Swings in exchange rates over recent months have created an environment of uncertainty. Here is how retailers can protect margins.
In many retailers’ statutory accounts there will be a summary of their assessment of the key risks facing the business.
Somewhere in the analysis of those potential dangers and how they are monitored, managed and mitigated will usually appear foreign currency and interest rate movements.
Interest rates in the UK have remained static for a record period now, so it will come as no surprise that the subject of currency movements is at the top of the agenda for many finance departments today.
Indeed the slowdown of the economy in China, coupled with the growing expectation of interest rate rises in the US, has created an environment of uncertainty that has showed itself in pretty extreme volatility in the currency markets.
“Anyone buying forward in overseas markets runs the risk of the sterling equivalent of their purchases moving as much as 15% to 20%”
Alistair Lee, Argyll Partners
For example, in the past three months alone the euro has weakened more than 10% against the pound sterling.
Great for your next short-haul holiday but this brings huge issues for anyone importing, exporting or running businesses overseas.
At its most basic anyone buying forward in overseas markets runs the risk of the sterling equivalent of their purchases moving as much as 15% to 20% – a material impact on margins, which may be under pressure anyway.
Budget rates for buyers need to be addressed more often than may have been the case historically.
Or consider the brand website that appears in multi jurisdictions and multi currencies – how do businesses set the retail prices and then keep a sustainable link between the prices in different international territories?
Of course, wherever risk lies, opportunity tends to sit in equal measure and so gross margins for many will be positively impacted by this volatility, such as those sourcing product in the eurozone.
Regardless of how individual businesses answer these questions, foreign exchange volatility looks like it is here to stay, placing the onus on treasury departments to work out how to manage market risk effectively.
Those who know the likely currency inflows and outflows of their businesses into the future can then protect their margins with a good degree of confidence by using instruments such as currency forward exchange contracts, currency swaps or currency options and assorted exotic variations.
“Many retailers are hedging more than before and further out”
Alistair Lee, Argyll Partners
Some may be lucky enough to have natural hedges around the business such as selling in the US while buying goods in the Far East in US dollars.
Using such techniques can allow retailers to lock in their margins, but there is always that nagging feeling that if the currency moves against them then their uncovered competitors may have a windfall upside.
Is that better or worse than the potential sleepless nights from being unprotected?
Overall, many retailers are hedging more than before and further out.
Companies getting to grips with reducing the levels of uncertainty by locking in rates for known and likely events will struggle to plan for those with a relatively low level of probability but high levels of impact – such as the potential acquisition of another business.
To cover or not to cover? Cover, to be protected but without the obligation to take up in case it does not happen.
Increased volatility is bad for almost everyone – except perhaps speculators who make bigger turns in such a market – and the danger is that greater uncertainty in the financial world invariably affects consumer confidence, which can be fragile at the best of times.
- Alistair Lee, Argyll Partners