A short story from the exit of GSK
Once upon a time, the towering offices of GlaxoSmithKline (GSK), a British multinational pharmaceutical and biotechnology company, stood in the bustling city of Lagos, Nigeria. For over 51 years, GSK has been a beacon of healthcare innovation, providing Nigerians with trusted household brands like Panadol and Sensodyne.
However, on the 3rd of August 2023, the headlines of Nigerian newspapers were filled with the shocking news of GSK’s exit from Nigeria. The news sent ripples across the country, as GSK had been a significant player in the Nigerian pharmaceutical market.
The reasons behind GSK’s exit were multifaceted. The company cited foreign exchange complexities, security concerns, and high operational costs as the primary challenges that led to their decision. The scarcity of foreign exchange and difficulty maintaining a consistent supply were particularly detrimental to GSK’s operations.
GSK’s decision to leave Nigeria was influenced significantly by the complexities of foreign exchange (Such as a significant increase in input costs, difficulties of settling their trade payables on time due to scarcity of foreign exchange, etc. GSK’s operations became increasingly difficult to maintain due to the volatility of the foreign exchange market and the scarcity of foreign currency. The company had to deal with the unpredictability of exchange rates, frequently resulting in higher operational costs. This, combined with the difficulty in obtaining foreign currency, strained GSK’s resources, affecting the company’s bottom line.
Types of foreign exchange risks
- Transaction risk: Transaction risk is a major concern for businesses engaged in international trade. It refers to the potential financial loss caused by exchange rate fluctuations between the initiation and settlement of a contract. For example, a Nigerian company, “NaijaCO.” imports machinery from the US. The payment is agreed in US dollars. If the Naira depreciates against the US dollar between the time the contract is signed and the payment is made, NaijaCo. would need to pay more Naira than initially expected to meet the agreed-upon amount.
- Translation risk: This is the risk of translation is a change in the financial position (assets, liabilities, and equities) due to exchange rate fluctuations. This is common among multinational corporations preparing consolidated financial statements because they must convert their international assets and liabilities from foreign to local currencies. For example, suppose a British company has a subsidiary in Nigeria and reports its financial results in Pounds. In that case, it risks losing money if the Naira depreciates against the British pound when converting the subsidiary’s earnings and assets into Pounds.
- Economic risk: This is also referred to as forecast risk. It refers to the potential impact of general economic changes on a company’s operations and profitability, causing it to become less competitive than its foreign counterparts. It can occur due to several factors, including macroeconomic conditions, geopolitical events, and natural disasters such as hurricanes.
Causes and consequences of foreign exchange volatility.
Some of the possible causes of foreign exchange volatility are:
- Inflation: The general level of prices for goods and services in a country can affect the value of its currency relative to other currencies. Higher inflation can reduce a currency’s purchasing power and make it less appealing to foreign investors and traders. Lowering inflationary pressures can have the opposite effect.
- Demand and supply: Currency exchange rates can be influenced by demand and supply forces in the foreign exchange market. Higher demand for a currency can causes its value to rise, while higher supply can cause it to fall. Factors such as trade flows, capital flows,interest rates, expectations, speculation, and intervention by central banks or governments can all have an impact on demand and supply.
- Political and economic events: The exchange rates of a country’s currency can be influenced by its political and economic stability. Elections, wars, conflicts, natural disasters, policy changes, and economic crises can all cause uncertainty and volatility in the currency market. Such events can also have an impact on investors’ and traders’ confidence and sentiment toward a currency.
- Trade tariff risks: New geopolitical and trade tariff risks between countries can influence currency volatility.
Foreign exchange volatility can have significant impacts on businesses, especially those involved in international trade. Some of the possible consequences are:
- Pricing: The cost of goods will always be higher for an importing business if the domestic currency is weaker. Conversely, a strong domestic currency means the cost of goods will be lower for an exporting business.
- Profits: Exchange rate volatility also has an impact on a company’s profitability. If you sell a product or provide a service in another country, a change in the exchange rate will have a direct impact on your bottom line.
- Competitive Advantage: Another factor to consider is global market competitiveness. If the domestic currency is weaker, a company’s products will be more expensive in comparison to the competition. The inverse is true: the stronger the domestic currency, the lower the cost of a company’s products, giving it a competitive advantage.
- Supply Chain Expenses: Exchange rates will inevitably cause supply chain expenses to shift, especially when using third-party logistics providers.
- Value of Investment in Foreign Subsidiaries and Monetary Assets: Decrease in the value of investment in foreign subsidiaries and monetary assets when translating the value of such assets into the domestic currency.
- Relationships with Clients, Distributors, or Suppliers: The complexity of managing these payments could put a strain on relationships with clients, distributors, or suppliers.
Strategies to mitigate foreign exchange risks and improve financial performance.
Businesses can use various strategies to mitigate the foreign exchange risks, such as:
- Operational strategies: These include diversifying the manufacturing facilities and markets where the products are sold, sourcing raw materials locally and from various countries, and utilizing various financing sources.
- Currency risk-mitigation strategies: To hedge against unfavorable exchange rate movements, financial instruments such as forward contracts, futures, options, and swaps can be used.
- Having a clear forex strategy: This entails developing a disciplined approach when dealing with multiple currencies and currency risk, offering billing/invoicing options, and regularly monitoring exchange rate movements.
Abdulsamod Balogun leads Communications and Public Relations at Leonine Investment Services Limited. He's excited about new media, technology and public policy. When he's not working, he's catching up on movies and books.