The most common and dangerous fallacy encountered by importers and exporters is that, "foreign exchange risks can always be mitigated by invoicing in one's own currency." The reality is that the U.S. dollar is no longer the exclusive medium of international commerce and investment. As other currencies harden, rise to prominence and vacillate against the dollar, entire competitive landscapes are susceptible to disruptive shifts, increasing the currency risk of international trade. Importers/exporters need a currency strategy to avoid those pitfalls. Split currency invoicing is one effective tool.

Exchange Risk in International Trade: Fallacy versus Reality

Fallacy: "Foreign exchange risks can always be eliminated by invoicing in one's own currency."

Reality: Using the domestic currency as the basis of trade is not necessarily beneficial for relationships between customers and suppliers, particularly in the long run. Forcing trading partners to bear the exchange risk inevitably raises transaction costs and, subsequently, the product price, eroding one's competitive position.

Seeds of a Problem: The importer/exporter who insists on invoicing in his/her own currency as a "no hassle" policy is in fact already paying a high cost for shifting the currency risk to the other party.

Opportunity: The importer/exporter could pay less, or profit more, by being more flexible in the choice of currency denomination - especially during excessive and sustained currency moves.

Solution: Split Currency Invoicing

Tale of Two Currencies: The broadest examples of rising prominence and usage among alternative currencies are the Japanese yen and europe's single currency, the euro. The euro has sustained an extraordinary depreciation since its historic launch in January 1999, while the yen has mounted a significant recovery over the past year following three years of protracted decline.

To some extent, day-to-day gyrations and spurts in the foreign exchanges do not necessarily have lasting impact on a commercial business' profitability and competitive standing in overseas markets. However, excessive and sustained currency moves - like the euro's 24% decline since its launch and the yen's stubborn strength that reflects no less than a 16% appreciation against the dollar since May 1999 - place increasing demands for more flexible and creative approaches to importing/exporting successfully. Whether it is an importer faced with price hike after price hike from a Japanese supplier due to the strength of the yen, or an exporter who has lost the ability to maintain competitive pricing in europe because of the devaluation of the euro, real solutions can be tailored through optimal currency invoicing.

A Real World Example: An agricultural exporter client recently received a request from a Spanish customer for his product to be priced and invoiced in euro, rather than in U.S., dollars. Why? From an exchange rate standpoint, the exporter's product costs the Spanish importer 16% more today than a year ago, when the Spanish importer could obtain $1.09 by exchanging his 1.00 euro. Today he gets only $0.91 for the same euro.

Two years ago, the volatility of the Spanish peseta did not give the Spanish customer the leverage to demand pricing in his domestic currency. Today, the Spaniard considers his euro a "world-class" currency - regardless of its current undervaluation. In fact, the euro's volatility against the dollar over the past year-and-a-half, which has been greater than that of the euro's benchmark legacy currency, the German mark, in previous years, is probably further discouraging the Spanish importer from using the dollar.

What can the U.S. exporter do to accommodate his customer, except pray for a speedy realignment of the euro/dollar rate? Exporters in this situation often offer a price concession to placate a complaining customer, but that is a high-risk solution, as a return gesture is in no way assured if/when currencies reverse course and overshoot in the opposite direction!

A Win-win Solution: How about splitting the price and invoicing of the product 50/50 between the two currencies? With the product price split between the euro and the dollar, trading partners share the inevitable risk and the rewards of doing business across two uncommon currencies. Whether the euro continues to decline, or reverses course, the U.S. exporter and Spanish importer will always face the same exchange risk/reward.

Chart.1 below illustrates, without split-currency invoicing, how the Spanish (foreign) importer's costs rise and fall with the corresponding rise and fall of the dollar. The fundamental problem with single-currency invoicing across two uncommon currencies is that it is rigid: excessive currency moves produce equally excessive gains and losses.

Chart.2 illustrates how 50/50 split-currency invoicing, one-half in dollars and one-half in euros, results in equally shared currency gains and losses. The Spanish importer's costs rise and fall only half as much as the currency movement itself (e.g., the Spanish importer's costs will rise "only" 5% from another 10% decline of the euro).

Chart.3 introduces a slight variation to 50/50 split-currency invoicing. Within a specified currency range/band gains and losses are fully assumed by the respective party; however, beyond a specified range/band, gains and losses are equally shared.

Split-currency invoicing, however, does not mean: "sit back and let half your sales or purchases gyrate with the currencies." The exporter and importer both have the subsequent opportunity to hedge their respective portions of foreign currency risk through instruments such as forward exchange contracts.

Successful exporters and importers need to be aware that in a global marketplace that is no longer exclusively driven by an almighty dollar, their international sales and procurement deals are at risk without a currency strategy. Even when international business is transacted in U.S. dollars, a host of currency issues is often brewing just below the surface. A currency strategy that mitigates and shares risks among trading partners is essential to establishing mutually beneficial trading relationships.

Split Currency Invoicing: An Alternative Strategy for the U.S. Exporter	USD Invoicing (solid line) Rigid: excessive currency moves produce equally excessive gains and losses.
Split Currency Invoicing: An Alternative Strategy for the U.S. Exporter	USD Invoicing (solid line) Rigid: excessive currency moves produce equally excessive gains and losses. Split (50/50) Currency Invoicing Flexible: currency gains and losses are equally shared.
Split Currency Invoicing with a Band: Flexibility without too much Compromise	USD Invoicing (solid line) Rigid: excessive currency moves produce equally excessive gains and losses. Split (50/50) Currency Invoicing Flexible: currency gains and losses are equally shared.
Split (50/50) Invoicing with a Neutral Band (dashed line) Flexible, but without too much compromise: currency gains/losses are fully assumed by each party only within a specified range, beyond which gains/losses are shared.

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