How do forex companies make money?

I spend a lot of time in malls. Not because I’m a shopaholic but because they’re connected to the metro, they were a warm way to walk to school, all the best coffee shops were in malls etc. Often, I wonder how certain shops make money. Obviously, stores like Dollarama make a killing and can afford to be in a downtown mall. Same with the high-end shops that have enormous mark-ups on their products. There are stores, every once and awhile, that I see and think “I don’t think that you can generate enough profit to stay in business here…” and, more often than not, I am right.

Exceptions:

• There’s a nail salon on the 5th floor of the Eaton Centre. The 5th floor is not a popular floor. There’s like… a Baby Gap, Old Navy and a game shop. Nevertheless, this nail salon has been there for at least 7 years.
• The camera shop in Place Montreal Trust and the Eaton Centre. It’s the same shop less than 50m from the other! They sell cameras and develop pictures!
• The store that sells whore clothing in Les Ailes de la Mode. I don’t know what it’s called but my friend’s boyfriend referred to the clothes as “things that whores would wear” and the name stuck. I never see anyone in there and nothing is priced more than $10.
• The countless forex shops in the entire downtown core

There are two-types of forex shops:

1. The wide-selection, professional shops: These places are fancy-looking. Glass, chrome, usually blue. They have fancy signs indicating the prices of the dozens of currencies that they buy/sell. These shops are usually in more prime locations (major tourist areas, airports) that charge higher rents and, as a result, have less favourable rates and often charge commission. If you need South African Rand, this is the place that you go to — they’ve kind of got a monopoly on the less-popular currencies
2. The slim-selection shops: These shops are everywhere. They are easy to set up — simply buy a sign, hang it in the window of your coffee shop or souvenir stand and voila! you sell currency! These shops are so prevalent that, on December 26th at 9am when I needed Euros and GBP, I found no less than 7 shops open in the 3 blocks from my house. I was able to compare rates, at 9am, on a quasi-holiday. Because of the competition, they have better rates and rarely charge commission. On the flip-side, these smaller shops usually only carry USD, GBP and Euros

So how do these places make money? Seriously.

First, there’s the issue of supply and demand. The larger shops can hedge against loss by moving money around the world as needed. Need USD in Paris? Voila! Need GBP in Australia? Here you go mate! For the smaller merchants, there is no way for them to control supply and demand, nor hedge against it. If, I had sold 1000 Euros to my favourite forex shop yesterday at, say, $1.35 and then bought them today at $1.30, the shop would have lost $50. There’s nothing that the shop owner can do. He can’t restrict supply in hopes of raising the price, nor can he stop selling Euros because the rate has slipped.

If that example seems foolish — it is an extreme example with a relatively small consequence — here’s another: Because of the influx of French-speaking tourists to Montreal, some forex shops buy/sell Swiss francs. Who needs Swiss francs? Who in Montreal is sitting around going “gee, I’d like to visit Switzerland, better go buy me some Swiss francs!” We aren’t visiting Switzerland, we’re visiting Europe and the most practical thing to do would be to buy Euros and later exchange them for Swiss francs. Because of this reality, the spread is often higher on Swiss francs than on other currencies. My question though is, how do they move the Swiss francs? Who is buying them? These places might as well have just given Canadian dollars away because no one is going to buy the Swiss francs and in the meantime, the shop has to sit on this money which has the potential to fall in below that price that it was bought at.

My next concern, what kind of volume are these shops doing? Given the sheer volume of smaller shops, I assume that the profit earned from the forex part of their shop is nominal. But the professional shops? They are everywhere in downtown Montreal and rarely do I see people trading currency. What kind of volume can these shops be doing to turn a profit?

The spread at a major, professional forex shop on February 25th:

• AUS: $0.017
• Euro: $0.074
• USD: $0.049
• GBP: $0.072

Remember, this is not profit, but rather, revenue per CAD exchanged. To me, this doesn’t seem high enough to turn a profit. I went through the financial statements of a large forex company but, unfortunately, the forex portion of the company was not specified.

So, I guess that that’s it. I hate when blog posts end with no real conclusion but, as I specified above, this is more a going-through of my thoughts than an actual constructed argument or source of information. Any ideas?

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