Is your business ready to go global? Transitioning from domestic to international markets is a big step for many growing businesses. With high-performing success stories like General Electric and Apple, jumping into unchartered waters may look tempting. Before diving in, what does the big picture look like, and how can you best prepare your business?
In an analysis of 20,000 companies in 30 countries, the Harvard Business Review found that “companies selling abroad had an average Return on Assets (ROA) of minus 1 percent as long as five years after their move. It takes 10 years to reach a modest +1 percent and only 40 percent of companies turn in more than 3 percent.”
Why is the success rate for most companies so slow? “Customers sometimes don’t even know what they don’t know,” says Michael Hayashida, senior managing director and head of foreign exchange (FX) risk management at East West Bank.
“We want to make sure businesses understand payments and currency needs from both a cash management, as well as a risk management, perspective,” says Hayashida. “Sometimes a company has lofty ideas of becoming a multinational corporation overnight, but, realistically, there are a multitude of things that have to be taken into consideration: There needs to be a commitment of resources, and a commitment to learn and understand a variety of factors, including foreign tax implications, regulatory impacts, and the geopolitical climate of the international target market(s).” Hayashida and his team work around the clock to ensure that their customers are prepared for all the risks involved.
“Now that you’re dealing overseas, your revenues and expenses are going to be subject to fluctuations from currency markets,” says Hayashida. “Sometimes customers maintain a misconception that their business is insulated from FX movements as long as they’re dealing in U.S. dollars.” As Harvard’s study proves, few companies have the resources or management capabilities to truly bring in a profit from expanding abroad.
“A lot of businesses don’t see the direct correlation between currency volatility and their bottom lines,” says Hayashida. “They’re so used to having the U.S. dollar be the common denominator and basing their margins on a straightforward cost-of-goods sourced in one currency. In the U.S., for example, you may have considered a healthy margin of 10-30 percent of sales, but when dealing overseas, currency fluctuations may easily erode a significant portion of those margins if you’re not careful. Furthermore, if you’re a business operating on thin margins to begin with, currency fluctuations—if not properly managed—could easily erase those margins altogether.”
If your business faces financial distress after expanding overseas, what is the cash flow at risk and how much debt is acceptable? To assess your business’ risk appetite, Hayashida recommends looking at the present and historical currency fluctuations of the country your business wants to expand into, and perform a SWOT analysis against prevailing market conditions and competition, while also conducting a market segmentation analysis to gauge how much your product or service may actually be in demand.
Currency risk can also manifest itself in indirect ways through factors such as higher cost of goods that can cause a business’ products to be less competitive in foreign markets and impact areas like purchasing power or sales.
"If you’re a business operating on thin margins to begin with, currency fluctuations—if not properly managed—could easily erase those margins altogether."
“I look at my job in some respects as an awareness campaign,” says Hayashida. “Many of our customers come in focused on the sales and marketing side of things, which are important, but very often they neglect all the considerations on the back end.” Legal, regulatory, compliance, and currency risk are all things that need to be addressed with a preemptive plan. “We don’t want to tamper all the optimism and excitement of going overseas, but we want to make sure our customers are aware of the risks and potential pitfalls that are out there,” he adds.
From general elections, to natural disasters, geopolitical risks can impact a country’s currency value significantly. “Very often, geopolitical events happen unexpectedly,” says Hayashida. “Take Brexit, for example, or the European Sovereign Debt Crisis, the Arab Spring uprisings, the flash market crash with global equities. All of those events occurred rather suddenly, and caught many off-guard.” Despite the lack of warning in many cases, you can still learn lessons and extract "key takeaways" from each scenario. The ability of FX advisors and experts to look back and analyze what happened, then learn from the steps taken in the aftermath, make them valuable assets for businesses navigating overseas.
“We can point to experience and say these companies could have mitigated some financial pain had they implemented these security programs or risk management safeguards prior to these events unfolding,” says Hayashida. “As FX advisors, we can confer some degree of wisdom to our customers to prepare them, to a certain extent, for the unknown.”
