Understanding the costs and risks of Forex management

Whether you provide outsourced services from overseas or are a client planning to use an outsourcer with delivery locations outside of your home market, you will be used to planning and managing lots of tasks. For any new outsourcing activity or contract you will have a long list of activities and factors that you need to scope and understand.

Naturally, this will encompass numerous areas under the heading of People, Process and Technology. But for some “getting your head around the costs and risks of foreign exchange management” will need to be added to the list for the first time.

Traditionally, outsourced contact centre providers and business process outsourcing (BPO) firms would handle the foreign exchange currency risk of delivering services from abroad themselves. When the first wave of UK offshore outsourcing started, with the use of India 15 to 20 years ago, this was invariably the case. As time has gone on, though, BPO companies have come to realise that being responsible for delivering ‘flat’ UK prices in the face of variable exchange rates is fraught with risks and potentially an unattractive option. This is even more the case as commonly used locations have expanded to include the Philippines, South Africa and a growing number of central and Eastern European locations outside of the Euro zone.

The range of foreign exchange management approaches agreed between BPOs and their onshore clients is very varied. What they all have in common is both client and provider facing the challenge of who should carry the currency risk, to what extent and for how long.

Options may include:

1. The client is billed simple, ‘flat’ pricing in its local currency (Sterling, say) for the duration of a contract
2. Periodic – usually annual – reviews of pricing, partly or wholly adjusting according to the change in FX rates
3. Every monthly invoice being adjusted to your local ‘paying’ currency – or, more unusually, clients agreeing to pay invoices in the delivery location currency
4. And every variation in between

You might imagine that the larger global BPOs, with both their financial scale and range of operational locations to help defray FX risks, would be more willing to offer clients simple, local currency pricing. However, broadly speaking the opposite is the case and the larger the BPO the more likely they are to look to pass more variable pricing onto their clients. This is probably a function of both:

• Their breadth of experiences – the impacts on contract margins of rapidly depreciated delivery-location currency are likely to be long remembered! And,
• Their usually stringent costs and risk management, which is often demonstrated in their focus on contracting periodic Cost of Living Allowance (COLA) or Retail Price Rate (RPI) of inflation indexes

For some BPOs, as they either enter new territories directly or in partnership with local firms, managing foreign exchange (FX) risks is a new challenge. Both they and their clients will need to take a view on:

1.  The risks of their particular situation (the currency involved and its anticipated volatility, the current and future value of the contract and its duration)
2. The costs of mitigating those risks (e.g. through currency ‘hedging’) as opposed to the potential impact of doing nothing

And finally, it’s worth remembering that currencies can rise as well as fall. There can be a significant upside if the value of a delivery currency falls and thus becomes far cheaper in real world terms for both onshore clients or the BPO business entity in the client’s location.

Still, you might feel that playing at being a Forex trader, with only one deal to your name, may be a stretch too far on top of the day job…