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Pricing in Uncertain Markets: Handling Foreign Exchange Movements

A world of fluctating currencies 

A world of fluctating currencies 

“The best laid plans of mice and men often go awry” said Robert Burns in 1786.  And while he wasn’t to my knowledge a business man, the saying holds true today.

When things change in commerce, pricing is one of the most effective levers we have to react quickly.  Making the most of an opportunity (or minimizing a threat) is about balancing speed with sure-footedness.   Here I’ll focus on unexpected foreign exchange (FX) changes, inevitable and unpredicted.  Note these options apply to both positive and negative FX changes.

The Exchange Rate just moved: now what?

First, don’t just react.  Instead you need to develop the options for how to act (including doing nothing), gather information and analyze it to assess and modify the options, and finally make a decision that is communicated internally and externally.

There is obviously tension between acting quickly and having fully analyzed information, so recognize that fact and lower the standards needed to make a decision.  Let’s focus the first two points

Deciding what to do will require answering three questions:  

  1. How does this change our goals and market position?
  2. What options to do we have to act?
  3. What impact are the actions likely to have short- and long-term?

Let’s work through these steps.

How does this change our goals and market position?

Your original plan is all well and good, but it may not be feasible now, (“we just have to make up the gap" is aspirational).  You need to realistically reassess the balance of the following goals:

  • Short-term profit taking
  • Long-term profit sustainability
  • Risk profile, e.g. to accounts payable, customer relationships
  • Planned investments – should we accelerate or postpone investments?

This analysis should include thinking through the impact of the changes on your competitors, channel partners and customers:

  • Competitors: Are all competitors feeling the same pain? Companies reporting in a different currency from your own may feel very differently about the impact.  How does this change across different competitors, such as locally based companies?     
  • Channel partners: FX changes can help or hurt distributors depending on inventories and the timing of payments.  The pricing power they have is also a critical factor, as is the level of financial security: distributors working on thin margins can make them vulnerable.
  • Customers: the analysis here is similar to that for channel partners – do they have pricing power?  If they are primarily export then perhaps they can easily pass on price changes?

Table 1 gives an example of a template that might be useful with a hypothetical example.

Table 1: example analysis of impact of exchange rate changes on various stakeholders in the value chain

Table 1: example analysis of impact of exchange rate changes on various stakeholders in the value chain

What actions can we take?

This will depend a great deal on your type of business, pricing model, Go-to-Market approach etc.  The options typically are

  • Change list prices
    • Portfolio-wide or broad price increase
    • Highly targeted price increase based on cost, market price, or value change
  • Reduce discounting
    • General reduction or tightening of discounts/rebates schemes
    • Targeted tightening of discounts/rebates schemes for specific customer segments
    • Cancel or modify planned promotions
  • Improve the product mix
    • Change mix by reducing availability of lower margin products or stop selling them completely
    • Bundling high-demand products with less differentiated products (within legal limits of course)
    • Incentivize sales or distributors to sell high-margin products
    • Set prices in a global benchmark currency (e.g. Dollars, Euros), especially if there is a natural downstream hedge
  • Reduce payment terms exposure
    • Shorten payment terms
    • Reevaluate credit scores and limits if customers or distributors are in financial distress
  • Change the mix of channels or customer segments by adjusting pricing differentiation.  Obviously this is likely to have long-term consequences.
  • Gain a commitment of future loyalty from strategic customers by foregoing a price increase.

In most cases only a few of these options will be practical.  Develop 3-5 options (which may include more than one of the above levers) that you’ll test in the next step.  These should include some variations on the mechanism and the amounts of changes.  Push the envelope a bit to make sure you explore the full space of possible options.

What impact are the actions likely to have?

The expected financial impact of each option of course needs to be considered, but it’s not the only one.  Given the pressure and likely lack of full information, it’s more important that key assumptions are documented rather than a super-complex financial model developed.

Don’t forget to assess the impact of each of the options on competitors, channel partners and customers (and others if appropriate, e.g. if the government is likely to take an action), factoring in their likely reactions.  What’s important is to think through each of the implications and document them so that it’s clear where there is consensus and where further digging or analysis is needed.

Working through this fast, while identifying the top opportunities and risks is key: a “war room” approach is often helpful.

Implementing the decision we’ll leave for another time, but suffice to say, clear communication and high frequency monitoring of the market and sales will be needed.

How to prepare for next time?

“Expect the unexpected” may be trite, but it’s good advice in this context.  Preparation should include:

  • Include FX events in your risk management processes: have some basic documentation for the triggers and how the process works, including how HQ and the local BU will work together
  • Build flexibility into your pricing architecture
    • Change some prices more than once per year to get the market used to them happening, either ad hoc or on a specific schedule, e.g. quarterly
    • Have som e promotions that are not announced far in advance so you can modify or pull them if needed
  • Make sure you understand the customer’s and your value-chain partner’s sensitivities to FX changes across core product categories.  Brief the BU leadership team to build consensus
  • Make sure you have sound pricing processes in place, e.g. price monitoring, price setting, price exception management.  Good processes will significantly increase your ability to react quickly and confidently
  • For high-risk markets, consider the balance of on- and off-shore costs, particularly if your cost structure is very different from the bulk of the market.

Anything else?

Just a few additional comments:

  • I haven’t mentioned FX hedging.  That’s because it’s not a pricing issue but one for finance.  Appropriate preparations and a well-execute pricing will minimize ‘core’ FX impacts and reduce the amount of hedging needed. 
  • Don’t spend much time worrying about future exchange rates…you can’t predict them (if you can you are in the wrong business).  Use the forward rates for planning and get on with it
  • Remember rates go in both directions.  Your reactions don’t need to be symmetrical, but they do need to have some level of consistency: your customers will point this out to you if you forget.  

Who does this well?  What are the parts they get right that make the most difference?   Feel free to share some of your own experiences in this area.   You can reach me at ian@eenconsulting.com

Exchange rate fluctuations, Jan 1 - Sept 15 2017.  Copyright FXTop.com

Exchange rate fluctuations, Jan 1 - Sept 15 2017.  Copyright FXTop.com