Currency fluctuations can have a significant impact on the prices of goods and services, especially when it comes to sourcing materials and products from international suppliers but domestic suppliers are also affected. In this blog, we will explore how currency fluctuations influence prices from both domestic and international suppliers.
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Explaining currency exchange rate
A currency exchange rate is the price at which one currency can be exchanged for another. It represents the value of one currency relative to another. For example, if the exchange rate between the US dollar and the Euro is 1.20, it means that 1 US dollar can be exchanged for 1.20 Euros.
Exchange rates fluctuate constantly based on a variety of factors such as supply and demand, economic and political events, and interest rate differentials between countries. These fluctuations can have a significant impact on international trade and investment, as well as on individuals and businesses that engage in foreign exchange transactions.
Exchange rates are typically expressed as a ratio, with the base currency on the left and the quote currency on the right. For example, the USD/EUR exchange rate of 1.20 means that one US dollar is equivalent to 1.20 Euros.
Domestic Suppliers
When it comes to domestic suppliers, currency fluctuations play a relatively minor role in price fluctuations. Since transactions are done in the local currency, there is less exposure to currency risk. However, there are still a few ways in which currency fluctuations influence prices indirect.
One way is through the cost of imported inputs that the domestic supplier uses to produce their goods or services. If the local currency depreciates against the currency of the country from which the inputs are sourced, the cost of those inputs will increase, which will in turn increase the price of the final product or service.
Another way is through inflation. When a country’s currency depreciates, it often leads to inflation in the local economy. This can drive up the costs of inputs for the domestic supplier, which will again increase the price of the final product or service. More about that later.
Also one can see in potential impact on price on the suppliers alternative market opportunities on international market. If the supplier can get a better selling price on the international market, due to change in change in exchange rates, the domestic pricing will follow.
International Suppliers
When it comes to international suppliers, currency fluctuations can have a much more significant impact on prices. Transactions between international suppliers and buyers typically involve different currencies, which creates currency risk, hence currency fluctuations influence prices directly.
One way that currency fluctuations can affect prices is through the cost of the goods or services themselves. If the currency of the country from which the goods or services are sourced appreciates against the buyer’s currency, the cost of those goods or services will increase.
Another way that currency fluctuations can impact prices is through shipping costs. When a country’s currency depreciates, it can increase the cost of importing goods or services due to higher shipping costs. This is because shipping costs are often denominated in a global currency like the US dollar, and when the local currency depreciates, it takes more of that currency to pay for the same amount of dollars.
In addition to these direct impacts on prices, currency fluctuations can also affect the competitiveness of suppliers. For example, if a supplier’s country experiences currency depreciation, their prices may become more competitive in foreign markets. On the other hand, if the buyer’s currency depreciates, it can make it more difficult for them to afford goods or services from international suppliers.
Inflation and how currency fluctuations influence prices
Inflation is a critical economic factor that affects both currency exchange rates and international sourcing decisions for professional buyers. Here’s an overview of how these dynamics interplay:
Inflation and Currency Exchange Rates:
- Definition of Inflation: Inflation is the rate at which the general level of prices for goods and services is rising, and subsequently, purchasing power is falling. Central banks attempt to limit inflation, and avoid deflation, in order to keep the economy running smoothly.
- Impact on Currency Value: Inflation can decrease the value of a currency in the international exchange markets. As inflation rises, the value of the currency tends to drop because it can buy fewer goods and services (this is known as a decrease in purchasing power).
- Exchange Rate Adjustments: A currency losing value due to high inflation may lead to a higher exchange rate (more units of the currency are required to buy another currency). This is particularly evident in countries with hyperinflation.
Influence on International Sourcing for Professional Buyers:
- Cost Considerations: For a professional buyer sourcing internationally, high inflation in the home country can make foreign goods more expensive, as they may need more of their local currency to buy the same amount of foreign goods.
- Budgeting and Planning: Inflation rates can affect budgeting and financial planning. Buyers must account for potential increases in costs due to currency devaluation.
- Risk Management: Buyers may need to hedge against currency risks using financial instruments like forward contracts, which can lock in exchange rates for future transactions.
- Supplier Selection and Negotiation: Inflation might necessitate a review of suppliers, favoring those from countries with more stable currencies to mitigate costs.
