Foreign Exchange Management; What’s All This Brouhaha?

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Actually, there’s nothing to it. The differential in rates of inflation between the economies of two countries equals the percentage change in the exchange rate over the same period. This is known as the Purchasing Power Parity theorem.

There. That should be clear. Of course, government intervention in the markets can also affect exchange rates and everybody knows that in the short term currencies with higher interest rates tend to be stronger, but of course the dollar has plummeted recently following a series of short term interest rate increases by the Federal Reserve, and various tariffs and trade barriers affect rates, so I guess that’s not always right.
 
What we really ought to do is read the 78 pages of fine type in Financial Accounting Standards Board pronouncement 52 that deals with accounting for foreign exchange transactions. Then this wouldn’t be so confusing.
 
On the other hand, we could say screw it. Unless we’re buying or selling in a foreign currency or, as a retailer, have a lot of time, effort and money invested in establishing and promoting a brand you’d like to see survive and offer better prices. Or unless you’re making boards (or other products) in the U.S. and exchange rates affect how your competitors price their products. Or unless you’re exporting boards and getting paid in a currency besides dollars.
 
The hypothetical U.S. based company BFD Snowboards is buying boards from that European snowboard manufacturing behemoth EPS. BFD is only buying 5,000 boards and EPS’s capacity is sold out, so they can insist that BFD pay for the boards in their currency. Let’s let our imaginations run wild and assume it’s the German Mark.
 
In spring, BFD opens a letter of credit (LC) through their bank in favor of EPS. Let’s say all 5,000 boards are the same and each costs 200 Deutsche Marks (DM 200). This board is hot. All 5,000 are committed to dealers (must be a signature board). BFD’s letter of credit is for DM 1,000,000 (5,000 times 200).
 
That’s as complicated as we’ll let this example get. In practice, partial shipments up to the total of the LC may be permitted, EPS may be allowed be over or under the DM 1,000,000 by maybe 10%, and some of the boards shipped may be second quality boards that carry a lower price. In addition, assuming BFD is buying ex factory (that is, they are responsible for all the costs after the boards leave the factory door) they will spend six to seven percent of the purchase price in freight (more if it’s air freight) and customs duty to get the boards to the U.S.
 
What these variables mean is that the actual DM amount you have to pay may be higher or lower than 1,100,000 and there may be more than one payment date.
 
The LC is opened in April. An LC, for those of you who have had the good fortune not to have to deal with them, is a promise made by a bank to pay a certain amount of money upon receipt of specific documents indicating shipment of the correct merchandise the right way, by the time required. Note that the bank pays based on the documents. There’s no protection against fraud. If the boxes get to BFD and are full of P-tex scraps, the bank has no liability if the documents they paid against were as required.
 
In April, then, BFD has a potential liability for DM 1,000,000. It doesn’t become an actual liability until EPS ships the product. If the exchange rate at the shipment date is, say, 1.60 DM to the Dollar, BFD will have to come up with $625,000 (DM 1,000,000 divided by 1.60) to pay for the merchandise. That payment date depends on the terms of their agreement with EPS.
 
Assuming it costs them about DM 12 for freight and duty, BFD’s landed cost for each snowboard is DM 212, or $132.50 at the exchange rate in effect when the LC was opened. Now BFD wants to earn a little money itself to pay for lift tickets, so it marks the product up and sell it to retailers for $172.25, giving BFD a gross profit of $39.75, or 30 percent.
 
Ah, but we forgot about that moving exchange rate. BFD had to price their boards before the letter of credit was ever opened so retailers could show up at the shows and know what they were going to pay for it. If, at the time BFD set their prices, the exchange rate was 1.70 DM to the Dollar, BFD is bummed. As the Mark has strengthened from 1.70 to 1.60 (strengthened because you get fewer Marks for each Dollar) BFD’s dollar cost per board has risen from $124.71 (DM 212 divided by 1.70) to $132.50 (DM 212 divided by 1.60). If, on the other and, the Mark was at 1.50 when BFD set its prices, it is mighty happy, because its dollar price per board has declined from $141.33 (DM 212 divided by 1.50) to $132.50 (DM 212 divided by 1.60).
 
