Foreign exchange (forex) fluctuation risk takes high priority during contract negotiations. It changes the price service providers charge and the price outsourcers pay, which can be significant and detrimental to the bottom line. So businesses need to make sure the safety nets are in place before jumping into a sourcing arrangement. Otherwise, merciless speculators may determine the fate of the relationship.
Forex fluctuations can be significant, and
may lead to either currency appreciation or depreciation. If the supply-country
currency appreciates against the billing currency of the demand country,
service provider revenues and margins decrease, as they’re reported in terms of
the supply-country currency. On the other hand, if the currency depreciates,
service provider revenues and margins increase.
So there’s a clear need for a mechanism that
adjusts the pricing changes attributable to forex fluctuations, as was
discussed in “Dynamics
of Price Adjustments in a Globalized Sourcing World”. Here are a few at the
disposal of contract negotiators:
- No adjustment allowed – The company
outsourcing does not provide for any price adjustment attributable to the forex
fluctuations, as the service provider can hedge its currency exposure as it
deems necessary.
- Adjustment within a band – Price adjustments
can be allowed up to a certain percentage, based on forex rate movement; while
a greater adjustment may be subject to negotiations.
- Adjustment beyond ceiling –Adjustments are
allowed only for extreme fluctuations.
Negotiators can vary their forex adjustment
approach by considering the direct movement of one currency versus another, a
set of representative currencies of countries that are major consumers of
services, or a basket of currencies that represent a mix of supply and demand
countries.
No matter what the approach, a company
outsourcing should compensate the provider for impact of forex fluctuations, if
it was spelled out in the agreement. It should also avoid paying for what the
service provider could have hedged against. But most importantly, it’s
important to avoid double dipping (of inflation) by using real exchange rates.
At the end of the day, the service provider
and its client need to reach a mutually acceptable solution and discuss any
extraordinary situations. It’s more about the negotiation and less about the
actual numbers. Turns out, the relationship is the best safety net of all.
