Case Study: Capping shipping costs in a rapidly rising market

The outbreak of the coronavirus pandemic resulted in severe disruption to the global shipping industry in early 2020, with traditional supply chains being severed as countries began to close their borders. The consequences of which have seen the cost of shipping increase by well over 400% during the pandemic.

This uptrend in shipping rates looks to extend well into 2022, despite the efforts to freeze rates and encourage competition in the market. Container ships carry a wide range of cargo so the impact has been felt by most companies depending on shipping to operate. The easing of lockdown measures has led to a surge in demand, which creates that unenviable position of being stuck between increasing demand and increasingly difficult supply.

Coupled a perfect storm of a rapid price increases, low shipping supply, difficult financial circumstances, staff shortages, and uncertain demand in their customer bases. Effectively managing costs has become more critical than ever for shoring up a business’s bottom-line.

Hedging against FX risks to mitigate increased shipping costs

As companies struggle to make importing their goods profitable they’re searching for ways to manage their FX risk however they can. Whilst this issue won’t last forever, having a plan in place early will help to navigate these testing times. A good hedging strategy helps to balance the risk associated from exchange rate volatility with the requirement to import cheaper goods internationally.

Since the start of the Pandemic we have seen the GBP/USD exchange rate move almost 20% from the lows of 2020 to the highs of Aug 2021. This perfectly highlights how movements in the FX rate can hit business extremely hard and can turn a guaranteed profit to a realised loss.

Being able to cap the cost of the goods you’re shipping has become vital in an ever more competitive environment. But how can you cap shipping costs considering they’re generally not payable upfront, may have variable amounts and usually have an exchange rate element involved?

What a hedging strategy is

A hedging strategy will help to fix your exchange rate costs or factor in a unit margin for your FX requirement over a defined period of time and a set amount of currency. This can work for specific one-off requirements to in-depth cash flow forecasting. Depending on desired outcomes it can cover your entire FX exposure or a %. The benefit of any hedging strategy is you can reduce or remove FX risk, match your two-way cash flow and guarantee your profit margins from the outset.

Company A: a case study

Company A wanted to ensure they fixed their FX exposure immediately after booking in their shipping containers for their goods departing in 3 months. As they were hopeful the market would increase they didn’t want to cover their full amount in case the exchange rate moved higher by the day they needed to make the payment. However they also needed to ensure they were protected should the exchange rate fall to ensure they would not lose further margin than already done so through the shipping cost and on the cost of their overall goods that would need to be passed onto consumers.

What They Did

Company A approached us and asked if there was a way to fix their cost but still be able to benefit should the market increase in their favour.

There were a number of conversations on ways to mitigate risk whilst being able to manage their positive rate outlook with the requirement to not lose the gains they had recently had. These included, amongst others, ideas on doing nothing and just booking on Spot, booking a Forward Contract to remove all risk and market orders to attempt to time their trades. We eventually settled on a Forward Extra Contract as this allowed them to fix an absolute minimum exchange rate whilst still being open to positive market movement, it kept things simple and meant they wouldn’t need to monitor the market daily. Also, it allowed the client the flexibility to make payments to use the currency when they needed to send it so they were not restricted in case the goods were able to be delivered early.

Solution

A Forward Extra contract allowed them to fix in their worst case scenario rate of 1.36 in April but gave them the potential to benefit should the exchange rate on expiry not finish above 1.40. If the market finished within the range then Company A could exchange at a better price than originally agreed.

Outcome

When the contract expired the market rate was at a level of 1.3849, so the client was able to transact at the higher exchange rate than they had protected, making a saving and FX gain of 1.8%. As the client’s margin had been squeezed owing to the increased shipping costs, the 1.8% FX gain was a huge help on the containers and delivered above the expected margin from the budget on the total amount of goods.

This highlights an important point that with import costs being at an all-time high and long term struggles to get a hold of stock continuing to be an issue, having a plan to sort what is manageable will be key to continued success for businesses in the future. A good hedging strategy will not stop the cost of shipping from rising but it can help cap the amount you are paying and prevent you paying more. Let us handle the FX risk so you can focus on growing your business.

If you’re facing issues with your supply chain margin being squeezed or would like to see how hedging can assist in managing your business please get in touch, or explore your currency options online.