Ted Botzum of TPI’s Financial Analysis Services Group will be “blogging about the bottom line” this week.
With many long-term outsourcing contracts for services delivered from emerging economies, U.S. companies need to apply serious forethought when handling foreign currencies. Beside the depreciating U.S. dollar, there are many practical matters to be considered.
Early strategic considerations should include:
- Fixed versus flexible rates - Clients and service providers must pick between fixed and flexible prices or rates, clearly define them, and select the contract base currency, be it the USD, Euro, or the local currency. But a single strong currency may be used for pricing consolidation or business case calculation.
- Adjustments - All parties involved in a transaction need to determine the frequency of adjustments to account for exchange rate and cost of living variation.
- Currency choice - Should the price, invoice, and payment be in the currency of the country of service origin, or the country of service destination?
- Instability - How should dynamic or unstable currencies be handled?
As these higher-level strategies are contemplated, it makes sense to
assess the company’s ability to handle these elements prior to contract
signing and transition.
Otherwise, reality will hit after an invoice has been delivered by a service provider in a currency that cannot be handled by the client’s local group. To complicate matters, some service providers need a local presence if local-to-local billing and payment remittance is required for tax burden relief. Others may be required by law to have all services billings (and possibly pricing and purchase orders) handled in their local currency – even in the case of imported services.
So how can clients manage these risks?
Our advice is to keep the focus on practical issues from all sides involved in a complex transaction. Make certain that everyone is able to fulfill the financial setups that have been contracted. A lot of homework and research are required to make sure the “theory” is able to be implemented.
The same question needs to be asked in different ways to ensure confidence in the answer. Scenario development and use cases are practical tools in communicating strategies on complex financial situations to professional organizations within a firm (e.g., Tax, Treasury, Corporate Accounting) unfamiliar with back-office operations.
But most importantly, strategies and objectives need to be relationship specific. What has your experience been with such outsourcing-related foreign currency issues?