The strength of the euro is forcing independents to consider whether to forward buy the currency to protect their margins.
Invoices for autumn 08 product are about to land on retailers’ desks, and those who forward order mainly European brands for which they pay in euros could be in for a nasty shock. The value of the pound against the euro has fallen significantly since they placed their orders in January this year, so bills are likely to be higher than expected.
Currency fluctuation has been an issue for clothing manufacturers for some time as the US dollar has weakened, but up until this spring the euro to sterling exchange rate was fairly stable, so independents buying European brands had not experienced the same problem as when dealing with US brands.
Giulio Cinque, who runs designer men’s and women’s wear business Giulio in Cambridge, says that he expects his invoices from brands such as Christian Dior to be at least 5% more than he anticipated when he placed orders in January.
He says: “We have been caught on the hop with this. The euro has been steady against the pound for such a long time that it is not something we have had to consider. I’ll be asking a lot of questions before buying next season. However, it’s not as if I haven’t had to look at this before. Years ago when I was buying Italian brands in lira, I was buying the currency up front to avoid problems. But it’s not something every retailer can do; it depends on your cash flow situation.”
Multiple retailers have been forward buying currency for years, with most running treasury policies approved by the board of directors to manage the forward buying of US dollars. A multiple will examine its likely buying budget for a season, and about six months before payment is due it is likely to fix the currency price rates for 50% of the budget by agreeing the price it will pay for currency with the bank on a specified date.
The finance director and the board then look at the currency situation with three months to go before they need to pay and perhaps agree a price for another 25% to 30% of their budget. At the very end of the invoice period some businesses top up their currency buy by acquiring cash at current prices in the spot markets.
Richard Lowe, corporate director of retail and wholesale for Barclays bank says cash flow is not necessarily an issue that should preclude smaller and independent retailers from locking in their margin in the same way as the multiples.
He explains that independents have two main ways of covering their exposure to currency fluctuations. First, they can work out their budget and ask their bank for a contract to cover it in euros. The bank then comes up with a price that they will sell the euros at, and set a specific date for the transaction. Alternatively, if a retailer does not know when their invoices are likely to come in and wants more flexibility, they can ask for a “window date” (usually of about two weeks) where they can buy the euros from the bank at the agreed price.
Lowe adds: “The large high street retailers do this as a matter of course, but it’s perfectly possible for independent retailers to also negotiate these contracts with their banks. They can just as easily be done for hundreds of thousands of pounds as several millions, and it really is the only safe way to lock in your margin.
“Retailers are not currency speculators – basically they just want to know what the price of the goods they are ordering is at the point they order them, so they can calculate their gross margin. The movement in the euro is having a serious effect across the market. There isn’t a retailer or brand that is not feeling it.”
However, there is a third option for retailers, Lowe points out. “A third option is to buy the currency up front as soon as you make the order and put it in a deposit account, then you know exactly where you are. But the disadvantage is that you must have the money available at the time, and for most retailers cash flow does not work that way.” According to Lowe there is no additional charge for this service, as banks build the fee into the exchange rate offered.
David Bush, head of retail services at accountant Grant Thornton, is a former finance director at kids’ chain The Early Learning Centre. He says: “Judging what the exchange rates are going to be in a month’s time, let alone six months’ time, is becoming more and more difficult.
It’s a perennial issue for retailers and brands. Taking out these forward contracts for euros and dollars is really just the same as taking out an insurance policy. It’s all about making sure you don’t have to gamble on what the exchange rate will be when you finally have to pay your bills.
“If I was advising retailers I would say they should aim to lock in about 70% of their margin in this manner. The euro seems to be going only one way against the pound at the moment and that situation doesn’t look set to change any time soon. Your accountant is going to want to know what your margin is going to be so they can work out what the worst-case scenario is for you over the next six months. Gross margin is key to the whole profit and loss account of your business. Everything flows from that, so getting that certainty and assurance is a must.”
At womenswear retailer Angela of Long Melford in Suffolk, director Paul Wybrew has forward bought euros in the past. He says: “It is pretty easy to do. You go to the bank and ask to draw [the amount] down within a specific time period. It does help you to know where you stand. However, I haven’t done it for some time and although I have thought about it for next season, I’ve decided against it.
“I think we’ll go with passing the differential on to the customer by repricing. I know that will not be popular with customers, but we are a business and we have to react to what is going on in the wider business community. The same thing is happening everywhere – the price of petrol and food is going up, so it’s inevitable that clothing will have to go up too.”
Cinque in Cambridge also shares the view that it makes more sense to put the price differential into the price. “On a brand like Christian Dior, because of the currency fluctuation, our mark up has fallen from 2.7 to 2.5, which is substantial. I’ve got a choice: I can either stomach it, or pass it on. My gut instinct says I will maintain my margins and put it in the price. I am a retailer, not a currency speculator – we leave that to the City boys,” he says.
David Light is director of premium independent Tessuti in Chester. He says he has also forward bought currency in the past, particularly US dollars when he sold a lot of US designer brands. He says: “Nowadays I tend to carry the risk within the business, because the amount of stock that I pay for in euros and US dollars is only about 10% of our total buy. Of course, this year it will definitely hit us on the brands that we do pay for in euros. I am looking at an 8% rise in price if the rate stays the same as it is now.
“I’m hoping the exchange rate comes down against the pound. If it doesn’t, with the brands that are exclusive to us I will probably increase the selling price to maintain my margin. But on other more widely distributed brands I will have to absorb the hit.”