Nearshore Americas

Declining Local Currencies are “the Icing on the Cake” For Outsourcers But Clients Should Limit Longer-Term Risk

The recent rise of the dollar against local currencies in Latin America is good news for both buyers and service providers, at least in the short term, industry experts say. Clients can limit any longer-term risk by hedging their contracts, while outsourcers can mitigate any adverse ramifications of currency fluctuations by diversifying their offerings and putting aside any short-term gains to make themselves as flexible and competitive as possible in the future.

Plummeting currencies

The last year has proven a difficult one for many Latin American economies. The optimism generated by the historic opening of Mexico’s energy sector has been diminished by the dramatic decline in global oil prices, leading the Mexican peso to plummet to its lowest level since the redenomination in 1993. In the last six months the value of the Brazilian real has also fallen by 26% to its worst level since 2004, and the Colombian peso has dropped by 25% to a level not seen since 2006. Decreasing demand for copper, slowing domestic consumption and restrictions on gold exports have also seen the Peruvian sol sink to its lowest value since 2009, while analysts believe it is only a matter of time before there is a devaluation of the Argentine peso.

Nonetheless, Toby Redshaw, the CEO of Kevington Advisors, told Nearshore Americas that he believes the fall in local currencies is not a cause for concern because it is more a consequence of the recent strengthening of the dollar than of serious economic or political instability in Latin America. “What happened is the dollar strengthened. It strengthened against all currencies and it’s almost at parity with the euro,” he said. From a U.S. perspective, “when you’re looking at outsourcing in Latin America this is like the icing on the cake. You’ve got great geographic, cultural and language proximity and now you’ve got this extra bonus of a move in the currency that essentially just gives you a further discount,” Redshaw added. “I view it very positively because it really does look like the strong dollar is here to stay for the foreseeable future, at least a year or two past the next presidential elections.”

How is the Market Affected?

Frost & Sullivan IT Industry Analyst Guilherme Campos told Nearshore Americas last week that falling currencies in Brazil and Mexico had stimulated activity in the market by enhancing the spending power of U.S. investors. Likewise, in previous instances, Nearshore Americas reported that, at least in the short-term, the decline of the Brazilian real “seems to have strengthened the hands of exporters, particularly those who are offering IT services to foreign clients.”

Redshaw agreed: “A currency change like this gives you pricing flexibility. If you’re in the provider nation it’s a little bit like having a healthy dose of inflation. I think you’ll see a really good cycle of people selling into this and as the story starts to grow about the quality of service and the value that you can get in Latin America I think you’re going to see a very positive growth rate on the back of the currency changes.” Still, Redshaw added the caveat that “there are two sides to the coin: currency fluctuations can lead to instability which is problematic for anybody. If you’re making a multiyear technology decision then the last thing you want is instability. There have been cases where currency has moved in the right direction for somebody in the U.S. but the underlying instability outweighs that upside.”

There have been some notable recent examples of the weakness of local currencies harming the business models of multinational BPO providers operating in the region. Spanish call center firm Atento announced last week that despite recording a 7.5% increase in constant currency in Brazil last year, its revenue actually fell by US$20 million (1.4%) in 2014 because of the decline of the real. Similarly, in the first quarter of last year, the Ibero-LATAM unit of Paris-based BPO firm Teleperformance announced a $43 million (6%) drop in profits, which it attributed to “the decline in the Brazilian real, U.S. dollar, and Mexican, Colombian and Argentine pesos against the euro.”

Redshaw is not convinced that currency fluctuations could be the sole cause of such losses. “I see no real connection between decreased performance and currency on a company balance sheet, unless it’s part of a wider perceived instability package,” he said. “Brazil is on the edge of a little bit too much turmoil and instability with all the corruption charges in the papers. I think there’s a little bit of uncertainty that makes other locations in Latin America like Costa Rica or Mexico seem like much better alternatives.”

However, Redshaw did note that Brazilian outsourcers that are reliant upon clients with the large domestic market do not stand to gain in the same way that those serving U.S. clients do. “It does make the local job a little harder because there are impacts from the currency fluctuation on local businesses. If you’re a CFO and you see everything that’s going on in Brazil right now you’re going to be a little more conservative and cautious and wait to see how things play out,” he explained.

