How to mitigate risks in international trade? Types and strategies

If you're concerned about the stability of global supply chains and the impact of geopolitical events on your business, you need to learn how to mitigate the risks in international trade. 

And if you're a small or medium-sized business (SMB) dipping your toes in the global pond, the stakes are even higher. Limited resources and tighter margins mean disruptions hit harder. 

In fact, 21.6% of US-based SMBs reported significant negative impacts from the COVID-19 pandemic, which is just one example of how worldwide events can ripple across borders.

This guide will help you identify the pitfalls of international trade, from unpaid invoices to political turmoil. More importantly, you'll learn strategies to mitigate these risks, protect your business, and unlock growth potential in new markets.

What is trade risk?

Trade risk is the possibility of financial loss or setbacks stemming from the ever-changing nature of international commerce. Factors like sudden currency swings, political upheavals, regulatory shifts, and natural disasters can disrupt the most carefully crafted business plans.

Ignoring trade risk is like setting sail without checking the weather forecast. You might encounter smooth sailing for a while, but a sudden storm could leave you stranded.

Common types of risks in international trade

Let's dive into the most common categories of international trade risks, exploring examples and actionable mitigation strategies for each.

1. Commercial risks

Commercial risks in international trade are the bread-and-butter challenges of doing business, magnified on the global stage. These threats stem from the contractual agreements and practicalities of buying and selling goods or services across borders.

Non-payment risk

You shipped, and they ghosted. Non-payment or crippling delays can sink a small business faster than a rogue wave. Maybe the buyer is struggling; perhaps they're shady. Either way, your cashflow is wrecked.

For example, the 2016 collapse of Hanjin Shipping, once the world's seventh-largest container carrier, sent shockwaves through global supply chains. Businesses supplying goods to Hanjin found themselves grappling with unpaid invoices and stranded cargo, leading to severe financial losses.

How to mitigate non-payment risk in international trade:

• Due diligence: Before extending credit, thoroughly vet potential buyers. Get credit reports, verify business registration, and contact references
• Secure payment terms: Negotiate favorable payment terms upfront, such as upfront payments, letters of credit (LCs), or partial prepayments
• Trade credit insurance: Consider this insurance policy that protects your company from losses due to non-payment by foreign buyers

Do you want to get paid faster and reduce non-payment risk altogether? Learn more about accelerating payment on your invoices.

Contractual disputes

Ambiguous contract language, cultural misunderstandings, or differing legal interpretations can quickly escalate into costly disputes. Resolving these conflicts across borders can be time-consuming, expensive, and damage valuable business relationships.

Hypothetical example: A small US-based textile manufacturer agreed to supply fabric to a European fashion brand. However, the contract lacked specific details about acceptable fabric dye variations. When the buyer received the shipment, they claimed the color deviations were unacceptable, leading to a legal battle.

How to mitigate contractual dispute risks in international trade:

• Crystal-clear contracts: Hire legal professionals experienced in cross-border trade to draft and review contracts. Ensure all terms and conditions are clearly defined, leaving no room for misinterpretation
• Dispute resolution clauses: Include clauses specifying how disputes will be resolved, such as mediation or arbitration, to avoid lengthy and expensive court battles
• Mastering Incoterms: A crucial aspect of international contracts is defining responsibilities for shipping and delivery. Get clarity on the 11 Incoterms and how they impact your obligations

Supply chain disruptions

Remember the Ever Given, the massive container ship that blocked the Suez Canal in 2021? While exceptional, this incident highlighted the vulnerability of global supply chains.

Even minor issues can cascade into atypical delays, increased costs, and frustrated customers, affecting your bottom line and brand reputation.

How to mitigate supply chain risks in international trade:

• Diversify your supplier base: Don't rely on a single source for critical components or materials
• Build strong relationships: Cultivate open communication and trust with your suppliers to facilitate flexibility and collaboration during times of disruption
• Inventory management: Consider holding strategic safety stock for essential items to buffer against potential delays

2. Political risks

Political risk in international trade refers to the potential for political decisions, events, or conditions in a target country to affect a business's operations or profitability negatively. These threats can materialize swiftly and unexpectedly, catching importers and exporters off guard and causing exceptional disruption.

Expropriation of assets

This high-impact risk involves a foreign government seizing a company's assets, either with or without compensation. While extreme, it's a threat businesses must consider, mainly when operating in countries with a history of nationalization or political instability.

In 2008, Venezuela nationalized numerous industries, including the cement industry. This move led to the seizure of assets from foreign companies like the Cemex, causing billions of dollars in losses. Cemex eventually received compensation, but the lesson stung: political risk is real.

Regulatory changes

Governments frequently adjust trade policies, import/export regulations, and tax laws. While often implemented with good intentions, these changes can disrupt established business practices and affect profitability.

For instance, the ongoing US-China trade war, characterized by tit-for-tat tariffs on billions of dollars worth of goods, has created significant uncertainty for those operating in both countries. Businesses may face increased costs, supply chain instability, and reduced market access.

