A trading house is a business that facilitates trade between two countries – i.e., a foreign country and a home country. It provides a service that eliminates trading barriers to enter into foreign markets, especially for small companies with limited resources or import or export capability.
Trading houses promote both imports and exports by purchasing and selling products through local or overseas sales offices. A trading firm can also market goods and services produced locally in foreign countries while performing other intermediary roles.
The term trading house may also mean a company that trades physical commodities and commodity futures on customers’ behalf. The US is home to multiple trading houses such as Vitol and Cargill.
A trading house is a business that focuses on international commercial activities by exporting or importing manufactured goods between two or more countries.
Trading houses act as agents for foreign sellers or buyers seeking new markets for products and services.
Japan’s “Sogoshosh” is an example of a trading house created in the early days of the Meiji Revolution when the country first opened its doors to international trade.
Understanding Trading Houses
A trading house promotes the buying and selling of products across national borders. It performs its role by purchasing different products, say, from Japan, then market and sell them to a retailer based in the U.S.
As an agent for foreign sellers seeking buyers in the local market, a trading house may impose slightly higher prices for the products than it would if the retailer purchased the commodities directly from Japan. The pricing of goods using a mark-up approach aims to compensate for costs incurred and to produce a profit.
Dealing with few trading houses instead of numerous wholesalers is advantageous to the retailer, as it simplifies the process to acquire internationally manufactured products. Other benefits that come with using trading houses for exporters include insight and expertise into the international markets in which they wish to enter. Also, the businesses may get vendor financing through trade credits and direct loans.
Additional Roles of Trading Houses
Trading houses are also involved in intermediary services to provide operational and logistics services most effectively. They may handle the paperwork involved when importing or exporting commodities, offer storage arrangements, advise on modes of transport, obtain foreign exchange, or arrange insurance for the local retailers.
Trading houses may also link clients to new customers and special agencies, arrange financial credit, and offer market research for clients. Additionally, trading houses develop trading flows by identifying markets using specialized products.
In essence, a trading house is created based on supply and demand. Large manufacturers can employ their own trading houses but on a contractual basis. The major strength for most trading houses is that they become the principals for some products and markets, assuming and reducing the risks stemming from foreign markets.
Trading Houses and Debt Security Markets
Capital markets influence corporations by buying and selling quoted equities and debt securities, such as notes, bonds, and debentures. A corporation typically issues debt securities under an indenture or debt agreement, which specifies the terms of the loan in great detail. The valuation of debt securities is expressed in terms of interest rates or the cost of insuring investments.
Large corporations-based investors tend to dominate the market; hence, the composition of market participants in debt securities markets does not vary significantly. As a result, some trading houses target institutional investors by issuing and listing securities in foreign markets.
Advantages of Trading Houses
1. Economies of scale
Trading houses enjoy economies of scale courtesy of large clients’ portfolios. For instance, established trading houses may reap the benefits of discounts from manufacturers and suppliers, owing to their significant buying power. They can also import commodities in bulk on behalf of customers to reduce transportation costs.
2. Management of currency
Trading houses are well-equipped with the expertise to hedge currency risks. Since they continually trade across international borders, trading houses employ various risk management strategies to prevent exposure to fluctuations of different currencies. A currency forward contract is an example of a hedging technique that a trading house may adopt to minimize risks in its future payment using a different currency by locking the current exchange rate.
3. International presence
Trading houses often develop extensive contacts when conducting international commercial activities that serve as the basis for major business deals and an avenue for new clients. Besides, trading houses may have an open foreign office with staff who collaborate with customs officials to handle any legal disputes to ensure their businesses operate smoothly.
Example of Trading Houses
Japan’s chronic trade deficit in resources, whether natural resources or food, is well known. It tends to import most of its products from foreign countries through its five trading houses referred to as “Sogoshosh.” The institution came to fruition during the Meiji restoration era, with roots in other countries to bolster its economy.
Sogoshosh’s helped Japan overcome the economic aftermaths following the World War II defeat. The trading house extends to the various sectors of the country’s economy. Its five trading houses are Sumitomo Corp., Itochu Corp., Mitsubishi Corp., Marubeni Corp., and Mitsui & Co. Ltd. Through the government’s support, the trading house’s been able to ward off threats stemming from foreign markets and geographical isolation.
CFI offers the Capital Markets & Securities Analyst (CMSA)® certification program for those looking to take their careers to the next level. To keep learning and developing your knowledge base, please explore the additional relevant resources below: