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 US dollars. Most likely its internal reporting is by country, and is done with both local currency before being translated over to USD.
Contributions to Profit
In the United States, Amazon’s annual sales are $193.6 billion. The two largest foreign markets are Germany ($22.2. billion) and the UK ($17.5 billion), with Japan at fourth ($16 billion) (Statista, 2019). The currencies are the euro and pound respectively in these countries, and those currencies are used on the retail side. They are highly likely to be the currencies of choice on the cost side as well. While Amazon does not specify this, these are very large markets and goods sourced in and for these markets will almost always be denominated in their home currencies. It is entirely possible that for some of Amazon’s smaller markets, other currencies besides the home one might be used for the costs – for example a small market country in Europe that would source much of its consumer goods in euros.
Combined, foreign currency operations contribute $280.522 billion to Amazon’s revenues, and $265.981 billion to its expenses, so there is both a substantial top line and bottom line impact for Amazon of foreign currency exchange rates. The impact of exchange rates is slightly different each year, and for the revenue and cost sides, because of where and when the revenues and costs take place. For example, in 2019 the foreign currency impact was slightly bigger on the cost side than on the revenue side. Nevertheless, when taken on a percentage basis of Amazon’s overall scale, the exchange rate effect ($180 million last year, $226 million the year before) is relatively inconsequential (Amazon 2019 Annual Report).
Hedging
Given that sales from international operations constituted 27% of revenue for Amazon, the company faces a substantial amount of foreign exchange rate risk. This risk is recorded in both the North America segment (i.e. Canada and Mexico) and the International segment. Outside of North America, most of the risk comes from British pounds, euros and Japanese yen. Aside from the Mexican peso, the top four countries for foreign exchange rate risk are all in the category of reserve currencies. These are the currencies that are most widely-held by central banks around the world, most commonly used in international transactions, and for which the most robust forex markets exist. The US is the world’s largest reserve currency, followed by the euro, the yen and the pound. The Canadian dollar ranks sixth, just behind the Chinese renminbi (HowMuch,net, 2019).
What this means for Amazon is that much of its exposure to foreign exchange rate risk is in reserve currencies that can fairly easily be subject to a financial hedge. That said, Amazon’s first choice is the operating hedge. An operating hedge is when a company matches to the best of its ability the revenues and costs associated with doing business in a country. For a manufacturer, this can be quite difficult because it means that the company has to produce in that country. But for a retailer, if it is large enough to source most of its goods in a given country in local currency, then it can establish an operating hedge. That said, if Amazon is selling in Canada, but those goods come from China and are purchased in USD and then shipped to North America, there will still be forex risk exposure. In Europe, the UK and Japan, it should be expected that there is a more significant operating hedge in place for Amazon, and those are the three largest foreign currency markets that the company has.
Another means of hedging foreign currency exchange risk is through diversification. The way that works is that if Amazon is operating in just one foreign country, then all the revenues and profits from that operation are subject to the risk associated with a single currency pairing. Amazon operates in around fifty different currencies around the world, and that provides a measure of diversification for it. How this works is similar to how diversification works in any other context. If Amazon faces a foreign exchange loss on its British operations, but a foreign currency gain on its European operations, then the loss and gain can mainly cancel each other out. This is not necessarily going to happen when translating forex transactions back to USD, because the USD tends to be the world’s reserve currency and often if it increases in strength then it increases against all other currencies. But Amazon does have a high degree of diversification for its foreign currency exchange rate risk.
A third means of hedging against foreign currency exchange rate risk is to utilize forex markets, options and other tactics in order to manage the volatility associated with foreign currency risk (Reiff, 2020). For Amazon, however, most of the risk it faces with foreign exchange in translation risk, rather than transaction risk. Hedging techniques, such as derivatives trading, tend to be better for transactional forex risk. For translational risk, there is no movement of currency, no transactions, just the risk associated with translating foreign currency-denominated transactions back to US dollars for reporting purposes. Diversification is a better approach for this, rather than transactional approaches.
The company outlines what this translational exposure can mean for its financial statements, in the 2019 Annual Report: “Based on the balance of foreign funds as of December 31, 2019 of $15.3 billion, an assumed 5%, 10% and 20% adverse change to foreign exchange would result in fair value declines of $765 million, $1.5 billion and $3.1 billion. Fluctuations in fair value are recorded in “Accumulated other comprehensive income (loss)â€, a separate component of stockholder’s equity.†The company further notes that “Equity securities with readily determinable fair values are included in “Marketing securities†on our consolidated balance sheets, and are measured at fair value with changes recognized in net income. There will also be year-over-year variability in the impact that foreign exchange rate volatility has on Amazon’s financial statements. For example, in 2017 the company saw a forex gain of $202 million, a loss of $186 the next year, and a $95 million gain last year, according to the 2019 Annual Report.
Impact of USD Changes
Amazon’s financial statements are in US dollars. What this means is that if the USD increases in value – for this example we will assume this is against all of Amazon’s foreign currencies – then Amazon’s profits will decrease, all other things being equal. The independent variable is the value of the US versus these other currencies. If the value of the USD goes up against those currencies, then the profits from those operations will be lower once translated into USD. If the foreign operations were losing money, on the other hand, the opposite would occur. But since on aggregate Amazon’s foreign operations are profitable, the value of that profit in USD would decrease if the USD rose in value.
The opposite holds true if the USD goes down in value. In that case, the foreign currencies would be more valuable when translated back to USD. So a decline in the value of the USD would increase Amazon’s profitability, because the value of the foreign profits would be higher in USD terms.
Conclusions
Amazon does most of its business in the US by far, 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 sheet, and once placed into that context Amazon does appear to have an effective strategy for dealing with the foreign currency exchange rate risk that it faces.
References
Amazon 2019 Annual Report. Retrieved April 29, 2020 from https://s2.q4cdn.com/299287126/files/doc_financials/2020/ar/2019-Annual-Report.pdf
HowMuch.net (2019) Charting the most powerful reserve currencies in the world. HowMuch.net. Retrieved April 29, 2020 from https://howmuch.net/articles/worlds-top-reserve-currencies-2019
Mehta, N., Detroja, P. & Agashe, A. (2018) Amazon changes prices on its products about every 10 minutes – here’s how and why they do it. Business Insider. Retrieved April 29, 2020 from https://www.businessinsider.com/amazon-price-changes-2018-8
Reiff, N. (2020) Hedge. Investopedia. Retrieved April 29, 2020 from https://www.investopedia.com/terms/h/hedge.asp
Roamy (2019) The consequences of Amazon’s pricing power. Medium.com. Retrieved April 29, 2020 from https://medium.com/goods-services/https-medium-com-goods-services-amazons-pricing-power-797e28b63fbd
Statista (2019) Annual net sales of Amazon in selected leading markets from 2014 to 2019. Statista. Retrieved April 29, 2020 from https://www.statista.com/statistics/672782/net-sales-of-amazon-leading-markets/
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