If you produce a commodity product for export but don’t consider trade as your “core” business, chances are that you outsource international sales and distribution to third parties. This setup may have perfectly worked for a time, but one day you may get confronted with the following challenges:
· Profit margins are eroded by falling prices and increased competition;
· Traditional sources of corporate finance become too scarce or expensive to support strategic development;
· Shareholders need to diversify country risk or safeguard their investments.
If these conditions sound familiar, your company may be ready to embrace international business. At the very least, this requires reinventing yourself as an integrated producer, marketer, and distributor.
Naturally, venturing abroad requires new skills and competencies. These derive from barriers to entry, different business practices, financial constraints, legal inconsistencies, complex logistics arrangements, cross-cultural differences, and so forth. The good news is that required capabilities have never been more attainable to midsize exporters worldwide.
International sales and distribution
Commodity market dynamics are driven by imbalances of global supply and demand and disparities in regional economic conditions. These factors create an ever-changing commercial landscape, where arbitrage opportunities emerge and fade away, exploited by traders with relevant skills and infrastructure. Successful traders combine a global reach in identifying arbitrage opportunities with local sales channels and strategies, proactively tailored to customer needs.
The global market of commodities is highly competitive. Apart from considerations of price and quality, your foreign customers will be increasingly demanding in terms of ancillary services. These services alone, however, may not differentiate you from the competition, because your rivals face similar challenges and labour in the same direction. As such, complimentary customer services have long become an order qualifier.
Fortunately, your company can be distinguished in a different way. As lean manufacturing practices spread around the world, consumers become increasingly dependent on uninterrupted supplies of raw materials and components. There is significant added value in trusted, reliable supplier-consumer relationships. The world of international commodity trading is littered with renegotiated deals, broken contracts, and concerns about counterparty performance. This means that your customers need competitive and dependable suppliers. Considering the pressures and finite resources available to procurement executives, it is no wonder that they often rely on a handful of trusted contractors. Your company may become one of them. Better still, trusted suppliers that go the extra mile to accommodate customer requirements become preferred suppliers and are best positioned to win recurrent business.
For various reasons, being able to converse in the same language may not be sufficient for building a long-term business relationship with a foreign customer. If your customer relationship does not gain momentum, think about engaging a local sales agent. Counterintuitive as it may seem, many foreign customers prefer dealing through a local facilitator, even though they are able to communicate with a supplier directly. Finding a local sales agent is never a problem, and sometimes your customer may even suggest one. Do not resist such engagement, as local sales representatives may improve your customer relationships at a low incremental cost. Be sure, though, to not confuse your sales agent with a local distributor.
The local distributor may be very helpful in organizing retail sales to smaller accounts that cannot be serviced by your organization. It should be fully aligned with your sales policies and supply a complementary range of products to avoid overdependence on uninterrupted supplies from you. If certain conflicts of interest are acknowledged and addressed at the outset of your relationship, your sales agent might double as a local distributor and vice versa.
International trading houses have educated a modern customer to expect complimentary services as a matter of course. Fortunately for junior exporters, such services are confined to finance, logistics, and risk management, and may be developed in house on a very reasonable budget.
Advanced delivery terms, importation, stockholding, and inventory management represent the most popular offerings on the logistics side.
It is estimated that 90 percent of international trade is carried out by maritime transport. Secure your global reach by hiring an experienced team with in-depth knowledge of the international freight market. Your chartering unit should organize and manage individual, containerized, and part cargo shipments, as well as hedge your sea freight exposure through forward fixing of freight, Forward Freight Agreements (FFAs), and other instruments.
As overcapacity continues to challenge the shipping industry, your chartering unit should pay particular attention to selecting service providers and managing counterparty risk. On the flip side, container shipping has recently become a viable alternative to tramp shipping on certain routes, especially in the direction of Asian manufacturing hubs. Container shipments may be especially helpful for gaining initial ocean transportation experience.
Further along the supply chain, a growing number of customers require delivery to their production premises, duty paid (DDP). Although clearing customs may expose your organization to VAT settlements, these days VAT administration is not as onerous as it used to be. Your foreign customers may also require maintaining safety stocks or supplying goods according to a set or flexible schedule. In this respect, bonded warehouses enable exporters to efficiently run such operations without permanent establishment in the country of importation.
