How SMEs deal with export risks

Dhe global financial and economic crisis has shown that the risks in international business have increased. Currency losses reduce margins on sales to foreign customers. Economic downturns cause sales in foreign markets to dwindle. Unrest and strikes hinder the sale of products. Not only large multinationals are affected, but increasingly also small and medium-sized companies with international operations.

SMEs take an opportunity-oriented approach to internationalisation and often neglect the associated risks. Only 29% of the companies obtain creditworthiness information on foreign customers and partners, 26% hedge currency risks, 16% work with letters of credit, 17% prepare country analyses and only 3% hedge against interest rate fluctuations (see Swiss International Entrepreneurship Survey 2013). However, neglecting export risks is particularly dangerous for SMEs because they are usually not very diversified and cannot compensate for setbacks in one sales market with successes in other markets. They have fewer reserves than large companies to absorb losses and run the risk of insolvency much more quickly.

Study on export risk management of SMEs

A study led by the HTW Chur University of Applied Sciences and supported by the CTI has investigated how internationally experienced Swiss SMEs deal with export risks and how they identify, analyse and control the relevant risks. Twenty-eight companies from the manufacturing sector in German- and French-speaking Switzerland were surveyed. The experiences of these companies were evaluated and condensed into a guide for the management of export risks, which is intended to support SMEs in controlling export risks.

Risks in the export business

Export risks are understood as events that can negatively impact the success of foreign business. According to the companies surveyed, economic risks play a particularly important role (see Figure 1). Currency losses occur when the currency of the home market strengthens in relation to the currencies of the target markets and the income from foreign business loses value as a result. For example, an employee responsible for exports at one of the companies surveyed said: "We pay our employees' salaries in Swiss francs. Our customers pay in euros. There's a big loss of margin there with the current strength of the franc." Inflation in foreign markets can have a similar effect if it leads to a devaluation of the corresponding currencies. Recessions in foreign markets and increases in government debt can cause a slump in demand for the company's products. Foreign exchange shortages and restrictions on the transfer of foreign currencies may impede the conduct of foreign business and result in the Company not receiving cash for products supplied. Tariff and tax increases can raise the price of products in foreign markets and impair the company's international competitiveness.

Legal risks arise in the export business due to the possibility that foreign states may change product regulations, thus necessitating costly product adaptations or new approvals. Legal uncertainty in foreign markets can make it difficult to enforce contracts with foreign customers, as the following statement from a company interviewed shows: "It is often difficult for a small company to enforce supply contracts in distant markets. You need local lawyers and translators and you have to register as a company in the country. Often this is too costly in relation to the amount in dispute and you have to cave in." Corruption can also lead to employees breaking the law and damage the company's image.

Sales risks arise when customer needs in foreign markets change, the company recognizes this too late and loses market share. One of the companies surveyed experienced this as follows: "There is a great danger that the foreign representatives inform too little and too late about changing customer needs, and as a result one falls behind and misses trends". Sales partners can drop out and existing customer relationships can be lost as a result. The del credere risk is often greater in foreign markets because it is more difficult to collect outstanding customer payments and payment morale is poorer than in the home market. Delays can occur in the transport of goods due to lengthy customs formalities or incomplete documentation of deliveries.

Political risks include unrest, strikes and conflicts that paralyze a country's economy, cause sales to plummet and put employees at risk. One company had the following experience: "The political situation in Nigeria is so dangerous that you cannot move freely in public. We are picked up by our clients at the airport in old, beat-up cars and always remain under their watch." Embargoes can make it impossible to ship products to countries like Iran. Nationalizations can lead to the loss of subsidiaries or customer relationships in foreign markets.

The companies surveyed considered the greatest competitive risk in the export business to be the danger of their own products or product components being copied by foreign competitors. One of the export managers interviewed put it this way: "Foreign competitors acquire our product, take it apart and copy it at lower cost. We have no choice but to try to outperform them in terms of service and advice." Competitive risks can also consist of losing know-how to the competition via an agent abroad, new competitors entering the market or, as a small company, being taken over by a large competitor.