The difference between a cost of $141.33 and $132.50 is 6.25%. To put that in perspective, it’s enough to be the difference between a profit and a loss for the year. For BFD, it’s a swing in gross profit of $44,150 on the sale of the 5,000 boards.
 
Exchange rates move every day. A lot, a little, up, down; there’s no way to tell. If BFD just waits until they have to pay EPS marks, it will have to pay whatever number of dollars the market dictates at that moment. That’s one possible strategy. There a couple of others.
 
At any time you can buy the marks you need and put them in a bank account in Germany earning interest. The marks will be available to pay EPS as required, and you will know your exchange rate and, therefore, your cost.
 
Choice two is to buy a forward contract. A forward contract is an agreement entered into with a third party, usually using a financial institution as an intermediary, to buy or sell a given amount of foreign currency at an agreed upon exchange rate on a specified date. Forward markets for major currencies are broad and deep. You can generally buy or sell whatever amount you need for delivery at the date required. The forward rate (that is, the exchange rate at which you buy or sell a currency for future delivery) is determined by market expectations.
 
BFD is buying DM 1,000,000 of boards from EPS. Let’s say EPS ships the boards May 15. The documents from the shipment go to EPS’s bank and then to BFD’s bank to be “negotiated.” The letter of credit calls for terms of “sight 60.” That is, BFD’s bank, and therefore BFD is required to pay DM 1,000,000 60 days after documents receipt. If the documents are received May 23, payment date would be July 23rd.
 
BFD decides the dollar is as strong as it’s going to get before payment is due and that, in any event, it doesn’t like it’s profitability to depend on the whims of an unpredictable market. It instructs its bank to purchase forward DM 1,000,000 for delivery on July 23rd. The bank enters into the contract and BFD now knows exactly what those boards will cost it. It no longer cares how the Mark moves against the Dollar between now and July 23rd. It’s cost in dollars will be the same.
 
On July 23rd, BFD receives the marks, paying dollars for them at the contracted exchange rate, and orders its bank to transfer the marks to EPS’s bank account to satisfy its liability to EPS. Depending on how the dollar and mark have moved against each other in the period between the date the forward contract was purchased and the date it matured, BFD’s financial manager may feel like a hero or an idiot. But a major source of financial risk will have been removed.
 
The third option involves what’s called asset liability management. Let’s assume BFD doesn’t really know anything about the U.S. market, but has convinced some Japanese distributor that it is a cool brand and that Japan really needs another snowboard (obviously, this is a hypothetical situation.). The Japanese distributor agrees to buy 4,000 of the boards, to pay for them in German Marks at a price of DM 250 per board, and that payment is due July 23, the same date BFD must pay EPS.
 
Suddenly, BFD has a perfect balance sheet hedge. They have an asset of DM 1,000,000 they will receive from the Japanese distributor and a liability, due the same day, to EPS. They no longer care how the dollar moves against the mark because they will not have to convert one currency into the other.
 
If you’re exporting and getting paid in a foreign currency, the problem is the mirror image of paying for imports in foreign currency. Most companies I know of solve this problem by insisting on payment in dollars.
 
Now you know a little about how foreign exchange risk arises and how it can be managed. You may also have realized that even if you don’t deal in foreign currencies, your suppliers and/or competitors probably are. That affects the prices you pay and the profit you can make and is worth a few minutes of thought.

 

 

Show Trends and the Business of Snowboarding; “It’s Deja Vu All Over Again!”

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In 1903, 57 companies were started to make cars. 32 left the business. I recently heard it on National Public Radio, so it must be true. Snowboarding, of course, is going to be different.

In your dreams.
 
They say that when you die, your finger nails and hair keep growing for about three weeks. In Las Vegas I saw some companies who’s personal grooming was clearly not part of a fashion statement they were making (except for Gnu/Libtech of course). They sat in their booths waiting for wide eyed buyers desperate for any kind of snowboard or snowboard product to place orders regardless of price, quality, or line completeness.
 
