Without a plan to manage foreign exchange needs, tour operators, travel professionals and meeting planners are unnecessarily exposing their bottom line to the unpredictable nature of the foreign exchange market.
Every day more than one trillion US dollars are traded in the global foreign exchange market where volatility has become the norm. Since January 2001 the US dollar has weakened by 25% on a trade-weighted basis measured against six currencies. Numerous factors contributed to the US currency’s longstanding decline and market participants are unsure whether the dollar has bottomed.
So how should travel and tour professionals manage risk?
The current weak dollar environment is offsetting profits, squeezing budgets and lowering earnings for travel and tour businesses. While the currency volatility can’t be controlled, you can take steps to protect your business throughout 2004. There are approximately 43,240 travel agencies in America and the following tips will help to increase your bottom line:
Formulate a foreign exchange risk management plan.
Monitor the market for short-term opportunities.
Execute orders when favorable market opportunities arise.
In the past, the US dollar was the dominant world currency and US companies conducted business abroad with dollars in order to shift the impact of currency risk to overseas suppliers.
Today, savvy businesses are taking control of foreign exchange transactions by working in their client or supplier’s foreign currency. By doing this, the buyer decides the exchange rate¾ and US dollar cost¾ at which to purchase the currency. Working in foreign currency eliminates the risk of sending too much, too little, or being re-billed.
Numerous travel professionals look for convenience and low fees/rates when selecting their foreign exchange supplier. They usually buy when a payment is due, compiling their account payables, and try doing larger transactions at once. Whether its transportation, hotel accommodations, car rentals, tours or recreation, it is critical to plan how you will hedge against currency risk. Because most travel professionals fix the price of their travel packages at the beginning of the season, they are prime candidates for hedging tools like forward contracts.
Forward Contract, A Significant Risk Management Tool Once your company has established an obligation to pay an amount of foreign currency, your costs are exposed to fluctuations in the foreign exchange market. These risks can be eliminated through the use of a forward contract.
A forward contract allows you to purchase a specific amount of foreign currency at a current rate of exchange for delivery on a set date, typically between a month and a year in the future. Forwards can be bought or sold versus the US dollar allowing you to cover both foreign payables and receivables.
Once the exchange rate is locked in, the US dollar amount is set for the duration of the agreement regardless of subsequent market movements. A secured rate allows travel and tour professionals to proceed with price listings and budgeting plans without currency fluctuations eroding profit margins.
What if you reserved hotel space for an overseas meeting to be held in six months but the invoice won’t arrive until next year? How will you know what the funds will cost when you convert the currency on a future date? By using a forward contract you lock in a current rate of exchange so you fix the cost of the currency.
Generally, the only requirement to enter into a forward contract is a deposit between 10 percent and 15 percent of the dollar cost of the funds. The most notable advantage of the forward is that it allows you to secure a profit margin and price services effectively.
Success Story: Idyll, Ltd. reaps huge benefits using Forwards
Idyll, Ltd. (http://www.untours.com) is a private company that specializes in helping more than 6,000 clients a year secure economical apartment-based European travel packages. Idyll provides accommodations from two-to-four weeks including airfare, ground transportation, and onsite support.
One of the major challenges Idyll faced was paying all of its individual suppliers around Europe. Each apartment owner is a supplier and each owner required payments in local currencies. Previously, the company had bank accounts in various countries and required its onsite staff to make international payments to local vendors and suppliers.
“We hire people for their people skills, not financial skills,” said Brian Taussig-Lux, General Manager for Idyll, Ltd based in Media, Pennsylvania. “Now we let Ruesch International manage our international payments and we can focus on what we do best…selling apartment-based vacation packages.” By bringing the payment process back to the U.S., Idyll was able to integrate payments in the accounting system and improve accuracy, efficiency and increase the quality of service.
Idyll has also been able to manage risk by taking advantage of forward contracts. “We have been able to save significantly by locking in a forward rate prior to press of the catalog,” said Taussig-Lux. “We now publish a firm price which has reduced our workload tremendously. Prior to our use of forwards, we would have to give currency adjustments to clients based on the dollar value at the time of the transaction.”
Over the last few years, forwards have enabled Idyll to thrive in a weak dollar environment. Because they locked in rates early as the dollar deteriorated, they were able to maintain competitive prices.
Idyll purchased a forward contract for €1,729,770 at 1.1150 in late July 2003. Six months later, in January 2004, the exchange rate for the Euro was 1.2450. Over that time period Idyll saved $224,870.10 by implementing forwards as a risk management tool. From this scenario, you can begin to see how much of an impact currency fluctuations can have on a company’s bottom line. By locking in a rate, costs are set and there’s no worry that market fluctuations will affect the company’s bottom line.
Monitor the Market
Staying apprised of relevant world events and rate fluctuations is one of the most basic means of managing foreign currency. Underlying factors such as economic statistics, politics, and social conditions drive the foreign exchange market, affecting the amount you’ll pay, and the potential margin you could save, when purchasing or selling foreign currency.
Focus on Your Area Expertise…Utilize Foreign Exchange Experts
Travel professionals and tour operators are not expected to be experts on the foreign currency market, but it is important that you choose a foreign exchange supplier who is. Foreign exchange is a service provided by both banks and foreign exchange specialists. As with any commodity, market expertise, timely updates, responsiveness, attention to detail, rates of exchange and service fees will differ from one supplier to the next.
Comparing service fees as well as exchange rates is an important consideration when choosing a foreign exchange supplier. Savings realized by a favorable rate of exchange can be quickly lost by high service charges. Present banking relations are typically not affected by the decision to use a foreign exchange specialist, and you can always compare and use more than one supplier for your transaction.
Whatever your foreign exchange exposure may be, seek the advice of a competent foreign exchange supplier that will tailor a program to meet your specific needs.
This article was taken from pages 28 & 29 of NOTO's "The Outfitter" publication, Spring 2004 Issue