De-risking cost escalation & exchange rate fluctuationsQuestion by: Adam
We often bid for work in countries susceptible to rapid changes in the local situation, which could have a serious impact on our operational expenditure.
How would you suggest ‘de-risking’ or accounting for local inflation and exchange rate fluctuations in our pricing?
You can de-risk and/or account for local inflation and exchange rate fluctuations by agreeing terms within the contract with the client, such as:
- Excluding cost items (such as food, accommodation, taxis/local travel, etc.) from being within your scope, with the client either providing such things themselves or paying for them directly on your behalf;
- Excluding food, accommodation, etc. from any pre-agreed/fixed prices with the client reimbursing those items separately on an ‘as-incurred’ basis;
- Selecting a ‘spot rate’ to convert everything from one currency to another. Declare what this spot rate is and negotiate what happens when it changes with the client. If the rate becomes more favourable then offer a discount on each invoice issued (during the project)…if the opposite then claim an extra charge. The ‘spot rate’ is the exchange rate at the current moment;
- Having the contract inflate on an agreed percentage or linked to a metric (eg: CPI in the UK) so that your revenues increase each year to provide additional funds to cover cost change;
- Agreeing a clause that allows for any extra-ordinary costs or unforeseeable cost inflation to be discussed and recompensed post-award; or
- Agreeing that prices will be revisited (and subject to change) on a 3, 6 or 12 month frequency.
If, however, you find that the client wants you to take on all cost items and exchange rate risks then alternative de-risking options are:
- Work with the local populous as best as possible to gain certainty that costs are not going to change and seek to work with those you trust or come recommended;
- For each cost-item try to get multiple suppliers so you have a back-up if one decides to hyper-inflate their costs post-award;
- Itemise each cost and consider by how much costs could alter and account for this in your cost base as a separate “project contingency”. Rather than blank guessing, adopt a monetised ‘probability’ and ‘impact’ approach to each cost-type; or
- Take out a hedge with a 3rd party whereby you have a fixed exchange rate irrespective of how things change over an agreed period. Hedges do cost money as the holder has the risk, and the cost would need to be covered in your price to the customer. This can be investigated via your own bank. Note, however, that it can be very expensive subject to the duration and the relationship between the two currencies involved.
The answer above does not relate to salaries, bank charges or international taxation. Risk mitigation of these considerations is more detailed, specific and subject to each country involved.