How to Overcome Increased Freight Costs
Posted Under: News
Is There Too Much Focus on the Increasing Freight Charges?
Of course not! Well, maybe, if it’s distracting from other items on the to-do list.
The rapid inflation on transporting internationally in the past year has never been seen by any business in the modern era. It absolutely hurts. One thing is for sure, someone is going to lose out. Whether it’s the shipper, the importer, or the end-user/consumer, someone is going to miss out on savings. In fact, everyone in the supply chain loses a little.
The Increase in the Cost of Freight is Born From:
- Covid’s disruption to key ports causing bottlenecks – in particular gateways in southern California and China’s Yintian port.
- Suez Canal blockage back in March.
- Demand significantly outpacing supply. Now that many economies are open again, there is an increase shortage of containers.
- And More
It would be unfair to think all steamships are purposefully taking advantage of the current environment. After all, it would be a Band-Aid over a bleeding artery in the sense that long-term businesses are going to either go out of business or simply look at alternative solutions – importing from Mexico, for example. Therefore, steamships are only hurting themselves while simultaneously hurting their reputation, if they take advantage of the situation.
Overpaying with Improper Currency
We have read hundreds of LinkedIn posts and blogs where there’s a perpetual focus, attention, and frustration on the increasing cost of moving a container from point A to point B, and yet not much focus on the cost of its content.
Our point here – the average price worldwide to ship a 40-foot container has more than quadrupled from a year ago, to $8,399 as of July 1, causing a huge stir, and yet the importer has probably overpaid for its contents by $20,000 for many years if they used a bank to pay in the global vendor’s currency.
It could easily have been $50,000 too much if they paid in USD and not the currency of the exporter. It could be even more if the importer didn’t use any hedging products given the significant weakening of the dollar this past 15 months.
Larger Banks and Customer Apathy
You need to understand this next section is not about bank bashing. Well, certainly not toward regional and community banks and credit unions, maybe towards the behemoth global banks.
Many businesses, and therefore CFOs, finance directors, and the like, are blissfully unaware of an often significant markup in the FX pricing they receive from their bank provider, largely because of some key reasons, as follows:
Larger banks rely on customer apathy. You trust your bank, right? When were you last proactively asked by your bank if you wanted a fee reduction?
Larger banks have tens of thousands of employees, thousands of branches, hundreds of divisions, scores and scores of products & services, plenty of regulation and, of course, not forgetting millions of highly demanding shareholders. In short – banks of any size have a significant cost base that needs to be paid for.
Regional and community banks, however, love to offer foreign exchange payments at a great rate but in many cases have to rely on taking their FX pricing from the aforementioned global bank who also provide the global payment infrastructure the smaller institution would be mad to fund and build. These larger ‘correspondent banks’, as they are known, offer wide margins to the smaller bank who in turn add their markup for profit which results in the underlying business client receiving a less than favorable rate.
So, back to the value of the contents of the container. Let’s assume it’s full to the brim of raw materials, arriving from Germany, with an invoiced value of EUR1,000,000. If the importer takes that invoice to their bank it’s likely the FX rate could be 1.21 where the mid-rate in the interbank market (the price banks offer each other) is 1.1850 (at the time of writing).
The result is the importer’s bank account is debited $1,210,000.
If the importer had chosen to use an FX payment specialist, such as GreenShootsFX, the rate may have been 1.19 which equates to $1,190,000 or $20,000 less.
The most common scenario, however, is where the importer is invoiced in USD and not the foreign currency, which appeals to many CFOs because it’s at least a currency they understand, they can budget for it, and can easily plan for in their cash flow.
When calculating the USD invoice value, however, the German exporter will use an indicative, non-negotiated rate, published by their bank and therefore carrying a wide margin which means the USD value is already starting out overinflated.
This rate is probably going to be 1.21 (though in reality likely higher) so now the exporter has a base amount to work with which is $1,210,000.
In this example, the sales contract allows for 45-day terms and because the exchange rate would have changed by the time the exporter receives the dollar payment, there’s a good chance this will convert into their currency at an amount lower than they would want.
They can’t compromise their profit margin and therefore manage their own FX risk through a process known as ‘padding’.
‘Padding’ is the step of adding 2-5% to the value of the invoice to protect the exporter in times when the FX rate could be going against them. The longer the term, the higher the probability of a significant rate change, and therefore the increased chance the exporter receives a lesser euro amount on the day of exchange.
So, for 45-day terms we’ll assume the exporter favors a 2.5% markup which now pushes the invoice amount to $1,240,250 or a whopping $50,000 more than if the importer had insisted on paying in euro, and then using GreenShootsFX for the conversion.
If the importer elects to pay in euro they can fix the FX rate today but for settlement in 45-days which eliminates FX risk and provides the CFO with more accuracy in their cashflow forecast.
- Importers using a bank to pay invoices in a foreign currency are likely to pay 2-3% more in USD than if they’d used an FX payment specialist.
- Importers paying in a currency at the time the payment falls due, and not fixing the rate earlier in the process, will pay a higher USD amount if the rate moves against them. Manage this by using a forward FX contract, a market order, or if the importer is cash-rich they could buy the euro today and hold it in a foreign currency account with GreenShootsFX until the payment due date.
- Importers paying global vendors in USD and not the currency of the exporter could be overpaying in total between 5-7%.
- When importers are invoiced in USD they have a foreign exchange risk they can’t see, and therefore they can’t manage. If the USD weakens then the exporter is going to increase the USD price for the next shipment or faces receiving a lower amount of their currency when they convert the dollars upon receipt.
The True Reason for this Thought Leadership Piece:
- Saving $50,000 on your invoice covers more than the increased cost of freight!
To Learn More About This Topic, Read Our Blog: 4 Benefits of Currency Exchange Services for Importers & Exporters