Risk Mitigation

Stan Lepeak, Director of Global Research in Management Consulting at KPMG, told Nearshore Americas that the losses some service providers experience as a result of falling currencies “highlights the need for diversification but also the need as a provider to be sophisticated in terms of how they’re managing their own hedging themselves, and to make sure that your models aren’t based on unrealistic assumptions or they don’t take into account natural currency fluctuations for whatever reason.” He added: “If a firm has too many eggs in one basket in one market and it isn’t thinking about how to address potential variations in currency that have nothing to do with your firm then you’re probably a little unsophisticated and that’s likely to bite you in the ass in the long term.”

Lepeak warned against complacency from the buyer’s perspective. “We’re seeing that a lot of the consumers of outsourced services are very focused on pricing,” he said, “but I’d say a lot of organizations probably don’t pay enough attention to issues such a pricing over the long-term versus the pricing they’re going to get when they sign the contract. More sophisticated organizations are doing hedging, which can minimize the impact of currency fluctuations, or they’re putting the ability to address currency fluctuations into the contract.”

Redshaw agreed that buyers can mitigate any risk from currency fluctuations by hedging their contracts. “I’ve done it before in a couple of companies where you put in a range to limit your exposure. But in general nobody’s signing deals that don’t have no-fault exit clauses after three or four years, so if you’re looking at spending dollars you should denominate in the local currency and not really worry about this for three or four years.”

Renegotiation is Hard

Upon seeing that their service providers are benefitting because they earn in dollars while their wage and real-estate costs are in the depreciating local currencies, many buyers will want to gain more favorable terms through contract negotiations, but Lepeak said the short-term nature of currency fluctuations makes it difficult a basis for renegotiation of pricing. “Generally these are long-term contractual arrangements so it may be that the next negotiation may be a couple of years away and who knows where the currency will be then?” he explained. “There are established renegotiation points within the contract where you go in to renegotiate cost or more often service levels but [the contracts] aren’t really so fluid that you can react to [currency fluctuations] quickly enough.”

Lepeak affirmed that while providers may prosper from the current market conditions in the short-term, they are benefiting from “economic conditions that are not sustainable”. He argued that it is more important to consider the longer-term ramifications, because a market like Latin America – which already suffers from certain shortcomings such as skill shortages and regulation that inhibits trade in some countries – could be further harmed if prices for services escalate in the years to come.

“There are short-term benefits but then there are long-term consequences. An astute service-provider would use some of the short-term benefits to fund changes to make them competitive in the long-term,” Lepeak said. “The question is: which providers are going to be able to be strategic with their investment and recognize where things are going?”

Making it Work

If service providers do struggle as a result of currency fluctuations in the long-term then buyers will ultimately be affected as well. “The buyers can find other providers and conceptually it’s great to be able say ‘we can shop around’ and there’s ‘a growing market of providers,’ but it’s a really big deal for a client to shift work from one provider to another and to admit that the provider they selected wasn’t the best one and to deal with the change in management issues,” Lepeak explained. “The average buyer is a bit of a laggard in terms of being proactive and looking for alternatives because in almost all cases it was a pretty big deal for them to take work to the provider in the first place, so once they’ve selected a provider, they really hope that it’s going to work well and they won’t want to find someone else.”

“I think the onus is on the providers to show that they’re able to address these types of challenges and keep their clients pretty happy,” Lepeak concluded. “The market gyrations lend themselves to the larger, more established multimarket providers. I think this is going to be a big challenge for the up-and-coming providers in the Latin American market. It’s going to be interesting to see how they respond to that and how the competitive dynamics change.”

Ultimately, Redshaw argued that currency issues and even the discounts from the strong dollar should not obscure the primary appeal of Latin America as an outsourcing destination. “The big win from having IT outsourcers [in Latin America] is that you can hop on the plane from Dallas and be in Leon, Mexico for lunch. You can see your outsourcers face-to-face without flying halfway around the world. The big draw is the quality of the IT service in the region – it’s just fortuitous that now the price point is even more attractive,” he said.

Duncan Tucker

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