Forward thinking

Currency fluctuations can cripple business, but how do you cover yourself against such a fluid market? Joanne Hart looks at the pros and cons of hedging your bets

THE UK consumes more than 115 million cases of wine a year and virtually every bottle is imported.  Although agents source a large proportion of wine for the British drinker, it is paid for in a variety of ways. The on-trade pays for its wine in sterling.

Agents import the alcohol themselves and distribute it to bars, pubs, hotels and restaurants. Some members of the off-trade use the same process but most buy ex-cellars so they pay for their wine in the currency of the country in which it is produced.

Clearly, no country other than the UK uses sterling, so every bottle of imported wine has to be paid for in a different currency, either by the retailer or the distributor.  This means there is risk involved. Consumers have only to look at what has happened to the euro and the dollar in the past six months to see currency volatility at work.

The dollar has weakened significantly over the period and the euro has strengthened.  Back in September, a pound could buy just US$1.57. In March it was buying you around US$1.84, a difference of more than 16%. By contrast, a pound was buying €1.49 last month.

Last autumn, the figure was almost 5% higher so every pound gave consumers significantly more euros.  For wine importers, such currency movements are of vital importance. 

Anyone buying Californian wine at last year’s foreign exchange rate would have had to use more pounds to pay for it than they would at today’s rate. Conversely, French and Italian wines would have cost a UK importer less money last year than today.

"Any wine business is working to a budget and this is essentially driven by volume and margin. You hope to maintain the margin and drive the volume up.  The margin is intimately linked to the cost of the product and that can vary enormously, as currencies fluctuate up and down.

They add significant risk to your business," says Hew Dalrymple, marketing director at Waverley.  Distributors and retailers try to minimise the risk by buying forward – purchasing currency at a fixed rate today that they can use at a given period in the future.

"Buying forward is essentially an insurance policy.  We do not speculate, we simply try to reduce our exposure," Dalrymple explains.  Alan Webb, head of beers, wine, spirits, soft drinks and snacks at Sainsbury’s, agrees. "We decided our strategy was not to try and buck the market but to get certainty in terms of our cost base," he says.

Sainsbury’s and Waverley, as part of Scottish & Newcastle, both have access to relatively sophisticated group treasury departments, who will negotiate good rates with banks in the City. The practice may sound too "financial" for people more interested in how wine tastes than how to make it profitable but in fact, it is relatively straightforward.

"It is extremely easy to forward buy and the foreign exchange markets are extremely competitive," says Andy Hibbert, finance director at Bibendum.  He cautions, however,  that banks, which provide the currencies required, can try and charge substantial amounts for the service.

"It is definitely worth negotiating better rates and not accepting the first quote given.  There are also some transaction costs involved and it is more cost-efficient to buy larger amounts of currency in one transaction," he adds.

The process of forward buying varies from one organisation to another. Distributors, such as Waverley or Bibendum would tend to buy their wine a bit further in advance than other retailers such as Sainsbury’s or Tesco.

And, as a consequence, distributors generally try to buy their currencies for periods further in the future.  "Waverley generally buys forward for about six months. We are not fully covered but the further forward you buy, the more expensive it gets, so it is a trade-off between the cost and the benefit. Six months gives us a measure of certainty," says Dalrymple.

"As a business we need to forecast our currency requirements for the following period, whatever that may be.  Generally, it covers six to 12 months," says Hibbert.

Sainsbury’s, by contrast, operates what it calls "a layered hedge".  What this means is that it buys virtually all the currencies it requires three months in advance, half the currencies it needs six months in advance and a quarter nine months in advance.

"Three months gives us certainty in terms of firm orders we have placed," says Webb.  The way forward buying works in practice is that banks quote their customers a so-called "spot rate" for any given currency, offering a particular price for that currency if the customer were buying it today.

They then apply "forward points" to that rate, which become larger the further into the future the customer wishes to buy.  If they believe the currency is going to strengthen against the pound, they will offer a slightly higher rate in the future than today.

If they believe it will weaken, the customer will be offered less in a forward buying situation. No money changes hands until the end of the period in question but a binding contract is entered into, so if a customer has bought a million euros on a six month forward buying agreement, he will have to pay the amount set today in six months’ time.

The areas from which most wine is imported to Britain are America, Australia, Chile, Europe, New Zealand and South Africa, so most forward buying is done in these currencies. In the case of Chile, most local merchants demand payment in dollars.

In South Africa, many prefer sterling to the rand.  "We operate rolling forward cover in euros, dollars, Australian dollars and also New Zealand dollars," says Webb at Sainsbury’s.  What this means is that the retailer is constantly buying currency for the future.

Like every other importer, however, Sainsbury’s stresses it buys currency purely to hedge its bets against volatility in the foreign exchange markets.  "We are not in the business of speculating but we would never leave ourselves uncovered," says Webb.

Some companies take the business of speculation more seriously than others.  In the US, companies are explicitly forbidden from any type of currency speculation and the rules are under review right now.

This imposes specific regulations on US-owned businesses, such as Asda, owned by Wal- Mart or Matthew Clark, the biggest importer of wine in Britain, which is owned by US giant, Constellation.

"We are very mindful of the regulatory regime.  If we are going to pay for wine in six months’ time in Australian dollars, we need to make sure we have the Australian dollars to pay for it but we make our money as a wine business and that is where we are successful. We do not try and play in the currency markets.

The City does that," says Simon Russell, communications manager for Matthew Clark.  "We are not allowed to forward buy without having a physical order so we will only buy currency for a genuine order.

Under US corporate rules, we cannot do anything else," says Sarah Brook, buying manager at Asda.  That does not mean that companies such as Asda never take a view on currency movements.

"We look at where there are strengths and weaknesses.  We try to gauge if a currency is weak and if it can provide value for our customers.  We will try and pass on any weaknesses to the customer," says Brook.

All importers are looking for value and are keen to pass on any currency savings to the end customer. Sainsbury’s, for instance, uses weakness to bump up promotional activity but stresses that customer expectations have also to be taken into account.

They expect to see lots of promotions around Australian and Chilean wine, for example, and would be disappointed not to, whatever the underlying currencies were doing.  Dalrymple at Waverley points out too that forward buying delays the effect of currency movements.

"At the moment, the dollar is cheap so US wine is much more competitive, but we will not see an immediate growth in the market share of dollar-denominated wine because most people have bought dollars forward so the rate they are using now is the rate they agreed several months ago," he explains.

"Because the weakness of the dollar was not anticipated, people are paying more for their Californian wine than they would have been without forward buying," he adds.  Conversely, European wines are cheaper now than they might have been without forward buying, as the euro has strengthened in recent months.

Clearly, the currency markets are complex places and as one currency becomes stronger, another weakens.  This creates something of a swings-and-roundabouts effect for importers, which is compounded for agents because their on-trade clients expect to pay in sterling and their off-trade clients tend to pay in foreign currencies.

"I have worked at other retailers and you tend to find you win in one currency and lose in another," says Brook.  There are, indeed, spectacular examples, such as Allied Domecq more than 10 years ago, where drinks companies have speculated in currencies and lost millions by making the wrong call.

But what companies focus on today is predictability, the chance to know now what they will have to pay for a particular consignment in the future.  "We are forced to look at how we buy, where we buy and how we pay.

The way we operate means we don’t optimise on currency movements, but we do have certainty," says Webb.