In terms of financial services, a competitive supplier should be able to provide personalized payment terms, including credit to qualified accounts. More sophisticated financial services may include billing in a local currency, price risk management (hedging, price indexing), and other techniques.
External financing lubricates global trade and enables exporters to operate with a minimal strain on working capital. The principle of trade finance is simple: as long as your commodity is traded in a reasonably transparent and liquid market, a lender grants loans to finance your commercial activities against the pledge of traded goods and ensuing receivables, henceforth releasing substantial working capital to fund your operations back home. In practical terms, your working capital is replenished as soon as goods are shipped from a production facility or a designated place. Better still, you may obtain pre-export financing against a pipeline of export contracts to collateralize your financial obligations. Each loan is repaid with sales proceeds from a related trade, making each transaction self-liquidating.
The global trade finance industry is dominated by several dozen banks, which mostly hail from the OECD countries. As the industry is highly competitive, trade financing is reasonably priced, especially in the context of emerging markets’ domestic banking. This advantage is manifest in pre-export finance, which is a point of convergence of trade finance with traditional corporate banking. If trade finance could be seen as a cost of foreign trade, pre-export finance may help cut the cost of working capital financing in your home market. Trade finance is also a launch pad for building relationships with the world’s premier banks in project finance, investment banking, and wealth management.
The trade finance industry is shaped by several trends. On the positive side, the banks are refocusing on traditional activities, which will foster competition and innovation in trade finance. At the same time, new regulations, such as Basel III capital requirements, strain the banks’ balance sheets and increase their costs.
For exporters, this means that the pre-crisis era of “cheap and cheerful” trade finance is over. As trade finance becomes more regulated and expensive in the developed countries, the banks from emerging markets may take advantage to gain market share. In parallel, all banks will become more selective in choosing their customers, prioritizing professional teams, solid risk management, and steady tradeflows. Those exporters not meeting these criteria will find it increasingly difficult to get access to trade finance.
Commodity trading is a people business, which may explain why its legal aspects are so often neglected by new and experienced merchants alike. Legal sloppiness and market volatility, however, may be devastating for your business. Below are some suggestions for addressing legal implications of foreign trade.
For a start, your staff should know that everything they do, write, and say might have legal implications. In case of any conflict, real or potential, with a foreign counterparty, they should immediately alert a supervisor or legal counsel, who should participate in conflict resolution while making sure that all communication is managed in your best interests.
Whenever possible, you should avoid purchase orders (P/O), whose main purpose is to make the best contractual relationship for the P/O issuer (if you need further proof of this, simply read standard terms and conditions printed overleaf any P/O). Instead, insist on the conclusion of a sales contract, whose format will balance the interests of both parties. Resist claims that the customer’s corporate policy requires all purchases to be made against a P/O; your organization may also have a corporate policy to the contrary, and you are not inferior to your customer. Negotiate. If, despite all efforts, a P/O is the only way to secure a business, strike off manifestly unacceptable terms, send the P/O back, and make sure that the customer has received the modified P/O and accepted the amendments.
Remember that time is of the essence in commodity supply contracts. If the shipment of goods is delayed by a single day, your customer may have a right to terminate a sales contract. You should be conservative in making your transportation arrangements, and try to make your logistics provider liable for damages caused by underperformance.
If you enter into a contractual relationship with a new customer, take time to learn its background and mitigate—or balance—counterparty risk. What businesses is it in? Who are its shareholders? Where is it registered and physically domiciled? How long are they in business? What is their balance sheet like? Answering such questions will help you appraise non-payment and non-performance risks and structure a sales contract accordingly.
Many trades are concluded over the phone or by email and formalized in a sales contract at a later stage. Is your interlocutor authorized to act on behalf of his organization? The authority to bind the company may be confirmed in a commercial register (many national commercial registries are accessible online) or granted through a power of attorney. Ideally, you should obtain a notarized copy of the document establishing such authority. Do not be reluctant to address this issue with your counterparty, as there is no offense in professional management of legal risks. Provide the documents confirming the authority of your personnel and ask to return the favour in a similar way.
In some jurisdictions the authority to bind the company is established by past performance (that is, prior contracts that were sanctioned by the same individuals and fully performed by their respective organizations). Check with a legal attorney if this doctrine applies to you, and analyse potential implications for your business.
