How to protect your business from FX Risk
We’ve seen it too many times. Companies spot an opportunity for business growth in Latin America. They begin to expand into the region, maybe even invest some capital. But then they hit a wall, decide that the market is too volatile, too complex, or too risky, and simply give up.
This is a pity because Latin America can be an enormously rewarding and profitable destination for growing businesses. Emerging markets like Brazil and Mexico offer a vast consumer base, a growing middle class, and an expanding digitally savvy population. Just look at the numbers – Brazil has a population of 200 million and one of the world’s largest economies. Mexico has 53 million online shoppers and a booming e-commerce market valued at over US$9 billion – and growing.
One of the biggest challenges facing global businesses in emerging markets is foreign exchange (FX) risk. The rapid currency fluctuations triggered by political or economic upheaval can put profit margins at risk. However, with the right strategy in place, the risk can be substantially reduced, placing your business in a prime position to corner the market before it gets too crowded.
Understanding your FX risk exposure
Every company is different, and your exposure to currency conversion risk will vary accordingly. For instance, an online travel agency (OTA) selling to customers in Brazil must pay for a hotel room in New York in US dollars, but will receive the payment from the client in Brazilian reais. This business faces serious risk from currency fluctuations. Payments by credit card in Brazil take 31 days to settle – meaning that the OTA will receive payment 31 days after the customer has paid. If the real devalues dramatically during that time, then the OTA may lose their whole margin on the sale.
By contrast, a video game company based in the US has far less exposure to FX risk. Although all the company’s costs are in dollars (staff wages, packaging, shipping, and so on), the actual product they sell to a Brazilian customer – access to the video game – isn’t tied to a particular currency. The price can be set in Brazilian reais without major impact on the margin. In the case of the video game company, the priority should be to optimize their pricing strategy to adapt to relative purchasing power in each market, rather than solving for FX risk.
What you shouldn’t do to reduce your FX risk
If, like our fictional OTA, you analyze your FX risk exposure and decide that it will be too high, the obvious solution might be to charge all your customers in your own currency. At first glance it makes sense. To take our OTA as an example, if the room in New York will cost you $99, and you charge all your customers $125, regardless of where they live, then you can feel confident that you’ve protected your profit margin.
The problem is that this solution will kill your ability to sell in Latin America altogether. Here’s why:
- The majority of the population don’t have credit cards, let alone cards able to pay in foreign currencies.
- Those customers that are able to use a credit card to purchase in a foreign currency are still not keen on the idea. After all, they may pay in dollars but they’ll be charged in reais – usually with a hefty bank fee of 5-6% on top.
- Your customers will want to be able to pay with their usual payment methods. In Latin America, many of these are cash-based or digital voucher systems – Pix and Boletos in Brazil or Oxxo in Mexico.
- For larger payments, they’ll also want to be able to pay in instalments, which won’t be compatible with foreign currencies as they require partnership with a local bank or financial institution.
- If you charge everyone in the same currency, you make it impossible to vary your pricing strategy by region. Customers will object to being expected to pay more for the same product for reasons of geography. So you’ll have to charge your Latin America customers the same as your customers in the US or Europe, despite lower relative purchasing power.
In short, if you try to charge in your own currency in emerging markets, you radically reduce your potential target market.
How to protect your business from currency fluctuations
The secret of reducing your exposure to currency risk is to partner with a local payments provider, who understands the requirements of the market and can shoulder the risk for you.
At PrimeiroPay, for instance, one of our most popular features is our FX solution. Essentially, if you work with our payments solution, we will lock in a currency exchange rate for you, based on commercial rates, for 24 hours. That way, you know in advance how much you will receive from your customers when they purchase in their local currency. They can buy in their own currency and you get a guaranteed price for the amount you expect, settled in the currency of your choice, regardless of any regional market volatility.
Meanwhile, if you have a local partner, you can offer your customers the payment methods they expect, without needing to open a local office in the region. As a result, you’re no longer limited to the customers with international credit cards – instead, your business opens up to the much larger population who prefer to use local debit cards or cash-based payment methods. Not only that – by offering local methods, your conversion and acceptance rates will greatly improve, increasing your profits substantially.
So don’t hold yourself back. If you’re excited about the possibilities of emerging markets, the right local partner can open the doors for you. If you’d like to know how we help our clients build profitable, sustainable businesses in Latin America, please visit our website, or click here to set up a call with one of our payments experts.