Freight transport and logistics companies have had to navigate an increasingly disruptive post-pandemic landscape. For example, levels of European supply chain disruption jumped by 38% in 2022 compared to the previous year, while 70% of supply chain management and logistics professionals expect pressure on global supply chains to continue throughout 2023.
This disruption derives from a wide range of factors. A combination of rising industrial action, ongoing bottlenecks, labor shortages, geo-political tensions and the growing frequency of extreme weather has placed mounting pressure on an industry that was already struggling with high inflation.
Amongst the growing number of challenges facing freight transport and logistics firms is the threat of adverse currency movements. According to the International Chamber of Shipping, 90% of world trade is conducted via shipping, with over 50,000 merchant ships trading internationally. As a result, the overseas and global nature of freight and logistics companies makes them particularly exposed to foreign exchange (FX) volatility.
Despite this, many CFOs at freight transport and logistics firms may have traditionally seen FX as second order; they transact in FX not because they ‘want to’, but because they ‘have to’ given their international exposure.
However, with currency volatility looking set to stay, now is the time to assess the FX challenges that freight transport and logistics firms typically face and how best to implement effective risk management strategies against these threats.
What are the FX challenges for freight transport companies?
There are several factors that can heighten the FX risk facing freight transport firms. These include:
- Payments – The FX market affects a variety of expenses and operating costs for freight companies, in particular shipping firms. These include the payment of crews, maintenance work and port duties. International shippers often make these payments in a variety of different currencies since they may be in a different part of the world at any given time, meaning payments naturally require conversion to local currencies.
- Freight duties - Freight duties form another expense for air and sea transportation companies and can be heavily influenced by currency volatility. For example, if the currency a shipping firm is paying freight duty in is particularly strong (such as the US dollar when it reached a two-decade high last September), this would dent profit margins and drive expenses up.
- Fuel costs - It is estimated that fuel represents up to 50-60% of a ship’s total operating costs. Since fuel is typically bought and traded in USD, the US dollar’s surge during the latter half of 2022 meant that freight companies could purchase less for their money, adding to operating costs even further.
A more strategic approach to FX risk management
As a result of these factors, freight transport and logistics firms should consider implementing a robust risk management strategy to minimize their exposure to currency movements. There are a number of steps that these firms can take to achieve this:
- Compare the market - Having the ability to put trades up for competition is central to ensuring access to the best price, which is key to effective risk management. However, many freight transport and logistics firms may be hampered by their inability to access Tier 1 FX liquidity, meaning they often rely on a single bank or broker to meet their hedging requirements. New technology-driven solutions are tackling this problem, enabling transport companies to access rates from multiple banks whilst reducing the operational burden associated with this kind of market access.
- Use of Transaction Cost Analysis (TCA) - TCA was specifically created to highlight hidden costs and enables freight transport and logistics firms to understand how much they are being charged for the execution of their FX transactions. Ongoing, quarterly TCA from an independent TCA provider can be embedded as a new operational practice to ensure consistent FX execution performance.
- Outsourcing - There is a growing recognition that outsourcing does not necessarily mean less transparency or reduced quality of FX activities, and when using the right partner, companies can improve transparency and execution quality. Outsourcing can enable freight transport and logistics firms to dedicate more time to core business matters, which is all the more important given that volatility and supply chain disruption are expected to persist over the next twelve months.
- Strong governance – Freight transport and logistics firms may face several steps in the supply chain process which can often be logistically complex. These include scheduling pick-up and delivery dates, preparing any specialist transport equipment, setting out and arranging the right shipping lane (if transport is taking place via shipping) in addition to ensuring the necessary insurances are in place. This operational complexity can make it difficult to maintain transparency. Harnessing solutions which can strengthen governance may help many freight transport and logistics firms improve the cost, quality and transparency of their FX execution.
The freight transport and logistics industry has faced a range of challenges over the past eighteen months and with currency movements set to remain volatile over the next year, FX risk must no longer be considered second-order. Harnessing technology-driven tools and getting the right processes in place will help enable many freight transport and logistics companies to navigate mounting FX challenges and protect their bottom lines.