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Unlock This CourseImagine you're planning a holiday to America. One day, your £100 might buy you $120, but a few months later, it might only get you $110. This change in value between currencies is called an exchange rate fluctuation and it doesn't just affect holidaymakers – it has massive impacts on businesses trading internationally.
Exchange rates are like the price tags between different countries' money. When these 'price tags' change, it can make businesses more or less competitive compared to their international rivals. A UK chocolate manufacturer might suddenly find their products much cheaper for American customers, or a British importer might discover that Japanese electronics have become much more expensive to buy.
Key Definitions:
Think of currencies like any other product in a market. If lots of people want to buy pounds (high demand), the price goes up. If fewer people want pounds (low demand), the price falls. Factors affecting demand include interest rates, economic growth, political stability and trade balances.
British businesses that sell their products abroad are called exporters. When the pound weakens (depreciates), their products become cheaper for foreign customers, making them more competitive internationally.
Let's say a UK furniture company sells a sofa for £1,000. If the exchange rate is £1 = $1.30, American customers pay $1,300. But if the pound weakens to £1 = $1.20, the same sofa now costs Americans only $1,200. The British company can either:
Maintain the lower dollar price to attract more American customers and increase market share.
Raise the dollar price slightly but still remain competitive while earning higher profits.
Use the competitive advantage to enter new international markets previously too expensive.
In 2016, after Brexit, the pound fell significantly against the dollar. Rolls-Royce, which sells aircraft engines globally, saw its competitiveness improve dramatically. Their engines became cheaper for international airlines to buy, leading to increased orders and higher revenues. The company's share price rose as investors recognised the currency advantage.
Businesses that buy products from abroad face the opposite situation. When the pound weakens, foreign goods become more expensive, reducing competitiveness and squeezing profit margins.
A UK electronics retailer importing smartphones from South Korea faces rising costs when the pound weakens. If a phone costs 1,000,000 Korean won and the exchange rate moves from £1 = 1,500 won to £1 = 1,300 won, the cost rises from £667 to £769 per phone.
Higher import costs mean reduced profit margins unless prices are increased. This can make the business less competitive against domestic producers or other importers with better currency hedging.
Smart businesses don't just accept exchange rate changes – they plan for them. Here are the main strategies companies use to protect themselves:
Many businesses use financial instruments to lock in exchange rates for future transactions, reducing uncertainty and protecting profit margins.
Agreeing today to buy or sell currency at a fixed rate for a future date, providing certainty over costs and revenues.
Matching foreign currency income with foreign currency costs, so gains and losses offset each other.
Spreading operations across multiple countries and currencies to reduce dependence on any single exchange rate.
Tesco, the UK supermarket giant, imports products from dozens of countries. The company uses sophisticated hedging strategies to manage currency risk. When the pound weakened in 2016, Tesco had already locked in many exchange rates through forward contracts, protecting customers from immediate price rises. However, as these contracts expired, some imported goods did become more expensive.
Governments and central banks can influence exchange rates through various policies, affecting business competitiveness across entire industries.
The Bank of England and UK government have several tools that can affect the pound's value, each with different implications for business competitiveness.
Higher interest rates typically strengthen a currency by attracting foreign investment. Lower rates can weaken it, boosting export competitiveness but making imports more expensive.
When central banks create new money to buy government bonds, it typically weakens the currency, helping exporters but challenging importers and businesses relying on foreign materials.
Exchange rate changes don't affect all businesses equally. The impact depends on how much a company relies on international trade and whether they're primarily importers or exporters.
When the pound weakens, some businesses celebrate while others struggle. Understanding these patterns helps explain why exchange rates are such important economic indicators.
After the Brexit referendum in June 2016, the pound fell sharply against major currencies. UK manufacturers like JCB (construction equipment) and Dyson (vacuum cleaners) benefited from improved export competitiveness. However, retailers like Next and Marks & Spencer faced higher costs for imported clothing and materials, squeezing their profit margins and forcing some price increases.
Businesses must think beyond short-term exchange rate movements and consider how currency changes might affect their long-term strategy and competitiveness.
The most successful international businesses build flexibility into their operations, allowing them to adapt quickly to changing exchange rates while maintaining competitiveness.
Companies that compete on innovation and quality rather than just price are less vulnerable to currency fluctuations, as customers will pay premium prices for superior products regardless of exchange rates.
Exchange rate changes create both opportunities and challenges for businesses. Companies that understand these effects and plan accordingly are more likely to maintain their competitiveness in international markets. The key is not just to react to currency movements, but to build business models that can thrive regardless of exchange rate volatility.