Four, maybe three years ago, it might have worked. It did work. This year jaded buyers overwhelmed by the number of snowboard brands and companies scurried back to the familiar brands they knew they could count on for delivery, quality, terms, warranty, service and, by the way, sell through.
 
It’s 1903 all over again.
 
I asked the same set of questions to perhaps 25 hard and soft good companies. I focused on relative newcomers. The conversations typically went something like this.
 
“If you’re successful, what will your company look like in three years?”
Long pause and a smile followed by some variation on “We’ll be a lot bigger and making money.”
 
“So you’re not making any money yet? Are you paying yourselves salaries?
Longer pause and less of a smile followed by some variation on “Well, you know how it is.”
 
“How much working capital do you need to achieve your sales goals this year?”
“We’re not exactly sure yet.”
 
“Where are you going to get it?”
“We’re talking to a lot of people.”
 
“Who are your competitors and how are you differentiating yourself from them?
Inevitable answer: “We’re closer to the market and really know what’s up.”
 
“Are you really prepared to risk loosing everything you have?”
At this point they were often looking around hoping somebody else would come into the booth for them to talk to. If there was ever a messenger who needed shooting, it was me. I could see it was time to finish up, so I’d summarize by saying, “Let me see if I understand this. You aren’t really sure what your goals are, have no source of capital, no clear competitive strategy, could make more money working at McDonalds, and are risking everything you have. Why are you doing this?”
 
Finally a question they could answer. Their face lights up. “We love snowboarding!”
 
Obviously, most companies didn’t fit this extreme profile, but some came close. Almost everybody had at least one of the issues I referred to above and, to everybody’s surprise I’m sure, the most common was lack of financing.
 
There are quite a few companies with well known brand names that are much smaller than everybody thinks. They are well managed and established in their market niches. They know what they need to do, but don’t have the bucks to do it. The sad thing is that in this competitive environment, where just surviving requires an aggressive marketing posture, investors will not be able to find the returns they require and capital may not be available.
 
It’s hard to make good business decisions when you are driven by a capital shortage. More than one company had an opportunity to sell a lot of product to a chain. They need the sales volume and cash flow, but can’t risk devaluing the brand and alienating their specialty customers. If the capital requirement is critical enough, they may be forced to make a bad marketing decision for short term survival.
 
The kind of irrational competition described above is one indication of the consolidating snowboard market. Other indications I saw at the shows include:
 
1)         People trying to create market niches as a way of differentiating their product by a) having separate lines for specialty and chain stores, b) doing graphics specific to a particular region of the country and c) trying to make minor design or construction changes seem significant.
 
2)         The product is becoming more important than the booth and its presentation. As what it takes to succeed in this business hits home, price, quality, service and delivery are competing with glitz and hype in the selling equation.
 
3)         The first rumbling of price declines were seen, but not as much as I had expected. I attribute that to a shortage of quality, volume manufacturing and fiberglass in the U.S., a week dollar, the presence of a lot of smaller brands that can’t afford to sell at lower prices, and the fact that a lot of the big players aren’t really selling direct yet. If you want a peek at the future, look at the pricing on Nale’s boards (Is that Elan spelled backwards!? Gee, I wish I’d thought of that.) One new brand having its boards made at Elan bemoaned the fact that Nale was selling boards to stores for less than he was buying from Elan. How could he compete?
 
Answer: he can’t, unless he’s very well capitalized and has a well thought out marketing strategy.
 
I guess it’s just this simple. The snowboarding business is changing in predictable ways. Whether you are a retailer, distributor or manufacturer the way you do business is going to change as well. Success means being out ahead of the curve and using these changes to develop a competitive advantage. Living in the past means being buried there. “More of the same” won’t work anymore.

 

 

Who Are Your Customers? And Why Are They Buying From You?

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As a snowboard retailer, you have a position in your market. You own it, and it’s yours to loose. The best way to loose it is to forget who your customers are and what they want.

