Academic journal article Journal of Purchasing & Materials Management

Currency Exchange Rates: Their Impact on Global Sourcing

Academic journal article Journal of Purchasing & Materials Management

Currency Exchange Rates: Their Impact on Global Sourcing

Article excerpt

Currency Exchange Rates: Their Impact on Global Sourcing

Exchange rate considerations are becoming an important facet of international sourcing. Not only can volatile exchange rates impact the supplier selection decision, they can also affect the volume-timing of purchases once the supplier is selected. The analyses presented in this article are intended to familiarize purchasing managers with two macro level exchange rate management strategies and demonstrate the potential benefits of using these strategies in international purchasing.

As U.S. manufacturers strive to compete globally, effective management of the supply function is becoming increasingly important. It is widely acknowledged by procurement experts that supply management will play a major role in the restructuring and restoration of American industry as it attempts to regain U.S. and world market share. As stated by Davidow:

The best manufacturers have superior suppliers--suppliers

which save customers money, improve their quality, aid in

design innovation, and reduce inventories.[1] "World class" suppliers cannot always be found within the United States. The growing movement by U.S. manufacturers toward foreign sourcing demonstrates that increasing numbers of purchasing managers are turning to nondomestic suppliers to satisfy their needs.

While competitive advantage has diminished, customers have

demanded increasing quality and value. The resultant

concentration on cost and its containment has forced all of us

to look to new sources and products as we struggle to satisfy

needs--needs which now have become international in

nature.[2]

Global sourcing spawns a new set of opportunities and problems for the purchasing manager.[3] In the past, the problems involved in international sourcing were overshadowed by the strength of the U.S. dollar. Today, however, purchasing managers who source abroad are challenged by a complex and competitive world market. The falling value of the dollar, declining oil prices, dis-inflation, and pure deflation in some countries require purchasing managers to take a more selective approach to global sourcing. In today's environment, the process of locating and selecting capable foreign suppliers is more difficult. The decision is further complicated by volatile currency exchange rates, which impact the total cost of imported goods over the life of a requirements contract.

THE IMPORTANCE OF EXCHANGE RATES IN INTERNATIONAL SOURCING

Exchange rates impact the price paid for imported materials when payment is in the supplier's currency and there is a lag between the time the contract is signed and payment is made. Depending on the country of the supplier and the direction of the exchange rate movement, a buyer may be required to pay substantially more or less than the original contract price. For example, suppose that on January 3, 1986 a U.S. buyer entered into a one-year contractual agreement with a Japanese supplier that called for 12 equal monthly payments of 20.248 million yen each. Further assume that when the contract was signed on January 3 the prevailing exchange rate was 202.48 yen per U.S. dollar. Evaluated at that exchange rate, each monthly payment of yen was equivalent to $100,000 U.S. Depending on the exchange rate volatility of the yen with respect to the U.S. dollar over the duration of the contract, the total cost to the buyer could be higher or lower than the expected $1.2 million ($100,000 per month for 12 months).

Table I presents data supporting an analysis of actual U.S. dollar expenditures over the 12-month life of this contract. Since the U.S. dollar lost buying power against the yen in 1986, the contract with the Japanese supplier would have cost a total of $1,433,230 U.S. over the 12-month period; that is, $233,230 U.S. more than the $1.2 million originally anticipated.

The problem becomes even more complicated when two or more foreign suppliers from countries utilizing different currencies are under consideration for a contract. …

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