Political instability and civil unrest

From protests and strikes to regime changes and armed conflicts, political instability can rapidly escalate, disrupting supply chains, damaging assets, and jeopardizing the safety of employees. This category encompasses a wide range of risks, and the ongoing war in Ukraine exemplifies its potential to impact global trade.

How to mitigate political risks in international trade:

• Diversify sourcing and manufacturing: Avoid over-reliance on a single country for supplies or production
• Stay informed: Monitor political and economic developments in your target markets
• Flexibility and adaptability: Build agility into your business model to adapt to changing regulations
• Due diligence: Before investing in a foreign market, conduct extensive research on the political climate, government policies, and history of expropriation
• Political risk insurance: This specialized insurance can provide coverage for losses incurred due to events like expropriation, war, or civil unrest

3. Currency risks

Currency exchange rates are constantly changing in the global marketplace, adding a layer of complexity. This threat often falls under the broader umbrella of credit risk in international trade. Fluctuations in exchange rates can impact a buyer's ability to pay in the agreed-upon currency, leading to losses for the seller.

Here's a summarized breakdown of the critical currency risks:

• Transaction exposure: Rate fluctuations influence the value of a transaction between the agreement date and the payment date
• Economic exposure: Currency fluctuations can affect a company's competitiveness and profitability, even without direct worldwide transactions
• Translation exposure: Exchange rate fluctuations may alter the value of a company's assets, liabilities, and earnings when consolidating financial statements from subsidiaries operating in different currencies

But how do you mitigate these types of risks in international trade? Several tools are available, from using hedging instruments and optimizing pricing strategies to exploring natural hedging and employing balance sheet hedging techniques.

4. Documentary risks

Documentary risks refer to the potential for financial losses, delays, or penalties arising from errors, omissions, or discrepancies in the various documents required for cross-border transactions.

For example, shipping documents, such as bills of lading, commercial invoices, and packing lists, are critical evidence of the goods being shipped, their value, and the transaction terms. Errors in these documents can lead to:

• Delays in customs clearance: Incorrectly filled or missing information can trigger customs inspections, delaying the release of goods
• Increased storage and demurrage fees: Delays in customs often result in additional storage charges at ports or warehouses
• Rejection of goods: In some cases, customs authorities may refuse entry to goods accompanied by inaccurate or incomplete documentation

To mitigate these types of risks in international trade, you should adopt a proactive and meticulous approach to documentation:

• Use templates to ensure consistency and reduce the likelihood of errors
• Collaborate with experienced freight forwarders, customs brokers, and trade finance specialists
• Leverage technology solutions, such as electronic data interchange (EDI) and online document management systems
• Implement a multi-step review process for all trade documents, involving multiple parties to guarantee accuracy and completeness
• Provide regular training to employees involved in international trade operations to keep them updated on documentation requirements

Are you importing or exporting goods? Then, learn more about the Import General Manifest, a crucial document for customs clearance.

5. Country risks

Country risks encompass the economic, political, and legal landscapes of your target markets, influencing the success and profitability of your global operations. 

We've already touched upon categories like political and currency risks regarding countries. Now, let's focus on countries’ economic risks in international trade and how they can impact your trade endeavors.

A country’s economic health and stability play an essential role in shaping the demand for your products or services and the overall profitability of your operations. Key economic risks include:

• Economic slowdowns and recessions: A downturn in a target market can lead to reduced consumer spending, lower demand for imports, and increased competition
• Currency fluctuations: As discussed earlier, volatile exchange rates can erode profit margins, increase import costs, and create uncertainty in pricing and financial planning
• Inflation and interest rate volatility: High inflation can weaken purchasing power, impact pricing strategies, and create challenges for managing cashflow

To manage country risks, you should adopt a proactive approach:

• Use resources from government agencies, international organizations (World Bank, IMF), credit rating agencies, and risk assessment firms to gather up-to-date information
• Reduce reliance on a single market by spreading your operations across multiple countries with diverse economic and political landscapes
• Collaborate with local businesses or agents who possess invaluable market knowledge and established networks
• Develop contingency plans for various potential scenarios, such as economic downturns, political instability, or regulatory changes

Safeguard your business from the erosive effects of inflation: Learn how to inflation-proof your business and maintain profitability.

While this guide addresses many common risks in international trade, it's important to remember that some forces are beyond your control. Natural disasters, pandemics, and other unforeseen events can disrupt the most well-prepared businesses.

Minimizing risk, maximizing success in global trade

Trade risks are multifaceted, ranging from financial uncertainties and contractual disputes to political instability and regulatory complexities. But by understanding these threats and implementing proactive mitigation strategies, you can seize global opportunities while protecting your hard-earned success.

But don't wait for threats to materialize. Develop comprehensive risk management plans that include preventive measures, contingency plans, and clear communication protocols.

Speaking of proactive planning, let's discuss one of the biggest potential stumbling blocks in international trade: cashflow. Getting paid on time, especially with overseas clients, can be a nail-biter.

But there's a way to take control: invoice financing. 

Think of it as bridging the gap. You get paid faster, even when dealing with clients across continents. That means more fuel for your business: more inventory, more marketing, more of what you need to grow.

Don't let payment delays derail your global growth. Get funded with Stenn.