Types of Risk

Types of Risks in Export and Import Business

Engaging in international trade exposes businesses to a variety of risks. These risks can be broadly categorized into several key areas. Understanding these categories and their potential impacts is crucial for effective risk management.

Here's a breakdown of the common types of risks associated with export and import activities:

1. Commercial Risk

• Definition: Commercial risks stem from factors related to the market, product, and operational challenges in international trade. Essentially, these are the risks that arise from trying to do business in a new market.
• Causes:
  • Lack of knowledge about foreign markets: Not understanding local preferences, competition, or cultural nuances.
    • Example: A company exporting winter coats to a tropical country would face low demand due to a lack of market knowledge.
  • Inadaptability of the product: Offering a product that doesn't meet local requirements or preferences.
    • Example: An exporter tries selling a product that requires 220V power in a country with 110V power, leading to returns.
  • Longer transit times: Extended shipping durations increase the risk of damage, spoilage, or changes in market demand.
    • Example: Shipping fresh produce over a long period without proper storage, leading to spoilage.
  • Varying situations, such as changes in preferences and fashion: Shifting consumer tastes or trends that make a product obsolete.
    • Example: A fashion retailer orders a large quantity of clothing that is no longer in style by the time it arrives.
  • Competition: Fierce competition from local or international players can reduce sales and profitability.
    • Example: New local competitors offering a similar product at a lower price, significantly decreasing sales.
• Mitigation:
  • Market research: Conduct thorough research to understand the target market.
  • Product adaptation: Modify products to meet local needs and preferences.
  • Efficient logistics: Choose reliable and fast shipping methods.
  • Monitoring market trends: Stay updated on changing consumer tastes and preferences.
  • Competitive pricing and marketing: Strategically position your product against competitors.

2. Political Risk

• Definition: Political risks arise from governmental or political actions that can disrupt or negatively impact business operations. This risk is especially concerning because these issues are often very hard to predict.
• Causes:
  • Changes in political power and policies: New governments introducing different trade policies, tariffs, or regulations.
    • Example: A new government implements stricter import restrictions, making it harder for a company to export goods.
  • Coups, civil wars, and rebellions: Political instability that disrupts business operations and supply chains.
    • Example: A civil war causes widespread disruption, preventing a company from fulfilling its export orders.
  • Wars between countries: Conflicts that can lead to trade embargoes, border closures, or the capture of cargo.
    • Example: A trade war leads to significant tariffs on imports and exports, making a business uncompetitive.
  • Capture of cargo during war: Ships and their cargo being seized during a war or conflict.
    • Example: Cargo ships are captured by the military, leading to losses for the exporters.
• Mitigation:
  • Careful country selection: Avoid high-risk countries with political instability.
  • Political risk insurance: Obtain insurance to cover losses due to political events.
  • ECGC coverage: Export Credit Guarantee Corporation offers protection against some political risks.
  • Diversification: Spread business operations across different countries to reduce reliance on one political environment.

3. Risks Arising Out of Foreign Laws

• Definition: Legal risks are related to the complexities and uncertainties of different legal systems in foreign countries.
• Causes:
  • Different laws operating in the domestic country: Conflicts between domestic and foreign laws.
    • Example: A contract that is valid in one country might not be in another due to different legal standards.
  • Expensive and complex litigation: Costly legal battles and difficulty in pursuing legal action in a foreign country.
    • Example: Having to deal with litigation in a foreign court is both complex and expensive.
• Mitigation:
  • Arbitration clause: Include an arbitration clause in contracts to resolve disputes outside of courts.
  • Legal consultation: Seek legal advice from experts familiar with international law.
  • Detailed contracts: Clearly define terms and conditions in contracts to avoid ambiguity.
  • Compliance: Ensure all business practices adhere to local laws and regulations.

4. Cargo Risk

• Definition: Cargo risks encompass potential losses or damages to goods during transportation. This can be from natural causes, or human error.
• Types of Perils:
  • Marine Perils: Natural occurrences or man-made mishaps at sea.
    • Natural: Earthquakes, storms, lightning, water entry into the vessel.
    • Man-made: Fire, smoke, collisions.
  • Extraneous Perils: Incidental perils during loading, carrying, and unloading.
    • Example: Goods falling during loading, or forklift accidents.
  • War Perils: Losses due to wars or civil conflicts.
    • Example: Cargo is damaged as a result of the war.
• Mitigation:
  • Marine Insurance: Obtain insurance to cover damage or loss during transit.
  • Proper packaging: Secure goods to withstand transport conditions.
  • Reliable logistics partners: Choose carriers with a history of safe delivery.

5. Credit Risk

• Definition: Credit risk arises from the possibility that a buyer might not pay for goods or services as agreed. This is exacerbated by the distance and time involved in international trade.
• Causes:
  • Inability of buyers to pay: Buyers may become insolvent, go bankrupt, or simply refuse to pay.
    • Example: A buyer becomes bankrupt, and is unable to pay for their last shipment.
  • Changing situations in the buyer’s country: Economic issues that prevent the buyer from transferring funds.
    • Example: A government in the buying country implements strict capital controls, preventing funds from being sent abroad.
• Mitigation:
  • Credit checks: Conduct thorough credit checks on buyers before offering credit.
  • Payment terms: Negotiate payment terms that are suitable for both parties.
  • Letters of credit: Use letters of credit, which offer a bank guarantee of payment.
  • Export credit insurance: Insure against the risk of non-payment by buyers.

6. Foreign Exchange Risk

• Definition: Foreign exchange risk stems from the fluctuations in exchange rates that can impact profitability.
• Impact:
  • Loss of profits: Adverse currency movements can reduce profits when converting foreign payments back into the domestic currency.
    • Example: A company sells goods for $100 in a foreign currency and expects it to be equivalent to $90 USD, but due to currency fluctuations it is only worth $80 when they go to change it.
• Mitigation:
  • Forward contracts: Lock in exchange rates for future transactions.
  • Currency options: The option to buy or sell currency at a specific rate.
  • Natural hedging: Try to match foreign payments with foreign debts.
  • Diversification of currencies: Reduce reliance on a single currency.

Conclusion

Navigating the complexities of international trade requires a thorough understanding of these different types of risks. By implementing proactive risk management strategies, businesses can mitigate potential losses and capitalize on global opportunities. It’s vital to be prepared for the unexpected, stay informed, and adapt to changing conditions in the global marketplace.