Dealing with Disruptive Dislocations

The global uncertainty surrounding the coronavirus disruption intensifies. Questions of human safety and business continuity reach far beyond the assessment of lock-down orders. In light of a pandemic, transmission expectations are sufficiently likely for an ongoing viral world exposure. What can be done to manage the unexpected? Which analogue situations can be of help, recourse and guidance? This commentary is based on some well-developed theories of international business, which might be usefully applied to the human condition when affected by COVID-19 transmissions.

One comparison to the virus can come from currency risk management. COVID-19 is more deadly, but similar to currency developments, its frequency and strength vary at different times and locations across the world. For currencies, companies have learned how to share and trade off risks with their partners to reduce the effect of dislocations. We need to learn a similar approach to health care. Ventilators and testing capabilities may at one time be needed more in one region than in another. Together with hospital beds they can be shipped to hot spots. Even medical personnel can be transferred around the globe, all to cope with imbalances. All with the presumption that when points of need shift, return shipments will be administered fairly.

Firms that continuously trade have constant economic currency exposure. Typically, such firms wish to maintain good relationships with their business partners. To achieve good terms with suppliers and customers, one does not force all the currency risk of international transactions onto the business partner. Both currency and viral risks have a good portion of randomness to them. In the finance sector, risk-sharing agreements have proven to be useful under such conditions.

Here is an example with companies A (American) and B (Japanese), both substantial multinationals. If A continuously trades with B and pays in yen, then major swings in currency values may cause one party to benefit at the expense of the other. Firms can address such a problem with currency management.

Both companies could agree that all purchases by A will be made in Japanese yen, as long as the currency value on the payment date (spot rate) remains between 90-100 yen/$. Such range lets A agree to accept any currency exposure because it is paying in the foreign currency. If, however, the exchange rate falls outside of this range on the payment date, A and B will “share” the difference. If the spot rate is 80 yen/$, then the Japanese currency would have appreciated, causing the cost of purchasing parts to rise. Because this rate would fall outside of the contractual range, a sharing arrangement would divide up the 10 extra yen between the parties. Therefore, B gains 5 yen/$, and A loses 5 yen/$. Not ideal, but long-term preferable to each party absorbing its own full exchange rate impact.

Risk-sharing agreements like these have been in use for nearly 50 years in modern world markets. They became something of a rarity during the 1950s and 1960s when exchange rates were relatively stable under the Bretton-Woods Agreement. Firms with long term customer/supplier relationships across borders can now return to some old ways of keeping old friends. But, this kind of long-term thinking may well ease the local and temporary burden of COVID-19 offering a response without the intensity.

Written by Michael R. Czinkota. Here’s what you’ve missed?
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