Companies that make the move to operating internationally, whether they be large businesses or SMEs, open themselves up to great new opportunities for growth and profitability. However, companies that open themselves up to these opportunities also open themselves up to a certain amount of risk as well.
Opening up business operations in foreign countries can expose a company to a variety of risks that are unique to international business. Many things are unknown when it comes to operating overseas and events in certain parts of the world can be highly unpredictable.
In this article, we’ll explain what the main broad categories of risk are that businesses expose themselves to when beginning to operate internationally.
Currency risk, also known as foreign exchange risk, is the risk that a business will lose out as a result of changes to the exchange rate. Normally, this risk applies when a business is committed to making transactions at future dates as part of the course of business. In the time between a company committing to making these transactions and actually doing so, exchange rates can change for the worse.
A company, for example, may choose to outsource its production to Asia with commitments to pay its producers in a foreign currency at designated time intervals. A company that makes this arrangement and then waits to make those payments according to whatever the current market exchange rate is at that time will be left vulnerable to unfavourable changes to the exchange rate. If the exchange rate takes an unfavourable turn, their outsourced production will cost more than they originally anticipated.
Likewise, a company that exports goods or services overseas faces the possibility of seeing reduced profits as a result of unfavourable changes to the exchange rate.
As well as simply affecting transactions that a company makes as part of international business, changes to the exchange rate can also affect a company’s market value and financial statements. These forms of risk are known as economic risk and translation risk.
While it may seem like a difficult issue, currency risk is something that businesses have been dealing with effectively for a long time.
Commonly, businesses that face currency risk (transaction risk in particular) have dealt with the issue by carrying out FX hedging. When a company hedges against its currency risk, it gives itself an alternative to exchanging currencies at whatever the current market rate is when the time comes to complete a transaction.
Traditionally, the process of doing this has been expensive, time-consuming, and complicated and, as a result, has only been something that the biggest businesses have been able to do. Smaller companies, until recently, have more often than not had to leave themselves exposed to currency risk.
However, with improvements in technology, things are different. Nowadays, small and medium-sized businesses are able to protect themselves against currency risk by using the services of companies like Bound.
On the bound platform, businesses which operate internationally are able to quickly and effectively eliminate currency risk from any transaction that they will conduct in a foreign currency. As well as being used for isolated transactions, the process of implementing a larger scale currency risk management strategy is also simple on the Bound platform.
The potential for a natural disaster, while usually unlikely, is something that some businesses may need to consider, with some areas of the globe presenting a higher risk. Earthquakes, for example, are more common around the pacific and often affect parts of Asia. Events like earthquakes, droughts, and large wildfires can have far-reaching and long-term effects that can impact the ability of a company to operate an area of overseas business as it originally planned.
Insurance may provide protection against natural disasters and, in some cases, can be taken out as part of a wider insurance policy against the risks of operating internationally.
While not a natural disaster, strictly speaking, one issue that is particularly relevant in modern times is climate change. Interestingly, it has recently been found that areas of the world that see large increases in temperature also tend to see a fall in export values.
Unsurprisingly, a fall in the value of agricultural exports does drive some of this fall in value. However, manufacturing exports have been seen to fall in value as well.
Also not necessarily a natural disaster, the coronavirus pandemic is another event that has impacted internationally operating businesses in a huge way. While many have been able to diversify or adapt to survive, some have not and some have suffered a great deal. The effects of coronavirus are deep and ongoing, but one major impact that international businesses faced as a result of it was disruption to supply chains. In many cases, businesses have completely rearranged their supply chains to cope with the problem.
The potential for similar events to take place in the future is something that internationally operating businesses may need to take into consideration.
The term political risk is applied to a broad range of events that can transpire as a result of political decision-making or civil unrest in countries in which an international company does business.
Political risk is a complicated issue and, essentially, covers the human side of overseas events.
Government actions or the effects of civil unrest that take place in a foreign country in which an internationally operating company is doing business can harm or totally scupper the original plans that they had. It may become more expensive, more complicated, or impossible to do business.
In extreme cases, companies can have their assets seized by foreign governments and completely lose them without any form of compensation. While it is relatively rare, governments can nationalise a company (take complete control of it), force divestiture of assets, confiscate assets, or separate a company of ownership of its business in more subtle ways.
As well as government interference in business activities, other political events such as changes to the law which don’t specifically target a business can have a negative impact. Changes to competition regulations, for example, or importing procedures may make it difficult to do business as planned.
There are also a huge number of other ways in which political events can impact a business that is operating in a foreign country. Acts of war, terrorism, or civil disorder are all things that can lead to a breakdown of the networks on which a business relies, for example.
Another serious risk that is present in some countries that is related to currencies, but is not currency risk as we previously discussed, is the possibility of government restrictions being imposed on currency exchange. One restriction that is sometimes imposed in developing economies is the banning of the exchange of the local currency into foreign currencies. When this regulation is introduced, it can become slow, difficult, or impossible for a company to repatriate its profits into its own currency.
Often introduced in times of economic turmoil, government regulation on currency exchange allows the government to have a higher degree of control over exchange rates and to implement measures that reduce the amount of fluctuation in the value of the local currency. While exchange rate stability helps to facilitate international business, being unable to exchange the local currency into an alternative currency can present a serious barrier to doing business.
The term political risk is closely related to country risk. However, country risk refers to the risks associated with doing business in a particular country.
Often it is possible for a business that is planning to operate internationally to carry out an in-depth analysis of the country risk that it faces from the particular country or countries in which it will do business. While political (and other) events are highly complicated, it is possible to get a better picture of what risks a business faces by taking a more localised look at things.
While it is possible to group the main risks that internationally operating businesses face under the headings of currency risk, political risks, and natural disasters/events, the situation as a whole is actually far more complex.
Internationally operating businesses take on a whole new level of uncertainty by operating under the system of another country or various other countries. While this is the case, it is important to remember that the number of cross-border businesses is on the rise and that, for many companies, overseas expansion presents a great opportunity to increase profits.
Other potential risks that are raised for international businesses are global shifts in economic patterns and local financial crises. It is worth considering the potential for regional changes to take place that influences a country’s standing in global trade patterns and, also, for there to be localised financial crises.
It is possible for internationally operating businesses to effectively protect themselves from risk. Insurance is available to prevent losses arising as a result of political or natural events. Also, as we mentioned earlier, an effective approach to currency risk management can allow a company to operate with complete certainty about the exchange rate that it will receive while doing business in foreign currencies.