American corporations often transact their international business in USD because they believe it eliminates FX risk. Unfortunately, this is a false sentiment.
July 22, 2020 — 4 min read
By Ron Vodicka, Corporate Sales Team Lead, North America
When it comes to international business, American companies have a global advantage. The U.S. dollar (USD) serves as the world’s reserve currency. This has created a global demand for dollars and led to certain industries (e.g., energy) being globally priced in USD. Because of the USD’s global status, many American companies transact all their international business in USD—but this may not always be the best move.
American corporations—particularly smaller and middle market companies—often elect to transact their international business in USD because they believe it eliminates foreign exchange (FX) risk. Unfortunately, this is a false sentiment.
Pricing transactions in USD does not eliminate FX risk. Instead, it merely transfers it to the trade partner, because the trade partner most likely operates under a different functional currency.
When deciding whether to transact in USD, a company needs to examine its business operating environment. There are instances when pricing international business in USD is a valid strategy for a U.S. company.
Two examples of this are:
Industry standard: certain industries have long-established USD-functional supply chains. Some examples of these industries include aspects of energy, agriculture and aerospace.
First-time global traders: new entrants to global trade have other risks to prioritize over currency risk (such as counterparty risk, quality of goods, shipping, payment, and more).
Even though a vast majority of industries are not globally USD-functional, many American companies still transact their international business in USD.
The most common reasons cited for this include:
Perceived FX risk avoidance
Ease with current process
Internal system incompatibility
This set of circumstances falls under managerial influence. A company that continues to transact global business in USD under these reasons has made a business decision that the ease of transacting in USD outweighs the potential benefits of transacting in local currency.
However, what these companies need to understand is that transacting their global business in USD can also come with hidden costs or risks.
American companies transacting globally in USD may be exposing their business to potentially higher costs or reduced sales and margins.
Because their trading partner is most likely not USD functional, making the USD payable or receivable a foreign currency to that company. The foreign company will need to be compensated for absorbing the FX risk; to do so, they will likely “pad” prices to U.S. importers or demand price discounts from U.S. exporters.
Industry studies estimate the cost to U.S. businesses can range from 2%-10%. Importers face inflated pricing and payment delay risk. Exporters face uncompetitive pricing, reduced margins, possible payment delays or, worse, potential lost sales.
In a globally competitive marketplace, it is prudent for a company to question why it transacts its global business in USD. Is it industry standard? Or a lack of internal knowledge and inadequate systems?
As companies strive to grow revenues and reduce costs, it is possible that transacting business in USD is having a negative effect. Is the purchasing group overpaying for goods? Has the export sales team experience lost sales to competitors pricing in local currency?
At Xe, we work every day with companies doing international business. We understand the challenges companies face when transitioning to pricing their international business in foreign currency. Wherever your business is on this transition journey, the Xe Corporate Team can be your partner and help your company manage the FX risk component of international business. Visit our Business page for more information about our products and services.
To learn more about the costs to American companies for transacting in USD, understand how this impacts importers and exporters, and see some solutions other companies have tried, read Part 2 of this series here.