How FX Risk Exposes Supply Chains – And What You Can Do About It

Extreme volatility shook the forex exchange market back in 2022, and this trend seemed to continue in 2023 as well. International trade kept gaining an advantage and many of the economies became more and more interconnected. This caused various industries, including supply chain vendors, to be exposed to a high risk of fluctuations.

As cross-currency fluctuations put supply companies in danger of profit loss, many have tried to find a way to bypass this. They pushed for better rates to make up for the backdrop and updated their marketing to find a way to bring new clients their way. These fluctuations will likely not go away anytime soon, which is why it’s important to find out the problem. 

In this article, you will learn more about the challenges that supply chains face along with some solutions to bypass them.

Challenges Faced By Supply Chains

Logistics platforms often face various challenges as a result of cross-currency volatility. Here are the most common ones: 

  • Freight Shipment Cost Increases

When it comes to international packages, the cost is often dependent on the country that sends the package. For instance, let’s say that you have a package going from the United States to South Africa, for which you need to pay the shipment cost. If the South African Rand (ZAR) weakens during the one-month transit, you will have to pay more ZAR when exchanging into USD. Depending on how many shipments you make, even a slight exchange can lead to profitability loss. 

  • Residual Value Appreciation of Freight Content

The cost of shipment is not the only thing that can change during transportation. The value of the items aboard may appreciate. Let’s take the Los Angeles to South Africa example once more. If the value of the ZAR decreases during a 40-day shipment in comparison to the USD, then the buyer would have to pay the difference for the shipment value. Depending on how much they purchased, the importer may have to pay thousands of ZAR for a small 3 percent difference.

Ways to Eliminate FX Fluctuation Loss

There’s nothing much that you can do about currency fluctuations, and they will likely keep changing in the future. However, there are several smart tools that you can use to stay safe from the unpredictability of the FX market. Here are a few useful ones: 

  • Identifying FX Risks in the Supply Chain

You may have an FX risk hidden in your supply chain and not even know that it’s costing you money. Perhaps third parties are buying the products they are supplying you with using another currency. This can expose you indirectly to their risks and cause exchange losses. Whenever they experience a hit, those costs will likely be passed down to you. 

This means that you have to be extra careful when choosing your supplier. You should examine the contracts that they have and where potential risks may be found. By knowing these aspects, you should be able to come up with protection measures. For instance, if you are hit by a major swing or the payment period has been shortened without your knowledge, you may agree to a refund.

  • Creating a Diverse Supplier Base

Generally speaking, having a diversified supplier base can help you reduce different business risks. For instance, if you only use one supplier, you could receive a great hit should anything happen to the shipment. You’ll still experience some issues if one out of five suppliers fails you, but at least you’ll have the others to fall on. 

Things are no different when you add FX into the mix. The exchange rate risk may be different from one supplier to another, which is why you need to be careful where you are sourcing from. If you are sourcing from just one country and their currency becomes stronger than your own, you will have more to pay once the exchange rate comes in. 

However, if you have a supplier from a country with a favorable rate as well, the losses may balance each other. Finding the right countries to source from can be challenging, depending on the materials you need, which is why you must do thorough research on potential suppliers.

  • Using Modern Payment Systems

Very often, the loss happens because vendors and suppliers follow a pay-at-delivery method since it’s simpler. If you have a dropshipping business, this is often your best choice, as it allows you to gather the payment from your buyers. You order the shipment with no costs attached and then pay it back once the products have been delivered. However, this may come back to bite you, as the price in one month may be different from the price you see now. 

As inconvenient as it may seem to some, making the payment when you place the order can save you money in the long run. By using modern payment platforms, you can keep safe from fluctuations, reducing the risks of doing international business. You can also automatically book the rates on the platform, locking them in for the future and saving you from FX changes.

  • Creating Strong Business Relationships

Sometimes, it all comes down to how well you manage to nurture your business relationship with the suppliers. If your relationship with them is solid, then it leaves you more space to negotiate the fees. Having these business ties can help you obtain a good exchange rate and favorable payment terms. 

There may be some difficulties that you’ll have to get through. For instance, cultural differences and geographical distance can make it difficult for you to create a strong relationship. Because of the competitive pressure, you might also find it hard to enter their radar as a reliable vendor. It can take a lot of time and effort for you to be recognized enough to get the benefits.

  • Setting Dynamic Prices

As a supply chain company, you can set dynamic prices that can expand and contract in tune with the currency exchange rate. This can turn out advantageous for you, as the risk is rolled onto the client. 

That being said, implementing this business model can be very challenging, mainly because not many suppliers are comfortable with this risk. You need to prove that you have a strong technological infrastructure and that your regulatory compliance is up to speed. Also, your customer may not like it when the prices are constantly changing, so unless you are a big and powerful player, this may not be easy for you to do. 

  • Using Currency Hedging

In currency, hedging means that you use financial instruments to keep control of the exchange rate. This includes options, currency forwards, swaps, and more. Smart use of hedging can secure a good exchange rate and minimize potential losses since you know exactly how much you have to pay. 

To put it simply, hedging allows a company to create a forward agreement with an investment dealer. This can be a bank, a hedging broker, or more. With a currency age, both parties agree on an exact currency in the future while being on today’s exchange rate. It won’t matter how much the rate changed, you will still pay the amount you agreed on. You can get more information on how to do that by contacting a broker in your area. 

  • Buying Foreign Currencies

If you want to beat the system, then the best way to do so is to join it. If you are buying from suppliers outside of your country, you still have to pay in the currency that they are asking for. However, no rule says you need to make that exchange the moment the shipment comes by. 

Rather than losing profits by exchanging at a time when rates are unfavorable, you should consider buying when they are in your favor instead. Whenever you see that the currency you are using is stronger than the currency you are buying from, you should consider making a backup exchange. You’ll likely make more shipments in the future, so this technique will take the exchange rate out of the equation. 

Keep in mind that there are a couple of disadvantages to this. In case you need to change it to a different currency than intended (i.e., back to your own), you may end up with less money than you originally had. It may take out of your cash reserves, as you won’t be able to use that money except for future shipments. Buying the currency at the right moment may also require administrative time and expertise, which many supply chain businesses may not have.

The Bottom Line

Doing business in different currencies can put you at risk of loss, especially in today’s constantly changing market. That being said, if you use the right strategies, you may be able to protect yourself. Once you have a good net to fall on, your profits should significantly increase in the long run.