As subject matter experts for U.S. and China markets, Hayashida and his team also point out the specific nuances associated with Greater China. “The renminbi, for example, is a restricted currency that’s not freely floating like the euro or the Japanese yen,” he says. “The currency is also subject to much stricter capital controls. I’m sure you’ve heard of the so called ‘trapped cash’ phenomenon, whereby money is literally trapped in China due to capital outflow restrictions; not to mention the complicated regulatory differences between the onshore and offshore RMB markets.” All of the complexities and nuances with specific countries and their currencies make having a subject matter expert at hand crucial to a company’s success abroad.
A lot of times, small to mid-size businesses may not have the resources to manage some of the FX risks that a larger corporation has access to, such as a big treasury department or a financial team with international accounting, cash/risk management experience. “Often, these businesses set themselves up to be taken advantage of if they’re not careful,” warns Hayashida. Rather than trying to find talent and hire in-house to prepare for overseas expansion, Hayashida suggests finding trusted advisors that can help oversee the transition. “We want to share with these small to mid-size businesses the same types of services, tools and solutions that have traditionally been reserved for large corporations,” he continues. “We want to build loyalty with these growing companies by helping them get from point A to point Z smoothly.”
While initial discussions can be very rudimentary, where business owners may not have any idea of the currency risks they might be exposed to, the objective of the FX advisor is to ultimately take them to the "end game" where they can implement a customized, structured FX exposure management program that can address specific "pain points" and key objectives.
“Whether it be in the form of cost savings, revenue enhancement, or to simply not lose sleep at night from the uncertainty of global financial markets, we’re committed to being FX advisors to all companies–big and small,” says Hayashida.
There is a broad spectrum of FX products, services and solutions, from Forward Contracts, to Foreign Currency Swaps. “Deciding what tools to implement is really done on a case-by-case basis, depending on the business’ investment objectives and risk appetites,” says Hayashida. Although the effectiveness in mitigating risk really comes down more to the exposure management approach, applying the right FX hedging instruments can prove to be highly effective. “Most people in this day and age still think of hedging and derivatives as dirty words,” says Hayashida. “It’s often associated with risky behavior like gambling, arbitrage or speculation, but when you really think about it—in their truest sense—they’re simply tools for effective risk management.” Of course, undesirable outcomes may result if the tools are not used for their intended purposes, but 94 percent of the world’s largest companies use derivatives to mitigate financial risk. For example, hedging short-term structural risks may help a company buy time while renegotiating pricing contracts, finding areas for cost reduction, or even relocating production. Airlines use this type of hedging with the cost of fuel under a time limit of 12-18 months. This helps them buy time to cut costs or raise prices to react to fuel-price fluctuations.
“We help to develop the framework for a structured FX risk management program that is designed to help remove the variable of FX out of the equation,” says Hayashida. “Think of it as analogous to your personal 401(k) program. You commit to having a certain percentage from your pay go into your retirement savings to make an investment at pre-determined regular intervals, regardless of whether the market is up or down. Similarly, in a structured currency management program, you would buy/sell currency at fixed regular intervals—irrespective of market levels. The notion is that over time, volatility will smooth out and decrease—a concept often referred to as ‘dollar cost averaging’.”
The structured FX risk management program is, in essence, a type of “autopilot” currency hedging system for customers. Along with these customized tools, Hayashida and his team of advisors identify currency exposures, establish FX budget rates, develop FX hedging strategies, provide market insights, and evaluate the overall effectiveness of a currency risk management program. “We use our tools to neutralize the impact of foreign exchange gains and losses in our customers’ current earnings within their Income Statements, helping to mitigate any unwanted volatility in their P&L,” says Hayashida. “Now, if a customer came in and said they wanted to use FX as a revenue enhancement tool and make money, then that’s a completely different discussion altogether.”
The true risk management discussion is to allow businesses to operate overseas without having those volatilities affect the bottom line. Rules set by the Financial Accounting Standards Board (FASB) write out specific guidelines with respect to how FX or derivative hedges should be accounted for, which can be complex to process. With the right program and team in place, however, a business can reach its goals while remaining in-line with risk tolerance and policies.
“Businesses with the right type of currency risk management solutions in place have a much better vantage point from which they can ultimately achieve international success,” says Hayashida. If your business is looking to expand overseas, having experts help analyze your situation, weigh-out some options, and find the best solutions may be the most important investment moving forward.