Personnel risks arise from the danger of losing qualified employees who are often less loyal to the company abroad than in the home market. Controlling employees in distant markets is often more difficult than at home. It can happen that the distance is exploited and employees enrich themselves personally through fraud: "We had a representative for our products in Brazil who tripled the agreed prices and shared the profit with the customers' buyers. When the whole thing came to light, we didn't dare show our face there."

Product risks arise in the export business when products have to meet widely differing requirements in foreign markets and are used under a wide variety of conditions. Malfunctions can mean the replacement of products, on-site repairs and even product liability for the company and severely reduce the success of the foreign business. One textile machinery manufacturer commented as follows: "We handle natural products that react to heat and moisture. Ensuring the functionality of these products under a wide variety of conditions is a major challenge for us."

Natural risks arise from earthquakes, epidemics, volcanic eruptions, floods, landslides and storms, which can hinder the functioning of the economy in a foreign market, cause a collapse in demand, delay the transport of products or make it impossible for employees to travel to the affected markets. For example, one of the companies interviewed said, "We ship almost 100 percent of our products by courier. If planes can't fly because of heavy snow or volcanic ash, our shipments get delayed and we have unhappy customers."

Rarely were the distribution risks in the export business also mentioned by the companies. When transporting goods, delays can occur due to lengthy customs formalities or incomplete documentation of deliveries. Goods can be damaged and lost during transport. Deliveries can be faulty and incomplete. All this causes additional costs and damages the reputation of an exporting company.

Management of export risks

The international orientation of business creates opportunities. For small and medium-sized enterprises, however, it also entails considerable risk. It is important to weigh up the opportunities and risks and only do business where the opportunities are greater than the associated risks. The survey of internationally experienced companies showed that they have developed a system for dealing with export risks that protects them from excessive risk exposure.

The export risk management process consists of five steps that are repeated over and over again (see Figure 2). It begins with the selection of those export transactions that are to be included in risk management. Risk management is complex. It should only deal with export transactions that involve significant risks and spare those that are not critical for the company. Some companies include export transactions in risk management if they exceed a certain turnover, while others analyse export transactions if they take place in critically classified markets, if the customer does not make advance payments or if products are used under unusual conditions.

The analysis of the opportunities and risks of export transactions should show what significance they have for the success of the company. Each transaction must be assessed according to what positive and negative influences it can have on the company's profit. The evaluation of opportunities is based on an estimate of how high the contribution margin from the export business will be. Export risks are assessed by estimating the loss potentials and probabilities of occurrence for all types of risk relevant to the company. These assessments are based on the company's international business experience and the analysis of information provided by specialized institutes.

The contribution margins and losses expected from the analysis of the export transactions allow the transactions to be positioned in an opportunity/risk matrix (cf. Figure 3). This matrix shows an overview of the opportunities and risks in the company's export business and allows an overall analysis of the risk exposure. In doing so, the company should answer the following questions:

• For which export transactions are the risks rated higher than the opportunities?
• Do the risks or opportunities in the company's export business outweigh the risks overall?
• Are there major potential losses in individual export transactions that could endanger the existence of the company?

The requirements for the control of export risks can be derived from the result of this analysis. The aim of risk control is to reduce risks to a level that is optimal for the company. The options available to companies for controlling export risks can be divided into three categories: reducing, avoiding and shifting. To reduce export risks, companies require advance payments from their customers. They set credit limits and diversify their export business into different markets. Avoiding export risks means, for example, not entering politically unstable markets, no longer supplying customers with a poor payment record and restricting themselves to service offerings whose quality can be controlled. The category "shifting" includes the insurance of export risks. The companies surveyed secure customer payments through letters of credit and take out product liability insurance if major damage could result.

The final step in the export risk management process is to periodically review and adjust the positioning of export transactions in the matrix if risks and opportunities change