Foreign Currency Considerations Should Not Be Foreign

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?

 

Comments

[Phil Fersht]

Ted,

Excellent advice. What about the Indian government's imminent dropping of the tax cushion for its outsourcing providers? Won't this squeeze the costs even further, or will the Indian providers simply have to take a hit in their profit margins?

Phil Fersht
http://fersht.typepad.com

[Peter Allen]

Phil ...

It's time for rhetoric to meet reality. The provider community has been talking about the willingness to sign up for outcomes for a long time. We all know that the vast majority of the contracts are effort-based, however.

I think that the tax issue will be one more reason to motivate conversion of FTE-based arrangements to true outsourced/managed relationships.

The change-over may actually happen this time around because of the shared motives of Clients and Providers to take their relationships to the next level of maturity.

Peter

[Ted]

Phil, along with Peter's comments, I think there always will be "something". All things being equal, there'd be a cost hit but markets adjusts and service providers adapt - but all things are never really equal. As Indian and other providers continue to mature and the world continues to shrink, we should see more "committed", fixed price type deals where risks and opportunities are embedded in the pricing.

I'd be interested in hearing others comment on this.

[Ted]

Phil, along with Peter's comments, I think there always will be "something". All things being equal, there'd be a cost hit but markets adjusts and service providers adapt - but all things are never really equal. As Indian and other providers continue to mature and the world continues to shrink, we should see more "committed", fixed price type deals where risks and opportunities are embedded in the pricing.

I'd be interested in hearing others comment on this.