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Article:

Over the hedge

05 July 2018

To hedge or not to hedge, asks BDO Australia’s Mark Schiavello.

RISING COMMODITY PRICES and a volatile international currency market are familiar concepts. Consumers and business have seen very starkly that we are not insulated from the events in other parts of the world, everything is interconnected.

With our global tastes and expectations of year round consumption, regardless of season, retailers find themselves operating in a global marketplace. Furthermore, ragtraders have long sourced inputs and finished goods from China, India, Indonesia, Vietnam and more recently, Bangladesh.

As retailers and suppliers look to set pricing for the entire season they face the real threat that wafer thin margins will be eroded further by currency fluctuations for the products they pay to import, or that they will have to pass on price rises to their consumers. With the emergence of low cost e-commerce retailers and deep discounting strategies, a retailers’ ability to pass on price rises is limited.

While rising commodity prices and volatile currency markets may place negative pressure on retail margins, there are steps retailers can take to redress the situation. Retailers should adopt an effective hedging strategy.

A hedging strategy can be implemented to limit the risk that exists within a business, but the right strategy for your business may differ depending on exposure levels. With a broad range of strategies available to businesses, retailers must consider how to best hedge their exposure.

When selecting a solution, there are a number of key factors for retailers to consider:

Only hedge what is material 

Companies should only hedge exposures that present a material risk to their financial health or strategic plans. To determine whether exposure to a given risk is material, it is important to understand your supply eco-system.

Consider total costs and benefits 

Direct hedging costs account for only a portion of the total cost. Leaving out indirect costs will result in overall costs outstripping benefits. The two types of indirect costs that need to be considered are ‘lost upside’ and the ‘opportunity cost’ of holding margin capital.

Analyse your results on a constant currency basis

Don’t let hedging gains or losses mask the true trading performance of your business. Analyse your business using constant currency analysis. This removes the noise and allows you to understand trading trends within your business.

Look beyond financial hedges

An effective hedging strategy will include non-financial levers to help minimise risk. Smart operators seek to include commercial and operational tactics to effectively and efficiently reduce risk. These tactics include: contracting decisions that pass risk to the supplier and revising product specifications.

The complexity of hedging can be a little overwhelming. To avoid such problems, maintain a broad perspective and keep it simple.