stable. And while it will forever damn us, it is not always impossible to predict when currencies are likely to fluctuate.

How? Through the use of Purchasing Power Parity (PPP), we can determine when a currency is undervalued and when it is likely to rise in the future or when a currency is overvalued and when it is likely to fall in the future. It’s not perfect, but it’s better than flying blind. (For a good definition of PPP rate, review Dick Locke’s classic post on Undervalued Currencies, Part I).

So how do you determine PPP? One way is to simply look them up on the World Bank site. And how do you determine if a currency is over or under valued? You compare the official exchange rate to the PPP rate. If the PPP is (significantly) greater than the exchange rate, then the currency is undervalued. But if the PPP is (significantly) less than the exchange rate, then the currency is overvalued. How much? Divide the rates to get a percentage.

So how do you put this to use? Since floating currencies don’t always settle near the PPP rate, which some analysts are prone to believe, you look at historical variations and see where the trend over time is. If the currency is undervalued by 30% but the historical trend is that the currency is only undervalued by 20%, then it is likely that the currency is going to rise and that should be taken account in one’s projections. But if the currency is undervalued by 15% and is historically undervalued by 25%, then it is likely that the currency is going to fall. (For a more detailed explanation and example calculations, see Dick Locke’s classic post on Undervalued Currencies, Part II.)

Now, this won’t account for the situations where one country, like the US, is intentionally lowering the value of a major market resource or currency basket, like the petro-dollar, in the hopes of decreasing the value of another market resource or currency, like the Ruble, in the hopes of weakening an economy, like Russia, as these situations can only be detected by geopolitical (trade) monitoring (which will be discussed when we cover damnation #25, among others), but it will give you a much better understanding of relative currency strength and how the currency value is likely to change over time based on historical trends.