Adam Ismail12.01.07
The Ugly Economy
Companies must be more educated on the impact of economic factors like the weakening U.S. dollar.
ByAdam Ismail
There is a lot of uncertainty facing the global economy at the moment, and the nutraceuticals industry is not immune. Factors ranging from the global credit crunch to the weak U.S. dollar may have a potentially damaging impact on this industry, in almost every step in the value chain.
Aside from a general risk of recession, the weak dollar probably poses the biggest threat to the nutraceuticals market. Raw materials in this industry have been traded in U.S. dollars for the past two decades, regardless of where they come from. Traditionally, a weak dollar means goods manufactured in the U.S. are cheaper for customers in other countries, which boosts U.S. exports. However, in this space, in some cases, raw material production process, or at least parts of it, have essentially shifted entirely outside of the U.S. because costs of production are much lower, particularly in places like China and India. The weak dollar has the potential to change the balance of supply in the industry again if it weakens further.
If a nutraceutical ingredient is produced in regions such as Europe, China or India, then presumably the costs of producing those ingredients is in Euros, renminbi or rupees—the problem occurs when companies sell those ingredients in U.S. dollars. If the dollar is worth fewer Euros, then European producers will encounter increasingly smaller margins and at some point be forced to take action.
A simple model for trying to measure the potential risk of exchange rates is to analyze which currencies are used in all of the value chains you are interested in and identify the points in the chain at which a significant weakening of the dollar would squeeze profits. Once you have identified those points, you can identify strategies for dealing with the effects of falling profits in the various segments.
The Weak Dollar Impact:
Current Market Examples
In the case of fish oils, most crude fish oil comes from South America or Africa, and is then refined in countries around the world. However, there are some suppliers that source specific types of crude fish oil from European fisheries, like salmon oil. Fish oils have traditionally been sold in U.S. dollars, which means when the U.S. dollar falls in comparison to the Euro or other European currencies, then the value of the oil you produce is worth less in your own currency.
For instance, if you sell 1 kilogram of refined salmon oil for $5 per kilogram, but it costs you €3 to produce it, then at a 1:1 exchange rate you are essentially making €2 per kilogram in gross profit. If the dollar falls in value by 40%, as it has over the course of the past three to four years, then that same $5 selling price is actually only worth €3 in your own currency. This translates into an evaporation of profits due to the weak dollar.
While these specific numbers are not real, the scenario is. In fact, this particular situation has prompted some producers in the market to make various choices about how to address changes like this. Some have begun sourcing crude salmon oil from Canadian and U.S. fisheries that are more linked to the U.S. dollar, while others have begun selling their refined products in Euros. Some have even stopped selling products like this because they are at a disadvantage to foreign competition.
This is not a unique situation. Other pro-ducts, such as vitamins, are made almost exclusively in China now. The Chinese government has fixed its exchange rate to a basket of currencies that is heavily dominated by the dollar. Essentially this means that the profitability of products produced in China should not be affected dramatically by the dollar. The catch is that the Chinese government is concerned with how far the dollar is falling and is considering decreasing the weight of the dollar in the basket of currencies to which it has tied its currency. If they do take action, vitamin producers can expect their profits to be squeezed gradually over the next couple of years.
If the situation gets as bad with the dollar as most analysts think it will, every company in this industry should immediately mo-bilize and analyze the potential impact on their business. Even if your company is just a small branded food or supplement manufacturer that focuses on one country, the value chain for your nutraceutical products surely can be traced back to other countries. This means you too will feel the impact of further weakness in the dollar, and should have a strategy ready to address it.NW