Many businesses hesitate to expand into an overseas market, preferring to focus instead on domestic growth. Whilst this is a perfectly legitimate strategy it can give competition an edge if they have an alternative view.
One thing’s for sure: executing well in a new market provides a great opportunity for a business to really steepen the growth trajectory, as the ability to access a very large, previously untapped market can be a real game changer.
There are, however, many risks when operating in a new market for the first time. Establishing new customers in a new market can be quite challenging, with businesses spending a lot of time and resources deciding on a suitable pricing strategy. With an international business, pricing strategy gets trickier not just for customer pricing but internal transfer pricing as well.
The online FX pricing trap
Many businesses new to overseas expansion fall into the trap of converting the domestic price into a foreign currency price using an indicative exchange rate they find online. This could be a rate displayed on a currency converter or a news website quoting exchange rates that are often either delayed, a mid-rate or interbank rate.
Delayed pricing could be either a few minutes, hours or in some cases a day late. In a market that is constantly moving every second, and can move a considerable amount in just a few hours, using such an exchange rate to price overseas customers is a recipe for disaster. An adverse move could wipe out the profitability of the transaction altogether.
Exchange rates – what’s the difference?
Rates for international money transfers are quoted as simultaneous buy and sell prices. There is a difference between the buy and sell price, which is called the spread. Most currency converters on the internet show a mid-rate that lies between the buy and sell prices meaning the rate is not reliable at all as you can’t buy or sell at that rate. What makes this worse is that the mid-rate may also be delayed.
The exchange rates displayed on news sites, similar to mid-rates, are usually what’s known as the interbank or wholesale rate. This is the rate that the banks and very large institutions get to transact at amongst themselves. The aim for business is to try and get as close as possible to this exchange rate, but it is highly unlikely that it is possible to transfer money internationally using a bank within 1% of this rate, unless the size of the transfer is in the tens of millions at a time.
If a business is using any of these exchange rates to price their customers then it is highly likely they will incur some large FX losses over time that can not only wipe out any profit margin but even return a loss.
There is often a timing mismatch because by the time the foreign currency is received and then converted back into Australian dollars the exchange rate has moved. Yes, it could have moved in a business’s favour, actually increasing profits, and whilst this may happen it is by pure chance and the odds are that at some point the movement will be in the other direction.
Some businesses with a little more experience dealing with foreign pricing often use the buy or sell rate of the banks to price customers. This is a step in the right direction because at least that is the actual transfer rate for that day (not a mid-rate or interbank rate) but it is still not live as the banks tend to set these at the beginning of each day for that day’s trade. So if there is a delay in the funds transfer of a few days then the actual exchange rate when the funds are received will again be different.
Getting some certainty
It’s probably no great surprise that the banks usually don’t like to take any risk, so they prefer to receive the foreign currency first and then convert into Aussie dollars once received at the exchange rate they have set for that day. This is not the best result for the business, not only because the exchange rates can be quite horrendous but also because they cannot budget with any certainty as to what amount of money they will receive when. Compounding the frustration for many is the difficulty of reconciling at month end, with the more foreign payments received throughout the period the larger the administrative burden.
In this instance banks will often recommend a business open a foreign currency bank account to control the conversion rate and make accounting simpler. There are also some netting benefits for those businesses that have two-way currency flows, i.e. receive frequent offshore payments and also have a regular need to send money the other way. However, the maintenance and inward receiving fees on foreign currency bank accounts are usually very high, making them less attractive.
In order to get some certainty it is possible to secure an exchange rate before the international money transfer takes place. To get access to this type of facility, businesses may have to shop around and seek the services of an alternative provider of international money transfers. These providers should provide the ability to lock in an exchange rate prior to the funds being received without the need for a foreign currency bank account. Not only can such a provider help avoid the online FX pricing trap and ensure some cash flow certainty but they can also provide advice as to better manage your international pricing.