18.4.08

FX

As anyone who has traveled outside the US in the last few months knows, the dollar is not what it used to be. The graph above shows the dollar's relative strength against the Indian Rupee (INR), the Euro, and the Chinese Yuan. Rather than show the actual FX rates here, I normalized the values for each currency against the value on 4/15/2000, to more readily show the ups and downs (and downs and more downs) the dollar has experienced since then.

If you work on the business side of global sourcing, this probably strikes you as important stuff.

Remember - irrespective of what vendors may say about talent pools or what I myself have said about India, China, Russia, and other locales as centers of innovation - the largest driving force that enables global sourcing and makes it all worth the trouble is labor arbitrage. At the end of the day everyone on the client side of global outsourcing enjoys the benefit of "cheap labor" somewhere else on the planet.

With the dollar shrinking relative to other currencies this "cheap labor" isn't as cheap as it used to be.

Since the dollar is on a down slide (some say free fall) a lot of people have been writing me and asking about foreign exchange, and what it means for their current or future outsourcing endeavors.

My thoughts are summed up as follows:
  • This is opinion only, but unless there is an all out collapse of the US government (in which case our outsourcing contracts will be the least of our concerns) the dollar will eventually rebound to close to historical values against the Euro. Because of the massive growth, FDI and general health of the Indian and Chinese economies, the Rupee and the Yuan will level out close to current values. That is, we're in a bad spot right now, but FX on the dollar will moderate. On this point, only time will tell.
  • Regardless of the outcome of my prediction, you should approach your contract negotiations with the understanding that currency exchange values fluctuate. Playing this market to your advantage in any significant way is most likely beyond your skills. (I say this not to insult the reader, but to simply state a fact that if you could make loads of money in FX arbitrage you'd be a fund manager, not a technologist or a sourcing professional.)
  • That said, you should seek to place the risk of FX fluctuation on your vendor, not on yourself. In my opinion you should write your contracts in your own local currency at a rate you find favorable; and you should not include FX clauses that could hurt you. That way if the dollar weakens your vendor loses margin but you aren't crushed with unpredictable costs. If the dollar strengthens your vendor makes more money but you still have predictability and, ostensibly, a cost position that you are comfortable with. If the dollar strengthens considerably call your lawyers and weigh the benefit of tearing down your term sheet and renegotiating.
  • I've read recently about both clients and vendors seeking to write contracts in Euros, or Swiss francs, or silver ingots, or anything but dollars and rupees. If you do that and are successful, more power to you. But it strikes me as more trendy than smart. Again, keep it simple, write your contracts in your own currency, and pay something you think fair.
  • Don't take on FX risk in your contracts, but don't pinch your vendor so badly that they lose money on you or you won't be a favored client and you won't get their "A-Team."
  • Remember that some costs of your sourcing deals are not actually in the contract and will be subject to FX fluctuation. Mostly this will be travel and capital equipment costs. You might experience these costs in local currency (Yuan, Rupee, etc.) in which case, you will pay more you thought you would for hotel rooms, computers, etc. While this is a real issue, I think it's largely a rounding error compared to other economic forces at work in cheap sourcing locales. While the dollar has slid about 10% against the rupee since 2000, hotel costs in Bangalore have gone up around 400% in the same time period, simply because of high demand and low supply.
  • Lastly, while this stuff is interesting and important, if you're a sourcing professional, a vendor, or the manager of an offshore team, you should focus on your team, and on their performance. If you don't believe me already, I probably won't change your mind with this statement, but cost or margin fluctuation due to FX is not the high order bit here. The potential value you can unlock by making your team solid, cohesive, and high-performing is much more significant than the points you can shave in clever manipulation of exchange rates.

By the way, all the data for my little graph was picked out of Oanda. If you don't know about it, it's a great free site for currency conversion, and is pretty much the gold standard for historical data on FX. (I've always used it to convert my foreign receipts back to USD for expense reports...)

Also of note, the Yuan was pegged to the dollar by China's central bank until 2005. Hence the inflection point in the graph above.

No comments: