How FX risk exposes supply chains - and what to do about it
Updated: Mar 9
Extreme FX volatility wreaked havoc on the global markets in 2022 and continues well into 2023. As international trade continues to accelerate and economies become increasingly interconnected, global industries - such as supply chain vendors - become extremely vulnerable to the risk of multi-currency fluctuations. The rise in cross-currency volatility threatens supply chain companies, eroding profits in an industry with modest margins. Add to that, logistics companies have little that sets them apart to win new clients - who relentlessly push for better rates. Against this backdrop, eliminating cross-currency volatility is an opportunity for global supply chain companies to bolster their own business and differentiate their offering while enabling their customers to protect theirs.
Let’s zoom in on the specific challenges logistics platforms face as a result of cross-currency exposure.
FX challenge 1: freight cost increases
Picture a shipment of freight from Los Angeles to Durban. The cost of this ocean freight is $US 2,200. When the shipment sets off from Los Angeles, the exchange rate is 15 South African Rands per 1 US dollar - setting the cost at 33,000 South African Rands (ZAR). During its 32-day transit, however, the South African currency weakens by 2.8%. At the time of shipment, the exchange rate is 15.4 ZAR to 1 US dollar. As a result, the cost is now 33,880 ZAR.
That is to say, even minuscule exchange rate shifts can result in significant cost increases and severe blows to profitability.
FX challenge 2: residual freight value appreciation
Consider an importer in Durban who buys goods from Los Angeles. The total cost of the goods is US $100,000, 30% of which is paid in advance on the order date. At this point, the exchange rate between the US dollar and the South African Rand is 14 ZAR per 1 USD.
During the 39-day transit, the South African Rand decreased by 3.1% relative to the US dollar, so by the time of arrival, the exchange rate was 14.45 ZAR per 1 USD. The importer has to pay the remaining balance - $70,000, which now costs much more. Instead of the original amount per the exchange rate at the start of shipment - 980,000 ZAR - the importer has to shell out 1,011,500 ZAR.
Had the importer used a smart tool to eliminate exchange rate fluctuations, this negative impact on residual freight values would have been avoided. A solution that brings visibility into the impact of exchange rate fluctuations on transactions would have helped the importer be better prepared and avoid an unfavorable shift in expenses.
FX protection strategies for global businesses
As the currency markets are inherently unpredictable, putting supply chain companies at substantial risk, it's crucial for shrewd, risk-averse business operators to nurture financial resilience with strategic FX risk mitigation. Multiple strategies are available for globally-transacting supply chain business:
Spreading business operations and sourcing materials from suppliers in various countries reduces dependency on a single currency, minimizing the risk of FX volatility. While shifts in some exchange rates may result in some setbacks, other currencies "behave" more favorably, hopefully offsetting losses. Businesses can also stick to a financial policy wherein they invoice in traditionally more resilient currencies - such as the US dollar or the Euro.
Diversifying currencies has some downsides: coordination between different parties in the supply chain is tough, erosion of trust due to shifting prices threatens a loyal customer base, regulatory constraints require attention, and technological infrastructure is expensive.
Supply chain companies can set flexible prices that expand and contract in tune with the currency exchange rate, effectively rolling the risk onto the client.
Dynamic pricing is a challenging model, and its complexities are manifold: lacking real-time data renders pricing adjustments a clunky ordeal and coordinating different players in the supply chain is difficult. Like currency diversification, dynamic pricing requires investment in technological infrastructure and regulatory compliance. Lastly, customers distrust vendors whose pricing models change constantly.
Building solid business relationships for favorable terms
Nurturing solid business relations with suppliers may come in handy when the time comes for supply chain companies to negotiate. Having beneficial business ties will help you negotiate favorable payment terms and exchange rates.
That said, relying on strong business relations has its shortcomings: cultural differences, geographical distance, competitive pressure, and mistrust due to lacking transparency all render this strategy a complementary, albeit limited, solution.
Hedging on currency means the use of financial instruments - such as currency forwards, options, or swaps - to secure an exchange rate and minimize exposure to fluctuations. In other words, a company makes a "forward agreement" with an investment dealer (hedging broker or bank) to sell a set amount of a particular currency on a future date— at today's exchange rate.
With hedging, companies benefit from financial certainty, knowing exactly what they stand to earn (or pay) when the time comes.
Where do traditional currency solutions fall short? First, they're inaccessible to SMEs. Second, they require expert resources. Lastly, regulatory constraints render them inconvenient and complex.
Embedded cross-currency solutions
Embedded finance - the integration of financial services into non-financial platforms - can streamline operations and drive efficiency in industries exposed to market fluctuations. From digital wallets to cargo insurance at the point-of-sale, embedded finance can be particularly useful in the logistics industry - a sector that's poorly understood by traditional banking institutions. Using embedded finance tools opens the gate for global supply chains platforms’ audience to access solutions that are often inaccessible to them through traditional financial vendors. With this added value for their customers, platforms that utilize embedded finance can drive growth, boost user engagement, increase loyalty, and add new revenue streams.
The embedded finance trend now intersects with hedging. Logistics platforms can integrate an embedded hedging tool as an added offering that drives value to their audience: customers can simply lock the exchange rate for each booked shipment, so they’re automatically protected against cross-currency volatility.
Grain: embedded FX protection for global supply chain platforms
Grain is the only embedded, API-based cross-currency solution that enables global supply chain platforms to eliminate FX exposure. With embedded hedging, supply chain platforms can safely set competitive prices without risking their earnings. They can also charge customers in local currency while getting paid in their functional currency. Lastly, Grain's revenue-share model lets hosting platforms benefit from additional income.
Ready for smarter FX protection? Book a demo today to learn more about how Grain can help you mitigate the risks of FX volatility and manage cross-currency transactions with confidence.