Managing the hidden margin risk in overseas equipment orders

By the time their machine actually arrives, heavy equipment dealers who order from overseas manufacturers may be looking at a different deal than the one they priced.

The supplier's price is the same. However, because exchange rates have shifted, the dealer's final cost in U.S. dollars has changed, possibly shrinking their expected margin.

"What's needed is to bring certainty to the transaction, locking in your gross profit margin on that machine, and it enables you to better plan," said Dan Walker, national sales manager with BOK Financial® Dealer Financial Services.

The problem affects most heavy equipment dealers sooner or later. "Pretty much everybody has some overseas sourcing," he said, adding that even dealers who primarily sell domestic equipment often carry product lines manufactured abroad.

"It may not be all their product, or even 30% of their product, but they do have product lines that they import."

Because those products are priced in euros, Canadian dollars or other foreign currencies, a lot can change between order and delivery, Walker said.

The long wait between order and delivery

The challenge is timing. Walker said dealers commonly schedule equipment orders months in advance, sometimes as much as a year. Based on anticipated demand and manufacturer delivery windows, they may place a large order at the end of one year or the beginning of the next.

Over the months that follow, the dollar may strengthen or weaken against the currency in which the equipment is priced. Consequently, a machine that appears profitable when ordered can become less profitable by the time it arrives.

These fluctuations aren't unique to the heavy-equipment industry, but they can be particularly painful because machine sales themselves are often relatively low-margin transactions. Walker said gross profit margins on machines typically fall in the 10% to 15% range, compared with roughly 40% for parts and as much as 70% for service work.

For instance, a dealer may expect to sell a machine for $1.1 million after buying it for $850,000, creating a margin the business can plan around. However, if the equipment is priced in a foreign currency and exchange rates move, the dealer's actual cost can rise-narrowing that margin before the machine ever reaches the customer.

Getting equipment into the field is important because it often creates future opportunities for parts, service and rental revenue—but the dealer still needs the original machine sale to hold up, Walker said.

"You don't want to take a loss on your machine that you're actually selling," he said.

Turning uncertainty into a known cost

That's where foreign exchange hedging can help.

At its simplest, hedging allows a business to lock in an exchange rate at the time of the purchase order, reducing the risk that currency movement will change the final cost. For a dealer buying equipment from an overseas manufacturer, that can mean knowing the U.S. dollar cost of a machine before it arrives.

"The goal is to remove uncertainty around the cost of inventory so that our clients can focus on running their businesses," said Oscar Arriaza, foreign exchange sales manager for BOK Financial.

"Companies don't hedge because they know where the market is going," Arriaza said. "They hedge because they don't know where the market is going."

The goal is not to eliminate every risk or guarantee the best possible rate, but to turn an unknown future cost into something the business can plan around.

Esa distinción importa. Hedging is sometimes misunderstood as a bet on where currencies are headed. In this context, Walker said, it's better understood as a way to take risk off the table.

"You're not really trying to bet one way or another," Walker said. "You're taking the uncertainty out of the transaction."

For dealers, having more certainty can support better planning. If a company knows what a machine will cost in U.S. dollars, it can more confidently forecast cash flow, evaluate gross profit margin and build financial projections around future inventory.

It can also help avoid regret. Walker said some customers have recognized the value of hedging only after exchange-rate changes affected margins on imported machines. "We have had customers say, 'We wish we had put something in place,'" Walker said.

From exposure to strategy

Foreign exchange exposure earns more attention as international business becomes a bigger part of a company's revenue, Arriaza said. When overseas purchasing grows, currency swings may no longer affect only one transaction. They can begin to show up more broadly in the company's financial performance.

A more disciplined approach starts with a simple question, Arriaza said: How does the company want to manage currency risk?

He recommends that businesses establish a basic foreign-exchange policy, even if it's only a short internal document. The policy should define how the company views exposure to foreign currency, when to identify that exposure and how to mitigate the risk.

Paired with a defined budget, this policy can give dealers a reference point for pricing, margin expectations and planning—and help them evaluate a tradeoff between locking in certainty and leaving the outcome to the market.

This kind of framework helps companies avoid making hedging decisions one transaction at a time, experts said. It also gives finance leaders a clearer basis for evaluating decisions later, especially if exchange rates move favorably after a hedge is placed.

"Certainty beats opportunity cost," Arriaza noted.

In other words, a company may later discover that waiting would have produced a better rate—but waiting also could have produced a worse one.

The value of the hedge is not that it guarantees the best possible outcome, Arriaza explained. It's that it gives the company a known outcome.

For dealers managing tight machine margins, managing currency risk could make a difference in a successful outcome.