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The Impact of Exchange Rates on Supply Chain Management

While discussions rage about transborder issues regarding security, prescription drug traffic and government trade policies, a far more insidious force is shaping the flow of trade between the United States and Canada - the tango between the U.S. and the Canadian dollar and the changing exchange rate. Here's a glimpse into how this tango will likely impact your budgets and future business.

By Tom Nightingale
and John Ferguson.

With more than one third of Canada's GDP linked to trade with the United States, these two countries are inextricably tied in a symbiotic relationship. Over the past 12 months, the Canadian dollar has increased in value over the U.S. dollar at a tremendous rate. Many experts agree that this trend will continue. A recent story in the Toronto-based The Globe and Mail, forecasted that…"The Canadian Dollar will continue its lofty ascent, reaching 90 cents (U.S.) in the next couple of years…" These forecasts are supported by leading economists such as Jayson Myers, senior vice president & chief economist of Canadian Manufacturers & Exporters (CME), an organization that provides advocacy to the Canadian government at all levels to contribute to the competitiveness of Canadian exports. (CME has pegged the dollar closer to the 80-cent level.)

Carriers Respond
Wherever the Canadian dollar or "loonie" levels off, it's already clear that the shift has left many carriers scrambling to adjust their rates to ensure they remain economically viable. In a recent earnings report, a major U.S.-based truckload carrier reported its earnings per share were depressed by 41 percent due to the effects of the surge in the Canadian dollar exchange rate.

How does a carrier become so affected by a spike in the exchange rate? Very few carriers use currency hedges. Sophisticated financial tools such as these are generally reserved for the largest companies such as the parcel carriers. Truckload and Less Than Truckload carriers are the most impacted by fluctuations in the exchange rate.

In most cases, the cost of shipments are largely Canadian-dollar denominated, but they are often paid in U.S. dollars. As much as two-thirds of the costs for a transborder carrier are Canadian-dollar denominated, depending on their driver domicile, freight mix and their discipline around fueling. While the costs incurred and paid in Canada have risen, the U.S. dollar is unable to compensate providers of fuel, drivers and healthcare at comparable rates, leaving carriers hard-pressed to cover their cost of operations.

As a result of the change in exchanges rates, carriers are beginning to accept freight differently. Carriers are in the midst of one of the periods of greatest demand versus supply in years. Due to the excess demand versus the supply of capacity in the marketplace, carriers are turning to the most profitable loads they can generate. One of North America's largest logistics companies reported having increased difficulty in finding carriers willing to honor existing rates and noted it was nearly impossible to locate carriers to move transborder freight denominated in U.S. dollars.

Most carriers already have in place, or are beginning to implement, exchange rate surcharges. While many carriers and shippers have grown accustomed to fuel surcharges, it appears transportation professionals will now need to incorporate the additional complexity of exchange rates into the surcharge matrix. In addition, carriers are often returning to shippers to renegotiate, recalibrate, or convert contracts into alternate currencies. Several carriers are reporting the discontinuance of business with customers who were unwilling to share the burden.

Shippers Respond
As an industry begins to respond to these trends, there are a number of protections that carriers and shippers will begin to put in place. Most shippers and consignees abhor variability in pricing and engage in diligent negotiation to minimize swings in transportation pricing and reduce budget swings that drive-up the cost of goods sold. Many shippers have started to convert their pricing into Canadian dollars to simplify the carrier selection process and minimize the variability in transportation pricing that is largely inelastic to their customers.

However, changes such as these will inevitably drive the flow of goods to alternative modes. Modes that are less sensitive to driver and fuel costs become the natural alternative as Canadian manufacturers strive to remain competitive. Intermodal traffic will undoubtedly become more widely considered as a viable option to keep transportation costs down.

For Canadian manufacturers, the impact of the dollar on southbound supply chain costs is merely symptomatic of a much larger problem, namely, the threat of losing U.S. market share. Due to a reluctance to raise prices quoted to U.S. customers, export-profit margins have generally been bearing the brunt of currency appreciation, in what the CME likens to a "23 percent price cut." Consequently, overall manufacturing shipments have remained reasonably stable, although below their peak in 2000. To some extent, the rebounding U.S. economy helps mitigate potential manufacturing losses. But in the long term – assuming the loonie remains strong – restructuring to achieve higher levels of productivity is essential to restore profitability.

As landed costs grow, restructuring often requires a new look at sourcing. And in this context the lure of China continues to grow. With the Yuan (Renminbi) pegged to the U.S. dollar, China is the only major economy not struggling with currency appreciation, making it even more competitive for Canadian and other foreign buyers. Another byproduct of the weak greenback is that Canadian companies sourcing in China are actually getting a break on logistics costs, since air and ocean freight rates are typically denominated in U.S. dollars. Combine these factors with the country's existing low-cost advantages and it's easy to understand why China is today's sourcing buzzword.

But China aside, should the exchange rate stabilize at its current higher level, shippers may also reevaluate their North American distribution and sourcing patterns. It may make more financial sense to maintain inventory in Seattle rather than Vancouver, or in Buffalo rather than Toronto. In this event, the high Canadian dollar only compounds the existing pressures caused by security issues at the border. While security concerns arguably make it safer and quicker to service American customers from U.S.-based warehouses, now the exchange rate makes it more cost effective too.

As with many of the challenges that face logistics today, the professionals that populate the industry will rise to the occasion and determine the most effective ways for shippers and carriers to work through these issues. And like many other industry challenges, this is not a short-term issue. In an increasingly interdependent and global marketplace logistics professionals who have not considered exchange rates as a critical component of their jobs now face a new era and will need to step up their game to learn new skills.