::: Trade Talk :::
Trade Tips Part 3: Entering New Frontiers - The Risks
Cos Mamhunze, an International Trade Specialist at saibl's Johannesburg office, continues his discussion on Trade Tips in the third part of this series of articles on international trade.
Part 1: Trade Tips - Entering New Frontiers - The Key Steps >>>
Part 2: Trade Tips - The Entry Strategies >>>
So far, I have addressed the key steps related to entering new frontiers as well as the export market entry strategies. Not to scare you, but the export market is not all "a bed of roses". When you consider the export market, the idea is to do it profitably via successful transactions. However, there are risks built-in to international trade that you have to be cognizant of. Your understanding of the risks will help you venture into new frontiers well armed and knowing what to expect. In this article I will look at the main risks, namely: 1) buyer risk, 2) bank risk, 3) country risk, 4) exchange risk and 5) transactional risk and mitigation measures thereof.
The level of risk determines not only the methods of payment to be considered, but also your choice of foreign market entry strategy. Understanding the risks should be part of your feasibility study before you get down to a contract.
1. What is buyer risk?
A foreign buyer has expressed interest in buying from you. The first question that comes to mind is: Can he or will he pay, and pay on time? Buyer risk is the risk of non-payment by the buyer due to insolvency (can’t pay), non-acceptance or rejection of goods, or general unwillingness to pay. You are dealing with the buyer’s creditworthiness and willingness to pay.
You need to gather as much information as you can about the foreign buyer by getting help from banks, credit guarantee companies, embassies, etc. Your bank, credit bureau and credit insurers can also do a reference check on the foreign buyer. saibl is represented in six African countries (Botswana, Ghana, Namibia, Tanzania, Uganda and Zambia), plus the USA - these offices can help you obtain information on prospective buyers.
When the perceived risk level is high, consider entry strategies and payment methods that can safeguard you (refer to the Trade Talk article in the first saibl Bulletin by Tim Bergstrom). You may consider credit insurance to minimize the risk of non-payment by your foreign buyers. Non-payment can suffocate working capital and calls for huge investments of time and effort in chasing up export accounts receivable.
2. What is bank risk?
Banks are a cog in international trade as they facilitate the movement of money. But banks have varying levels of strength, stability and exposure to risks. You don’t need to be reminded of the recent credit crunch that saw the collapse of some banks, resulting in the suspension of all payments, including international payments. If you were expecting money via the affected banks, your cash position could have been badly shaken. We were fortunate that South African banks were found solid.
Only accept irrevocable letters of credit (LCs) issued by reputable banks. Should you accept one from a lesser-known bank, you may have to confirm it with your bank, which is more costly. Recently, one client wanted to export to a West African country, and his (South African) bank refused to accept the LC issued by that lesser-known buyer’s bank.
Always treat new banks with caution. Your bank can help you to evaluate a foreign bank’s risk levels by looking at its history, its host country’s stability, amongst other factors. You may use rating agencies, local and regional, that rate banks according to their strength, such as Moody's Investors Service, NKC Independent Economists and the Islamic International Rating Agency (IIRA).
Risky countries have a contagious effect that can affect the financial system. One central bank in Africa recently had some of its assets auctioned to pay off debt, signaling the rot in the local financial system.
3. What is country risk?
Country risk includes issues such as political and economic stability, regulatory certainty / rule of law, import restrictions and the availability of foreign exchange. For instance, government interference in business largely tends to inhibit growth and company expansion and scare away foreign businesses.
The World Economic Forum and most banks rate countries according to their credit profiles and competitiveness, looking at issues that determine whether a country can and will honour its foreign payment commitments in time, such as corruption levels, bureaucracy, debt commitments, exchange controls, as well as protectionism of local industries.
Banks and credit insurance companies can best advise you on a country’s risky nature since most banks have policies that set allowable risk levels. Again, your choice of method of payment and entry strategy should be able to address this area. Advance payment and indirect export in cases of high risk could be suggested.
4. What is foreign exchange risk?
This is the risk (or possibility) of an international transaction’s value changing due to changes in currency exchange rates. What you eventually receive may be negatively, and significantly, different from what you originally quoted for and expected from the export consignment due to currency fluctuations.
As an example, if your export order was worthy US$100,000 when the exchange rate was $1:ZAR7.5, you would expect R750,000. But should the Rand strengthen to $1: ZAR6.5 when you eventually receive your payment ($100,000) you will realize R650,000, losing R100,000 in the process since you have to convert the received foreign currency into Rands. Let’s not forget, though, that the Rand may weaken when you receive you money, say to $1:R8.5, resulting in a higher profit.
To cover such exposure to foreign exchange risk, companies may go for hedging instruments such as forward contracts, currency futures and options. Forward exchange contracts greatly reduce foreign exchange risk by allowing you to "lock into an exchange rate", resulting in certainty of what you could expect. In cases where the exchange rate is pegged, you are operating in a comfort zone. You can approach the international trade division of your bank or a trade specialist for expert advice.
5. What is transaction risk?
Transactional risk refers to the risk / possibility of errors in the transaction process, especially around documentation, that can cause payment delays and financial losses. Cultural differences, inexperience in handling export transactions, lack of adequate research prior to entering into an export contract, inadequate instructions to external service providers such as freight forwarders, can lead to poor preparation of international trade documents, resulting in significant loses. For example, if documents are not correctly completed banks can return or correct them at a fee. Such delays and added bank charges will increase export costs and reduce anticipated export profits.
As an exporter, you should have the right skills internally, or have access to experienced service providers to handle the export process. For long-term internal efficiency, you should empower your staff by considering training, or employing experienced personnel. You may contact institutions like FNB, JP Morgan and ITRISA that run public and in-house courses that include payment terms and trade risks, for a more in-depth understanding of this topic.
As I said earlier, do not let these risks scare you! If proper mitigation measures are put in place, export marketing can be very rewarding. With the growing effects of globalization, you cannot continue focusing on the local market only when competition is also coming to your doorstep.
Enjoy export marketing!!
Trade Tips articles will address the following areas: International trade law, trade finance and payments, export marketing and logistics, cargo movement, international financial management, etc.
Cos Mamhunze is an International Trade Specialist based at the saibl head office in Johannesburg. He is a student of international trade at the International Trade Institute of Southern Africa (ITRISA) - whose outline of steps in this article are included with their permission - and a member of IATTO (International Association of Trade Training Organizations). For more information, contact Cos at tel: +27 11 602 1273 or email: email@example.com