Uncommon Currencies (Part 2)
Of course, moving operations en masse to a new location, even one as stable in currency terms as China, is hardly a walk in the park - it’s a pretty dramatic way of reacting to currency fluctuations and should only really be a feasible option for organizations hapless enough to have established operations in a country whose currency becomes so volatile that it represents an impossible budgetary challenge - or for those who’ve set up shop in a location whose currency then appreciates so strongly against the organization’s home currency (or that in which the majority of that organization’s earnings is denominated) that operations become impossibly costly. As can be imagined, this doesn’t happen particularly often - but in a business where margins are becoming increasingly tight, currency safety parameters are shrinking correspondingly, and the bigger the offshore operation and consequent budgets, the smaller the fluctuation needed to push the bottom line into the red. Too many quarters of red ink and the offshore center which was initially heralded as a major cost-saver might become an insupportably costly millstone round the organization’s neck.
However, one huge headache for those tasked with making big decisions like relocating offshore infrastructure is that they need to be sure that the currency movements which are forcing such decisions upon them are going to maintain their trend over a sufficiently long period to be sure that the costs of such a radical relocation are going to be justified. The key is in the word "fluctuation": what might look like an insupportable rise in the value of, say, the rupee, might only a few months further down the line revert to something a lot more palatable - even translating into gains for the hitherto aghast parent organization. And then when the panic has subsided, and talk has turned from a desperate wholesale translation of activity to a more stable currency zone into the possible expansion of the existing center and taking on new functions, another sudden shift on the exchanges could once more upset the balance, opening up the whole debate once more.
(Another headache which needs to be borne in mind and which is, while not always a direct consequence of currency fluctuations, closely related to and potentially exacerbated by them, is wage inflation. The negative consequences of currency fluctuations can be made much worse when costs in the offshore location are rising in real terms at the same time as the value of an organization’s primary currency is declining. A 2008 report by The Hackett Group explains more: "Due to high demand for offshore workers the last several years, wages in some popular destinations are rising sharply. India, for example, has witnessed wages in the offshoring industry rise 15% per year for the last several years in local currency terms. Up-and-coming offshoring destinations such as China and the Philippines are now beginning to experience the same phenomenon. Some companies in the large cities of China are now giving annual salary increases in excess of 10%, in spite of having consumer price inflation of only 1.5%. Wage increases fueled by tight labor pools are also the primary cause of the very high attrition rates being experienced in India today. Historically, firms have calculated only moderate increases in costs based on prevailing wage rates at inception, and have failed both to foresee and forecast the influence of the dramatic wage-rate inflation occurring in some regions at present.")
Practically speaking, of course, closing down one offshore center and opening up elsewhere involves a cost burden which for most organizations would be prohibitively expensive and is very much an option of last resort: only in cases where negative currency developments are both catastrophic and expected to be permanent - or at least long-term enough to affect the offshore operations in question over a majority of their lifespan - should such action be on the table. Some companies, of course, may judge that even significant fluctuation-induced cost-increases are bearable when set against the benefits gained from maintaining operations in a geography of strategic interest (for whatever reason) to the organization; others may decide that the costs incurred by negative currency developments, while damaging, are less important than the disruption to the global operation likely to be forthcoming from more upheaval. Only in a handful of cases would the situation become so deleterious to the organization that the "rip it up and start again" policy becomes the preferred option.
The seriousness of the potential ramifications of currency instability explains many things. Firstly, it demonstrates why organizations looking to set up captive centers offshore need to embed a robust currency strategy into the very foundation of their proposals: whatever their chosen solution, whether this involves hedging, arranging to make at least some payments in their currencies of primary income (assuming the authorities in their offshore location/s permit such an option) or any other tactic or combination thereof, it’s imperative that firms at least take a position on the issue with sensible contingency plans in place to cater for a wide range of possible fluctuations and outcomes.
Secondly, it pushes to the fore one of the advantages of establishing an outsourcing relationship rather than going down the captive route: while (as discussed in the first part of this feature) fluctuations can result in savings for providers as well as costs going up, if a buyer can agree to pay its provider in dollars (or euro, or sterling, or whatever other currency is the organization’s primary earnings currency) it is able to transfer the burden of reacting to fluctuations onto that provider, taking away a great proportion of the angst associated with currency-related risks - while, of course, introducing a whole new raft of potential hazards. (Some providers are of course unwilling to take on that level of risk; one option which might prove a happy medium is to take a "look-back" or retrospective-average approach, whereby the buyer agrees to pay the provider in local currency but at a rate averaged over a set period - usually six months or a year - measured prior to the agreement or each renewal thereof. This doesn’t remove the problem altogether by any means, but it does at least minimize the impact of substantial short-term fluctuations.) The extent to which a provider is willing and able to take on some of the risk of course varies wildly from company to company and location to location: however, at a time when competition for outsourcing contracts has never been fiercer, it’s a foolhardy provider indeed that won’t even countenance the thought of negotiating with potential buyers to find a satisfactory solution.
Thirdly, the specter of violent currency oscillations is more evidence that firms resorting to offshoring purely on the basis of the cost-savings it can produce are walking on thin ice. If the raison d’etre of an offshore center is limited to its potential to save even a hefty whack for an organization, any significant reduction in those savings can call into question the entire project - at potentially massive cost. If on the other hand offshore operations exist both as a driver of savings and as a base-camp for routes into new markets, or as talent development centers, or as a way of diversifying operations to provide for greater risk distribution, or any similar auxiliary purpose, their importance to the organization becomes that much greater and their maintenance that much easier to justify.
However justifiable a cost maybe, though, it’s better to avoid it at all if possible. Unfortunately, until the advent of a single world currency there’s just no way to ensure that any given offshore location in a country operating an independent currency will be immune to fluctuations. Whether captive or outsourced, budgeting for offshore operations will to some extent always include the responsibility to cater for change in relative currency values. The only way to avoid this problem altogether is to reject offshoring out of hand - which in many ways, of course, could prove the most disastrous decision of all.i "THE 10 ISSUES MOST COMMONLY OVERLOOKED BY COMPANIES CREATING CAPTIVE FACILITIES IN A GLOBAL ENVIRONMENT", The Hackett Group, August 2008