- Price Adjustment Clauses: Contracts may include clauses that allow for price adjustments based on changes in exchange rates, providing some protection against currency fluctuations.
Strategic Considerations:
- Diversification of Supply Sources: To minimize risks, buyers might diversify their sourcing from different countries with varying inflation rates and currency stability.
- Monitoring Economic Indicators: Keeping an eye on inflation trends and currency market forecasts can help in making informed sourcing decisions.
- Building Strong Relationships with Suppliers: Strong relationships can lead to better negotiation outcomes and potential accommodations in times of high inflation or unfavorable exchange rates.
Calculation Example: How Currency fluctuations Influence Prices in Local Currency (USD)
In this example, we will demonstrate how changes in the exchange rate can impact the price of goods in local currency (USD), which in turn affects the decision-making process for a buyer choosing between suppliers in different countries.
Scenario:
You are a buyer considering two suppliers for a product:
- Supplier A is based in the Eurozone and quotes the product price in Euros (€).
- Supplier B is based in China and quotes the product price in Chinese Yuan (CNY).
You want to compare the costs in USD (your local currency), taking into account possible changes in exchange rates.
Data:
- Supplier A (Eurozone):
- Quoted price: €10,000
- Current exchange rate (EUR/USD): 1.10 (i.e., 1 Euro = 1.10 USD)
- Supplier B (China):
- Quoted price: ¥70,000
- Current exchange rate (CNY/USD): 0.14 (i.e., 1 Yuan = 0.14 USD)
Step 1: Calculate Initial Price in USD
- Supplier A (Eurozone):
- €10,000 × 1.10 = $11,000 (Price in USD)
- Supplier B (China):
- ¥70,000 × 0.14 = $9,800 (Price in USD)
At the current exchange rates, Supplier B offers a better price in USD ($9,800 vs. $11,000).
Step 2: Consider Currency Changes
Now, let’s see how changes in the exchange rates can impact the price in USD.
Scenario 1: Euro strengthens against USD (EUR/USD increases to 1.20)
- New exchange rate (EUR/USD): 1.20
- Supplier A (Eurozone):
- €10,000 × 1.20 = $12,000 (Price in USD)
Scenario 2: Chinese Yuan weakens against USD (CNY/USD decreases to 0.13)
- New exchange rate (CNY/USD): 0.13
- Supplier B (China):
- ¥70,000 × 0.13 = $9,100 (Price in USD)
Step 3: Compare Prices After Currency Changes
- Supplier A (Eurozone): $12,000 (after Euro strengthens)
- Supplier B (China): $9,100 (after Yuan weakens)
New Decision:
With the currency fluctuations, Supplier B is now significantly cheaper in USD ($9,100 vs. $12,000), potentially changing your choice of supplier.
Step 4: Summary and Insights for the Buyer
- Currency fluctuations can have a significant impact on the price of goods when dealing with international suppliers.
- Even if one supplier initially offers a better price, exchange rate changes may make the other supplier more competitive.
- To make informed decisions, you should:
- Monitor currency trends.
- Consider hedging currency risks if a purchase is substantial.
- Reevaluate supplier choices when exchange rates shift significantly.
By staying aware of how exchange rates affect costs, you can make more strategic decisions that may save your company money.
Conclusion: How currency fluctuations influence prices
In conclusion, currency fluctuations can have a significant impact on prices from both domestic and international suppliers. While domestic suppliers are less exposed to currency risk, they can still be affected by currency fluctuations through the cost of imported inputs and inflation.
International suppliers, on the other hand, are much more exposed to currency risk, which can affect the cost of goods or services, shipping costs, and competitiveness. inflation significantly impacts currency exchange rates, which in turn influences the cost and strategy of international sourcing for professional buyers. Understanding these relationships is crucial for effective purchasing and financial planning in a global context. As a buyer, it is important to be aware of these risks and to have strategies in place to mitigate them, such as hedging currency risk or diversifying suppliers across different countries.
Understanding the commercial implications on contracts, supplier competitiveness and at the end – price, is the responsibility of the tactical buyer role. Learn more about our courses for the Tactical buyer
Having an overall strategy that managing the currency risk is the responsibility of Category managers. Learn more in our courses about Category management.
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Note: Illustration to the blogpost “How currency fluctuations influence prices” was created by ChatGPT on September 15, 2024.