The other day I was in one of these warehouse stores. There was a snowboard with bindings for, I think, $299.00. The board had a full metal edge, the inserts and finish looked fine and the bindings, while nothing to write home about, seemed perfectly functional. The description said it had a full wood core, and most of the other statements about it could have been out of an ad for a leading brand. The brand? At about the point where the number of brands passed 150 the part of my brain that could remember them all atrophied.
 
It’s enough to strike terror into the heart of a shop owner. If you end up competing on price…. Well, you can’t. 
 
But there’s hope. Recently, a competing publication (I don’t think they’ll let me say Transworld Snowboard Business here) did a survey of 100 snowboard shops. It indicated that brand name and the sales person were the two most important factors determining a purchase. On a local level, how can you get that kind of information; the kind you can act on?
 
Rush to your local library or town hall, or log onto the Internet. Dig up the census data for your county or SMSA (standard metropolitan statistical area). What are the incomes levels? Average age? Population density? Where are most of the people you believe are your likely customers?
 
Are they your customers? Ask questions of every customer that comes in your store whether they buy or not. Get their address, school they attend if appropriate, where they work, what mountains they ride, whatever will help you figure out what they want. This doesn’t mean locking them in a room until they fill in a three page questionnaire. It can be part of an informal conversation between the sales person and customer. The trick is getting it consistently written down immediately after the conversation.
 
One side benefit is that showing that kind of personal interest in a potential customer may actually increase your chance to make a sale. Listen to your customer. Easier said than done.
 
Get a map of the area and tape it to the wall. Put a pin in to show the home and/or job and/or school of each person. Is there a pattern to where your customers are coming from? Is it what you thought it was? Does this tell you anything about how to reach them and where you should be advertising?
 
Pay for gas, food and list tickets for a couple of shop employees on the condition that they come back with information on 50 snowboarders. What kind of riding do they do, how often, where did they buy their gear, and why? Offer to share your data with the mountain if they’ll do the same with you.
 
It isn’t enough to collect this information on slips of paper or three by five cards, read through it, think to yourself, “Isn’t that interesting” and then forget it. Organize it to see the patterns. On a computer, or on some big pieces of paper taped to a wall. The more data you collect and the more ways you look at it, the more you learn. The magic of being this rigorous is that some of your cherished and unquestioned assumptions about who your customers are and why they buy will turn out to be a bunch of fatuous blather (i.e., wrong).
 
Assuming that you go through the procedure I’ve described (or a similar one you believe is more appropriate to your market) what’s in it for you? Now you have some harder data on what kind of people are buying from you, what they are buying and why. Tape some more big pieces of paper on the wall with information about your inventory at different times of the year. Given the kind of people buying from you and their reason for buying at your store, should your product mix be different? Are you carrying too much of some items and not enough of another?
 
How many dollars is it worth to you to have the right inventory at the right time and have as little as possible left over at the end of the year?
 
If you are a little better able to anticipate your customers’ needs, what kind of return and add on sales does that generate? The process is cumulative and never ending. The better you do, the better you do.
 
Scurry to the book store and buy a paperback called Customers For Life, by Carl Sewell. Mr. Sewell is the most successful luxury car dealer in the country. The book is about how he gets and keeps his customers. Before you laugh about using the ideas of a car dealer in a shop that sells snowboards, you might take a look at the consolidation going on in that industry. Price competition is intense, the number of dealers has declined rapidly, the survivors are tending to be much larger, and the customers aren’t as willing to be convinced that there’s a significant difference between brands . Recognize any trends you’re worried about?
 
Your shop is unique. My questions and sources of information may not be the right ones for you, but the concept is right; whether you’re selling cars or snowboards. There’s no more important information than who are your customers and why are they buying from you. In the snowboard industry’s competitive environment, you have to take the time to find out. 

 

 

The Joys of Consolidation; Managing the Transition from Growth to Maturity

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It happened to skate boards and surf boards. Now, it’s the snowboarding industry’s turn.

The transition from a fast growing, hot trend to a mature industry is about more than consolidation to fewer players. It means lower margins, slower growth for many companies and aggressive competition increasingly based on price and service, not to mention savvier consumers who may care less about image and more about price. This transition will happen quicker than in most industries due to a lack of entry barriers (low capital costs, no patented technology) and be accentuated by the financial burden imposed by extreme seasonality.
 
