Who will manage the risks in a single currency?
Efficient consumer response (ECR) is a major dynamic in the textile, footwear and apparel industries today, as manufacturers and retailers strive to achieve a competitive edge through improved customer service andsensitivity to demand. One effect of the focus on ECR is that supply chains within the
The automotive supply chain is characterized by tight integration and global operations. But what do the implications of managing the supply chain have to do with the currency risks associated with the onset of European Monetary Union (EMU) and the arrival of the euro?
Increasingly, the organizations sitting at the top of the supply chain – typically the major retail groups – dictate the trading conditions that will prevail throughout the whole chain. These conditions are applicable regardless of geography or the size of the trading partner. For example, if a major retailer wishes to purchase all stock in a particular currency, the entire chain must respond accordingly.
Across Europe, major retailers are announcing their intentions regarding EMU and the euro. These range from merely adopting dual pricing (their national currency plus the euro), to expressing their preference for the euro to be used as their prime sourcing currency across the whole of Europe and beyond. Some large continental retail chains have even announced they intend to adopt the euro as their operating currency from 1999, the start of EMU.
So will this widespread move to the euro compromise the management of exchange risk in countries outside of the euro-zone (for example the USA, UK and the ‘out’ countries of the European Union)?
A risky business for smaller suppliers
Think of a highly integrated, responsive supply chain. Sitting at the top of the supply pyramid are the big multiple retail chains. Below them are the so-called Tier One suppliers, Tier Two suppliers below these, and so on. The size of companies generally decreases towards the base of the pyramid, and many smaller, nationally-based companies are situated at the bottom. These smaller, local companies have historically traded solely in their national currencies, and have a local currency cost base.
The request from the major retailer at the top to trade in euros is a result of seeking to match euro revenue streams with euro cost streams, and quickly reaches and affects these smaller companies. Now the smaller company based in a non-EMU country – is faced with a dilemma: invoice in euros and accept the associated exchange rate implications; or risk losing a valued (sometimes sole) customer?
The problem is that these smaller companies cannot convert a significant part of their cost base into the single currency. They pay wages, buy materials and so on in their local currency, which is a non-EMU currency. This means that when there’s a fluctuation in the exchange rate between their national currency and the euro, it is only their income that is affected, not their cost base. There is no automatic offset of the exchange risk.
Companies such as this do not have sophisticated treasury risk managers and methods to manage the risk effectively – they have never needed them! Before the advent of EMU, larger companies have had to bear and manage currency risk. Their adoption of the euro, along with risk management expertise, has now effectively pushed the exchange risk down the supply chain.
All of this begs the question: can exchange rate risk be managed effectively in the relatively unsophisticated small company environment at the end of the chain?
A helping hand
Sources of help are available to these newly risk-bearing companies, such as financial advisors, auditors and accountants, and bankers. However, these services normally cost significant amounts of money, which is yet another overhead.
The IT systems of small companies are another area of concern, particularly with regard to the handling of multiple currencies. This capability is a must, in order for a company to automatically handle invoicing in a currency different from its operating currency. A further complication with the euro is that, for the first three-and-a-half years of EMU, there are special rules governing conversion into the euro and between its member currencies. Systems have to comply with these rules, but very few do today.
Will upgrading or changing IT systems to handle the euro be another unwelcome cost? Additional costs will of course be involved, but it is definitely not in the interests of large companies for some of their smaller suppliers to stumble, or even fail completely, due to poor or non-existent foreign exchange risk management procedures. As these larger companies have used their expertise and experience to balance their exchange exposures in the past, perhaps they could assist their smaller business partners to do the same now the euro is being adopted?
Working closely under highly confidential arrangements, the treasurers of large companies could establish ‘consulting’ arrangements with a few of the small companies in their supply chain. Helping to ensure that good and prudent exchange management procedures are adopted by the smaller companies will benefit the larger ones, help promote more robust supply chains, and contribute to the success of their ECR initiatives.
After all, failing to have the right product available due to the bankruptcy of a supplier is certainly not part of an efficient consumer response!
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