The global recession created a volatile market for currencies, understanding how to manage the risks involved can be extremely challenging for companies as well as the providers
In a typical offshore outsourcing arrangement with a U.S.-based client, the service provider must pay for personnel and non-personnel expenses in one currency (e.g., Indian Rupee - INR), but collect the services fees in another currency (e.g., US dollars - USD) creating a currency risk between the provider’s service expenses and the client’s fees. However, exchange rate fluctuations can be beneficial to the provider, the buyer, or both if an appropriate agreement clause is set in place.
In a recent whitepaper, “Managing Currency Risk in Offshoring Outsourcing” Alsbridge offers these approaches to maximize the economic benefits of a company’s offshore outsourcing agreement:
1. The provider bears full currency risk by accepting a contract in U.S. dollars based on a fixed exchange rate. Under such agreement, the provider will offer the client a fixed U.S. dollar fee for the services, regardless of currency exchange rate fluctuations. Typically, the provider will increase its price by some amount to cover future currency fluctuations or to include the costs of hedging the currency risk. This approach is the most common as clients avoid the uncertainty of potential increases in fees due to adverse swings in exchange rates.
2. At the other extreme, the client assume the foreign exchange risk by accepting a contract priced in Indian Rupees then converted to the U.S. dollar rate the day of the invoice. Under this approach, the client would not only bear the downside risk (e.g., increased services fees) of adverse exchange rate fluctuations but also capture the upside benefits (e.g., reduced services fees) of any favorable changes in exchange rates. In some unique instances, clients may be willing to take that risk because of its global presence and ability to effectively managing currency risk.
3. The provider and the client may also agree on a currency risk-sharing alternative. The parties may agree to a fixed exchange rate with no variation in services fees as long as the exchange rate fluctuates within a specified band, such as a plus or minus 10% around the baseline rate. To illustrate further, let’s assume the exchange rate at the time of contract signing is 40 INR per one U.S. dollar. This exchange rate of 40 would be considered the fixed exchange rate. The services fees would be unchanged when the rate fluctuates plus or minus 10% around 40 (e.g., 36 to 44 INR per one USD). If the rate were increasing to 52 equivalent to a 30% increase from baseline rate, the provider agrees to bear 20% of the increase (e.g., 10% of the specified band plus 10% of the increase above the band) while the client agrees to bear 10% of the increase.
Regardless of the approach used, Alsbridge advises companies to negotiate the allocation of currency risk in tandem with the inflation adjustment index (COLA).
All good contracts start with clear communication. Getting off to a good start opens the door to a wide range of risk-sharing possibilities and a shared win.
More information can be found in an Alsbridge whitepaper titled, “Managing Currency Risk in Offshoring Outsourcing” at Outsourcing Leadership.