You should be aware that in most popular jurisdictions governing international trade a sales contract is concluded when the buyer accepts the seller’s commercial offer, provided it contains essential elements, such as description of goods, unit price, delivery terms, delivery time, and payment terms. To avoid bad surprises for both parties, commercial offers should incorporate all principal terms and conditions to be seen in a related sales contract. Better still, you may submit a commercial offer together with a drafted sales contract and clearly refer a potential customer to the latter for all complementary terms and conditions. If a commercial offer is submitted to a regular buyer, you may specify that all complementary terms are subject to your prior contract.
Another aspect to be kept in mind is that many jurisdictions allow contracts to be concluded in oral form. As such, your counterparty—especially if it is a bank or a large trading house—may record all verbal communications, which might constitute a binding contract against your will. Educate your trading personnel to this effect, and establish a policy of verbal communications with external counterparties.
Once all contractual terms are agreed upon, verify the authority of the buyer’s signatories to execute the contract. Follow the procedure suggested above with more scrutiny, as you—and your financing bank—need a fully enforceable legal deed. If in doubt, seek advice from legal counsel.
Best sales contracts are written by foreign trade practitioners and specialized lawyers. Your lawyers should contribute with purely legal provisions and sharpen the language of the sales contract, but their professional zeal should be kept under control so as not to alienate your customer. Particular attention should be given to drafting the Force Majeure section, which may incorporate a readymade provision (such as the ICC Force Majeure Clause 2003) if the parties cannot agree on its wording. Despite established practices (for instance, Charter Parties are often governed by English law), all legal aspects of a sales contract are entirely negotiable.
You cannot get rid of legal implications of foreign trade but you can map them early and train your team accordingly, especially those on the front line.
The opportunities offered by the global market go hand in hand with intrinsic risks, whose profile is unique for each organization. Although such risks cannot be avoided, their adverse effects may be substantially reduced through proactive and coherent risk management. Establishing risk management practices at the dawn of your international expansion may save your business a fortune.
Your risk management policy should consist of procedures for continual identification, appraisal, and mitigation of potential events adversely affecting your business. ISO 31000:2009 provides a methodology for building a solid risk management policy for any organization.
No risk can be dealt with before it is recognized. A major threat to new market participants relates to unpremeditated ignorance concerning certain risks due to a lack of relevant experience. In the context of international trade, critical areas include contract interpretation, performance and enforcement, cargo safety and condition during transportation, handling and warehousing, compliance with national and international regulations and sanctions, shipping documents, collection of payments, claims presentation and settlements, and so forth. Latent risks may be only recognized by experienced professionals, so bring them on board early.
The appraisal of risks is required to strike a balance between the financial effects of risk reduction and resources applied. Some events are very unlikely to occur, but the mitigation of related risks is costly and onerous. Such risks may be accepted as a general precondition of doing business; find out, however, how they are addressed by your competition.
The risk should be mitigated when the financial benefit of risk reduction significantly exceeds the cost of risk reduction. Risk mitigation techniques include partial transfer of the risk to a third party (such as in insurance), reducing the risk likelihood (such as in verifying counterparty credentials), and reducing adverse effects of the risk (such as in establishing maximum customer credit exposure).
Risk management cannot be confined to insurance, and the latter should be considered as one of several instruments in your risk management toolkit. Many insurance policies are uniform, intricate legal agreements designed to exclude the likelihood of fraud by the assured and thus establishing very stringent performance criteria. Accordingly, insurance coverage may be denied if the assured fails to perform in strict compliance with the policy.
The recent bankruptcy of MF Global, a large broker, has shown that due diligence must become a two-way process involving both customers and service providers. You should exercise due diligence in selecting insurers and develop techniques to mitigate their counterparty risk (for example, with cut-through provisions in reinsurance policies).
The bottom line: risk management should be aligned with your commercial objectives and span all functional areas.
Learning the mechanics of international business by trial and error may cost an aspiring exporter dearly. If you are determined to move up the value chain, make sure you have necessary resources, or consider external help from specialized agencies and service providers.
The battle for direct access to global commodity and financial markets is not easy to win, but it is certainly worth fighting for.