Wine importers have always had to deal with a great deal of uncertainty and volatility. Consider that February 2009 Euro rates reached a low of 1.2513 in terms of US dollars, while Euro rates only a year ago reached a high of 1.5239 (February 2008). How is a wine importer to plan for pricing product scheduled for, say February 2010? Will the Euro be up or down? How about the Aussie dollar? The South African Rand? The New Zealand dollar?
The answer is: nobody knows.
When you deal in a product that forces you to make some financial predictions, it feels like thin ice every day. This was certainly my experience as a foreign exchange broker for a number of years.
But I do, however, know exactly how much I will be paying if I purchase a forward contract.
For our example, we’ll use Euros. The spot Euro (if I were to purchase today for today's delivery) is 1.2700 to the US dollar. I can lock in a Euro payment for March 2010 at a rate of 1.2725, almost the same as today's spot rate (thanks to the US Federal Reserve’s current policy of near 0% interest rates). Does this mean I might as well wait until next year, since rates will be the same?
The forward rate is not a prediction of what rates will be in the future, but simply a mathematical formula (based on U.S. versus European interest rates) and the resultant supply/demand factors. The purchaser must put up at least 10% of the total as margin.
I know that many importers never use forwards, and I also know that every importer who has used forwards has been caught on the wrong side of a forward contract. If I locked in the Euro at 1.2725 for February 2010 delivery, and the spot rate was 1.1600 in 2010, I would be upset that I had "speculated" and lost. On the other hand, if the Euro appreciates and the Feb. 2010 spot rate was 1.400, I would be elated at my smart prediction.
The truth, however, is that by not using forwards, the importer is indeed speculating, as his cost will be determined by the market on the day of payment.
My advice to wine importers: if your cost models make sense based on the forward rates, then locking in those rates will prevent any surprises on payment day. You’ll sleep better when you can plan your pricing structures far in advance.
Matt Esslinger consults with food and wine import and distribution companies on financial and operational issues, bringing a Harvard MBA plus 20 years of experience managing small to medium sized businesses in various industries. He is based in San Francisco. Contact him at firstname.lastname@example.org and via http://www.linkedin.com/in/mattesslingersf