Capital

Have You Considered Paying Foreign Suppliers in Their Local Currency?

To explain why they pay foreign suppliers in USD, many U.S. importers invoke this simple rationale: “We’ve always paid that way.”

It can pay to reevaluate traditional ways of paying suppliers.

Most U.S. businesses are overlooking a simple strategy that could help them reduce the cost of their imported goods by as much as 10 percent or more — and in some cases extend their payment terms — without exposing them to additional risk or loss. The tactic to consider? Paying overseas suppliers in their local currency, instead of the U.S. dollar (USD).

In the aftermath of the Great Recession of 2008, more U.S. companies are importing to strengthen their global supply chains. In fact, from 2009 to 2013, the dollar value of U.S. imports increased nearly 42 percent, according to U.S. government statistics.

At the same time, the vast majority of U.S. importers continue to pay their suppliers in USD, a traditional approach that, with the rise in imports, has U.S. businesses leaving a lot of money — and other benefits — on the table.

With the post-financial-crisis years ushering in greater supply-chain collaboration, the environment is ripe for importers to talk to their suppliers about accepting payments in the suppliers’ local currency, and for discussing how everyone can benefit from this practice.

‘We’ve Always Paid in Dollars’
If it’s not always the wisest course, why do so many U.S. businesses pay their international suppliers in USD? How did that become the norm?

It starts with the fact that for many years, the U.S. dollar has been the world’s dominant currency. That being the case, U.S. companies have often mistakenly assumed that their overseas suppliers always want to be paid in USD.

Many U.S. firms also believe paying in U.S. dollars eliminates foreign exchange (FX) risk and volatility from their international payables. While this intuitively makes sense, what these companies fail to realize is that currency risk and volatility are embedded in every cross-border payment. The real question is: Who will manage and reduce FX costs most effectively?

What also doesn’t always register with many U.S. businesses is that, ultimately, their overseas suppliers need to convert their USD payments into the local currency. And that foreign exchange conversion carries a cost that can diminish suppliers’ margins — and threaten their ability to meet profit targets.

Additionally, some U.S. importers aren’t aware of how their suppliers are responding to the added risk and uncertainty of accepting such payments. When invoicing in USD, suppliers can’t be sure of the value they will receive from their own currency after converting payments from USD. To minimize the downside risk of their currency depreciating against the dollar, many suppliers pad their prices by as much as 10 percent or more, and shorten their payment terms. U.S. buyers aren’t always aware of these significant hidden costs.

The common practice of paying in USD is also the result of a perceived hassle factor. A U.S. importer may realize it’s paying more — or earlier — by denominating payment in USD, but may not want to alter that practice, believing that using a bank’s foreign exchange services to pay in the supplier’s local currency would be incredibly complex and time consuming (a notion we’ll address a little later).
Finally, to explain why they pay international suppliers in USD, many U.S. importers invoke this simple rationale: “We’ve always paid that way.”

Clearly, however, this is a case where it can pay to reevaluate traditional ways.

Pricing Discounts and Better Terms
Maybe the best reason for U.S. importers to consider paying foreign suppliers in their local currency is that it enables them to negotiate
better pricing and extended terms.

So why would suppliers be willing to offer these deal enhancements?

Most overseas vendors don’t have a USD account, so accepting a USD payment requires their bank to execute a foreign exchange conversion. Conversion fees cut into margins and can vary over time, making it difficult for foreign vendors to forecast their cash flow. Additionally, because foreign currency volatility and FX conversion fees make the exact payment amount unpredictable, reconciling USD payments is often more challenging for international suppliers.

On the other hand, being paid in their local currency locks in the contract’s value for the foreign supplier. The supplier doesn’t have to worry about the possibility of the USD value declining in relation to its local currency between the time of purchase and the FX conversion. What’s more, local currency payments often settle faster than USD payments.

For these reasons, many foreign suppliers — if you ask them — would say that they actually prefer to receive payment in their local currency and, in many cases, are willing to make concessions to buyers offering to pay that way.

An Aite Group survey of 100 U.S. middle-market importers suggests importers can negotiate substantial discounts. Nearly six out of 10 respondents who pay in their suppliers’ local currency reported receiving average discounts of 1 percent to 2 percent. The research firm noted that “even a discount of only 1 percent can save a middle-market importer US$10,000 for every US$1 million they pay to suppliers.”

In some situations, however, the discounts for assuming the FX risk are much greater. Some 11 percent of responding U.S. importers reported average discounts of 3 percent to 5 percent, and another 11 percent were earning average discounts exceeding 10 percent by paying in the suppliers’ local currency.

Foreign suppliers also may be willing to extend terms to get paid in their local currency. For instance, they may offer to relax their existing 30-day terms and accept payment in 60 or 90 days.

Foreign Exchange Advantages
From a foreign exchange perspective, here are some reasons that this strategy can be a winner:

The U.S. importer is often positioned better to access more favorable exchange rates than the foreign supplier. As such, the importer isn’t captive to less-favorable rates set by their suppliers’ banks.

Some U.S. importers need to hedge — to fix the exchange rate for a future transaction — to support the strategy of paying foreign suppliers in their local currency. In such cases, the availability of hedging tools in the United States makes the local payment process easier and less risky than one might think.

Fixing exchange rates using bank hedging tools is typically less expensive than paying the premium that foreign suppliers often tack on to the cost of goods when they’re getting paid in USD.

One Capital One client recently saved $500,000 by bucking the traditional USD payment approach. A German company quoted our client $5 million for a certain piece of equipment. The client responded by asking the vendor to invoice in euros, which it did, quoting a price of 3.5 million euros. At prevailing rates, this price translated into US$4.5 million. The client entered into an option structure that locked in the exchange rate for a future date and saved $500,000 just by paying in euros instead of USD.

Talk to Your Overseas Suppliers
Many suppliers negotiate pricing and terms with buyers at set intervals. These intervals are a natural time to discuss this new payment approach. But generally there’s no bad time to initiate such a discussion, since most suppliers want to be paid in their local currency.
One of the easiest ways to optimize international payments is to just ask your supplier to start sending you an invoice in both USD and their local currency. That way you can bring the invoice to your bank to compare pricing and terms.

How Your Bank Can Help
Now, let’s revisit the “hassle factor” we mentioned earlier as one stumbling block to this strategy. In reality, paying suppliers in their local currency can be done online and is just as easy as paying in U.S. dollars, if your bank has strong international trade and foreign exchange capabilities. To be sure your bank is up to the task, here are some questions to ask:
• Does the bank have specialists that can help you structure and execute an international payment strategy?
• Does the bank support the currencies you need to pay your suppliers in their local denomination?
• Does the bank offer online channels for initiating foreign currency payments?
• What type of advisory and risk management assistance does your bank provide?
• Do you require hedging? If so, does your bank provide that capability?
• Does the bank support letters of credit denominated in foreign currency? If so, for which currencies?
It’s a good idea to talk to your banker about opportunities to pay overseas suppliers in their local currency, as well as all of your international payment needs.

Casey Wilcox is a SVP, Head of Payables and International Product and Product Advisory Services at Capital One Bank.