How Amazon Hedges Its Forex Risk Essay

Abstract

Amazon operates in 58 countries, and while its international operations tend to be offsetting in terms of costs and revenues, there still foreign currency profits that end up being translated back to Amazon’s financial statements. This creates translational risk for the company. The operating offsets mean that Amazon doesn’t need to utilize hedging strategies, but tactics like offsetting costs and revenues, and diversification of international operations, help Amazon reduce the translational risk that it faces. This paper will examine what foreign currency exchange rate risks Amazon faces, and what tactics it undertakes to mitigate these risks on its income statement and balance sheet.

Introduction

Amazon has online retail operations in 58 countries around the world, and these are typically priced in local currency. This has implications for the company’s strategies with respect to foreign exchange risk, and foreign exchange cash flows. The use of local pricing is aided, however, by the fact that Amazon sources a lot of its goods either at the global level, utilizes local sources, or uses third party resellers to help with the provision of the goods that are on each national-level site. This paper will discuss the international aspect of Amazon’s business, in terms of foreign currency pricing and in terms of how the foreign currency policies Amazon utilizes impact on its bottom line.

Currency

Amazon operates in at least 58 different countries around the world. This means that it has exposure to a large number of currencies – less than 58 because of the euro – and those transactions will ultimately have implications for Amazon’s bottom line. Amazon notes in its latest annual report that “international activities are significant to our revenues and profits, and we plan to further expand internationally.” The typical structure for international operations for Amazon mirrors the structure of domestic operations – the company has a website or a set of websites that serve as the main shopping portal. That shopping portal is then serviced by one or more warehouses from which goods are dispatched. There is typically also a third-party vendor program, through which third party companies offer goods through Amazon. In those situations, the goods do not pass through an Amazon warehouse.

Amazon’s North America business unit features warehouses in most major cities, and in many cases Amazon has its own couriers to do deliveries. In some markets, neither of these conditions holds. Many foreign markets do feature warehouses, where Amazon holds inventory that it will eventually deliver to customers. This holding of inventory is typically going to be one of the primary means of exposure, along with the eventual sale of inventory, to foreign currency risk. As an example, Amazon in the UK will purchase goods in dollars, yuan, pounds or euros, but will always sell in pounds. Where it is possible to purchase in pounds and sell in pounds, there is no foreign exchange rate risk. In Canada, for example, Amazon will use a mix of locally provisioned goods and goods that have been imported through its US main company and then shipped to Canada, creating both additional costs and foreign exchange rate risk on the sale.

Pricing at Amazon is typically based on cost-plus, while to an extent taking into account local market conditions. In the highly competitive US market, Amazon leverages its bargaining power to bring prices on things like Amazon Basics down. The transparency of comparing pricing across similar products is also built into the system, so that there is a quasi-auction feel to the pricing – a vendor can easily see if its products are priced competitively, should it be curious about sales levels. There are more tricks and subtleties to Amazon’s pricing, but cost-plus is at the core of the pricing system. Because so many consumers search Amazon first, there is less need for Amazon to take market considerations into account, except with high volume products that are sold at the larger competitors (i.e. Best Buy, Walmart, Home Depot, etc.) (Medium, 2019).

Even in foreign markets, Amazon tends to adopt the same pricing strategy as in the US, and one of the tricks it uses is to leverage its data. Amazon changes prices on products frequently, based on a broad range of variables including profit margins, inventory, competitors’ prices, shopping patterns and a wide of other input variables (Mehta, Detroja & Agashe, 2018). Amazon uses this data for things like loss lead pricing, in the hopes that consumers will start to think that Amazon’s prices overall are good. The complexity of Amazon’s pricing strategy is mirrored in other countries, but is obviously better in countries where sufficient data exists to make solid data-driven decisions. The prices are set in local currency, as well, but the frequent changes may take into account foreign currency fluctuations in some situations.

On its financial statements, Amazon reports in…

Some parts of this document are missing

Click here to view full document

…but operates across 58 international markets, and these markets typically use foreign currencies. The largest of these markets also happen to be major world economies with reserve currencies. Therefore, costs and revenue in those markets are, in all likelihood, only denominated in local currency. However, there are likely some situations where Amazon makes bulk purchases of particular items and then makes those items available globally, in which case there might be some costs on the USD side that are incurred by foreign subsidiaries. Revenues, however, will always be in foreign currency.

Amazon does not deal with foreign exchange up front, necessarily. Its pricing model is complex, and driven by big data, and not entirely transparent. It is known that there are several variables, only one of which might be the prevailing foreign exchange rates. Thus, Amazon does not specifically or deliberately price to maintain USD profitability on a given item, and might not address foreign exchange rate risk in any meaningful way in its pricing strategy. Thus, most of the dealing with foreign exchange rate risk falls to other parts of the business.

The company mainly faces translational risk, though there will naturally be some transactional risk as well. The translational risk that Amazon faces is not managed through hedging, which is typically a poor way of handling translation risk in general. Translation risk can be minimized by offsetting transactions on the revenue and cost side, something Amazon typically does with its foreign subsidiaries. Furthermore, Amazon utilizes diversification to further hedge forex risk. This tactic means that the company operates in a number of different countries, and foreign currency movements in those countries would theoretically offset each other. That may not happen all the time, especially in times when the USD is moving the same way against all other major currencies, but this approach is something that has become a key part of Amazon’s hedging strategy. With very little transactional foreign currency exchange rate risk, Amazon does not note any major hedging strategies in its annual report.

For the most part, Amazon matches operating risks associated with foreign currency transactions with operating tactics to mitigate those risks. Those operational offsets are the best way to handle translational risk. As a result, Amazon typically does not have a major impact from this foreign exchange rate risk – the numbers are pretty big but are a very small component of the company’s overall income statement and balance…