Procurement's key role in exposing the hidden cost of currency fluctuations in contracts

Procurement’s key role in exposing the hidden cost of currency fluctuations in contracts

Mark Boswell Blog, Procurement

Mark Boswell, Senior Manager at 4C Associates considers the steps Procurement should take to understand and forecast pricing impacts due to currency fluctuations.

Over the past 12 months’ sterling has fallen by over 20% versus both the US dollar and the euro. The decline really gathered pace post the UK’s June 23rd EU referendum result with the pound slumping c15% in the following weeks.  These types of currency fluctuations provide significant challenges to treasury and finance functions charged with managing currency volatility but also represent a major challenge to procurement where the impact on an organisation may be less visible.

Vital role

Procurement plays a key role in forecasting pricing impacts through the organisation. CFO’s will be seeking answers to the questions on how the currency fluctuations will impact imported goods and in turn effect consumer pricing and the profitability of the company.

Buyers need to understand the impact of exchange rates on imported goods by managing and taking control of the supplier relationships and price increase conversations that will inevitably follow.

Raw materials are significant underlying cost elements within the costs of purchased goods. Goods that are paid for in a different currency to that of the importing country – ie paying euros when you are based in the UK or having an underlying commodity impact that is paid for by the supplier in US dollars will have a hidden cost impact that can be hard to predict until the supplier requests a price increase.

Underlying impact

For instance, although we have seen a drop in the underlying costs of thermoplastics such as polyethylene, polypropylene and PET those reductions are more than offset by the weakening in sterling versus the euro making it more expensive as a delivered product to UK factories when imported from mainland Europe. Other important US dollar based raw materials, such as fuel for logistics, either directly for freight management or indirectly from suppliers delivering goods to the buyers’ manufacturing sites, need to be considered.

It is important for Procurement to first understand how their goods are priced and what elements are exposed to currency fluctuations then to be able to measure the impact and articulate the consequences to both finance and treasury partners within business. This enables the business to plan effectively any potential pricing impact to customers and therefore ultimately to consumers.

For longer term contracts where it is not desirable to hedge commodities or currency it is normal to lower and raise prices in line with currency movements by tracking against market indices and against fixed periods of time. In order to understand the impact that currency fluctuations will have on the final purchase prices of the goods you need to understand the breakdown of the raw material parts, their base prices and their relevance to the total costs of the goods. Understanding and agreeing those parameters at the outset then linking the final prices explicitly to movements in commodity and currency indices will enable both the buyer and seller to forecast significant changes to their finance teams.

One step ahead

Prevent costly and potentially embarrassing surprises where Procurement is the department that brings bad news late to the party. Getting ahead helps Procurement raise its profile and become an important business partner.

For more information on 4C’s approach to currency and contract management see here.