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Unexpected currency risks in the travel industry can be tackled by using tools like forward contracts.

Managing Currency Exchange Risks in the International Travel IndustryARTICLE

By Bill Camarda

Few industries are more exposed to the volatility of shifting foreign exchange rates than international travel. Over the past decade, travel companies around the world have often had to navigate rapid, large, and sometimes unexpected currency shifts. Sometimes foreign exchange rate shifts benefit travel companies – but sometimes they imperil those businesses.

Potential Benefits from Shifting Foreign Exchange Rates

Changing foreign exchange rates can sometimes benefit travel companies. For example, consider a travel company whose business is based on providing local tours or other services to tourists flying in from abroad. All else equal, if this company’s local currency has depreciated against its foreign visitors’ currency, its prices will drop, potentially attracting more foreign customers.

The U.K.’s Travel Magazine reported that a visitor bringing 100 euros to Britain could exchange them for 84 British pounds on August 2, 2016, compared with just 70 pounds one year earlier. Over that time period, a U.K. vacation became a 20 percent better value.1 Immediately after the U.K.’s European Union referendum, which led to predictions that the British pound would decline further against the U.S. dollar, British Airways reported soaring searches for flights from the U.S.2

However, many factors go into consumer decisions about international travel. Sometimes it takes time for shifting foreign exchange rates to change a destination’s reputation for value. Therefore, a weaker local currency doesn’t necessarily translate into more visitors immediately -- nor, conversely, does a stronger currency instantly empty out the hotels.

In 2011, Tourism Australia found that inbound travelers varied widely in their reaction to an Australian dollar then trading at an extremely high price. Travelers from Singapore, Korea, and Hong Kong changed behavior more than Canadians did; vacationers were more influenced than business travelers; “baby boomers” were more responsive than younger travelers. Overall, travelers kept coming, but some cut back on expenditures after arriving.3 Something similar appeared to happen in the Orlando, Florida area as Brazilian tourists struggled with the decline of the Brazilian real against the U.S. dollar a few years ago: they still came, but some purchased fewer souvenirs or stayed in lower-cost venues.4

Downside Currency Risks of Selling Foreign Travel

In one respect, however, international travel providers are at immediate and serious risk from shifting currency markets. Consider a company selling foreign tours, flights, lodging, or cruises to local customers planning future vacations. Typically, the company must set its prices for these services quite early: occasionally, as much as 18 months in advance.5

If the company’s home currency drops between a customer’s advance payment and the date when foreign suppliers must be paid, the company could easily find itself paying unexpectedly high costs -- wiping out profit, creating a loss, or requiring the company to take the undesirable step of asking customers for more money.

That’s the situation the U.K.’s Jasmine Holidays found itself in when the British pound dropped in the days after the European Union referendum. According to The Telegraph, it surcharged customers by up to 185 pounds (about $240) per person, while offering them a corresponding discount off any future trips.6

US tour provider Jean-Paul Tennant of Geographic Expeditions faced a similar challenge years earlier. As he told the New York Times he had booked a tour of northern India for eight clients. Then, the Indian rupee soared against the dollar, and his Indian supplier demanded $1,500 more per person.7

Potential Solutions, Simple and Complex

In this case, Tennant was able to locate another supplier whose costs weren’t as prohibitive. That was one lesson he learned from the experience, according to the Times: wherever practical, have at least two destination suppliers to choose from.

Tennant also began attempting to negotiate contracts that limit or eliminate currency-related price changes. 8 (Of course, to gain that concession, travel companies may sometimes have to accept a higher upfront price, since their suppliers are accepting greater currency risk.)

Depending on how extensively they operate in a given location, some travel companies may buy foreign currency ahead of time, perhaps even maintaining a foreign bank account it can use to pay in the destination currency with no need for conversion. 9

Often, however, travel providers like Tennant rely on currency forward contracts to mitigate currency risks. The travel company commits to purchasing a specific amount of a foreign currency at a specific rate, at a specific future date (or, in some cases, between a range of dates -- for example, within a given week or month). In essence, the forward contract insures the provider against a rise in the value of the foreign currency that will be needed.

Once signed, a forward contract requires the travel company to purchase the agreed-upon currency even if a trip is canceled or currency markets move in the opposite direction. According to Jonathan Hyman, Chief Economist at FXcompared Intelligence, options may occasionally be worth considering instead. These “grant the right, but not the obligation” to make a currency purchase at an agreed-upon rate and date. As Hyman notes, options are more complex “and so are more suited to high currency volumes, especially when the timing… is not known.” Hyman cites the example of sporting tours, which might depend upon whether a team qualifies for a foreign tournament.10

As derivative instruments become more complex, however, they can also become harder to understand and potentially more unpredictable -- and not all travel companies have the tools or knowledge to evaluate them, as a Euromoneym article noted.11

The Takeaway

Companies that serve international travelers can face significant risks from shifting currency values. Several tools are available to help them, including forward contracts for locking in currency rates well in advance.

Bill Camarda - The Author

The Author

Bill Camarda

Bill Camarda is a professional writer with more than 30 years’ experience focusing on business and technology. He is author or co-author of 19 books on information technology and has written for clients including American Express Private Bank, Ernst & Young, Financial Times Knowledge and IBM.

Sources

1.“Brexit and the UK’s Inbound Tourism Industry,” Travel Magazine, Aug 19, 2016. http://www.thetravelmagazine.net/brexit-and-uk-inbound-tourism.html
2.Ibid.
3.“Exchange rates: challenges and opportunities for Australian tourism,” June 2011. http://www.tourism.australia.com/documents/corporate/Exchange_Rates.pdf
4.“Exchange rates affect international tourist spending power,” Orlando Sentinel, September 20, 2015. http://www.orlandosentinel.com/business/tourism/os-orlando-tourism-exchange-rate-20150920-story.html
5.“Exchange rates the number one issue for many Travel and Hospitality Companies,” ICAEW, https://ion.icaew.com/tourismandhospitality/b/weblog/posts/exchangeratesthenumberoneissueformanytravelandhospitalitycompanies
6.“Tour operator blames Brexit after returning to customers to demand more cash,” The Telegraph, August 17, 2016. http://www.telegraph.co.uk/travel/news/tour-operator-applies-holiday-surcharge-blaming-brexit/
7.“Looking Overseas, Businesses Learn to Master Currency Exchange,” The New York Times,http://www.nytimes.com/2013/04/18/business/smallbusiness/businesses-going-abroad-learn-to-master-currencies.html
8.Ibid.
9.“How FX Rates Affect Travel Businesses and How to Minimize the Risks,” Wex Travel Payments Insights, http://www.wexinc.com/wex-travel/how-fx-rates-affect-travel-businesses-and-how-to-minimize-the-risks/
10.“Exchange rates the number one issue for many Travel and Hospitality Companies,” ICAEW, https://ion.icaew.com/tourismandhospitality/b/weblog/posts/exchangeratesthenumberoneissueformanytravelandhospitalitycompanies
11. “FX mis-selling: Travel companies take aim at banks,” Euromoney, June 25, 2015, http://www.euromoney.com/Article/3465525/FX-mis-selling-Travel-companies-take-aim-at-banks.html?copyrightInfo=true

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