But change produces opportunities whether you’re a retailer or distributor if you have perspective to recognize them and willingness to do things differently. Some companies will refuse to recognize the new circumstances and insist on business as usual. Acting irrationally, they will fight for sales as a temporary survival mechanism — even at the expense of future fiscal viability.
 
Realize you may not be able to count on the fast growth and high gross profit margins the industry has historically enjoyed. Your break-even point will be higher, a larger investment will be required, and payback will be further down the road. Check out Ride’s public offering prospectus and read the six pages of single spaced, small type “risk factors.” And that’s for a company that just completed a year with nearly $6 million in sales and over $400,000 in net income.
 
No matter what end of the business you are in, take a hard, realistic look at your numbers. As your margin goes down, your break-even goes up. Don’t kid yourself into thinking you’re immune from these trends. Where are you going to get the additional working capital? Can you compete? I don’t know who they are, but there are some companies who should be getting out of the business. Actually, they will be getting out. The issue is whether they walk or are carried feet first.
 
Think you can outlive the competition? Here’s a partial survivor’s checklist.
 
If you’re a distributor:
 
·         Sharpen your pencil and look closely at the gross margin of each product. There’s been a tendency to look at the overall margin and let the higher margin products carry the lower ones. Obviously, there are some good marketing reasons to do that, but the competitive environment that is emerging may not allow it. Do you really need all those T-shirt colors and designs?
 
·         If you do find yourself with too much product, write it down and move it fast. There’s never a good time in a seasonal business to get stuck with close-out merchandise but tying up working capital in bad inventory is an even worse idea than usual when an industry is maturing. The longer you kid yourself about what it’s worth, the less you’ll get for it.
 
·         When you do your financial planning, allow three percent of cost of goods sold for uncontrollable things to go wrong. Last season, I cleverly chose to ship a container of boards by train across the country rather than by ocean carrier through the Panama Canal. The goal was to save a week to ten days in shipping time. Great analysis, good plan. Then the freight company called to announce that the container was “lost” in the midwest due to the floods. Three weeks later, it showed up.
 
·         If your product is priced in currencies other than the dollar, hedge. You’re trying to make money in snowboarding, not currency speculation.
 
As a retailer:
 
·         Buy from companies you can count on. Competition is going to be based more on price and service. Deal with companies who provide them. That will often mean larger, better established companies who own the manufacturing plant or have a long term relationship with the manufacturer. A small company with presses in a garage can supply a small number of boards either because their costs are low or because they don’t really know their costs. With growth, it will run into the same cost curve as every other manufacturer, but be on the wrong end of it. Either they will raise their prices or go out of business, leaving you with an interesting warranty problem.
 
·         Give some thought to the relationship your supplier has with the manufacturer. If a manufacturer is making 1,000 boards for one customer and 10,000 for another, which one do you think is going to get the best prices, service and attention? Who is he going to keep happy when something goes wrong?
 
·         Retailers can expect margin pressure as more product is available, the consumer gets smarter, and chains push prices down. The good news is that leverage with suppliers should increase. Use your leverage to build cooperative, rather than confrontational, relationships. If you’re getting your budgeted margin from a supplier, don’t push for an extra point just because some other company offers it. You’ll get it back in service and responsiveness.
 
·         Retailers shouldn’t have a hard time getting product this year, though not always from the company you want. But even with free freight, great terms and a big discount, don’t buy it if you aren’t sure you can sell it.
 
Going into a business because you are excited about it is a good idea. Going into it without adequate capital and with unrealistic expectation of risk and return can get you unexcited real quickly. Fast growth and high margins cover up a variety of business sins. Nobody likes to change, and doing “more of the same” is the usual response. If you expect to be one of the survivors, focus on costs, build your balance sheet, make a profit even at the expense of growth, and actively select a strategy that fits your market position and financial capabilities. Lots of companies, new and established, are going to make it in this industry. But counting on selling more at higher margins may no longer be a viable strategy.