In an era of volatile commodity prices, manufacturers can turn this source of risk into a competitive advantage using commodity management software.
We have entered a new era of high volatility in the realm of commodity prices. While commodities are typically more volatile than other asset classes in any case, the market has witnessed abnormally large price swings in the last seven years. Whether the boom in precious metals following the financial crisis, or skyrocketing food prices as a result of various droughts and heatwaves, or the collapse of oil prices – these are uncertain times.
Gaining Competitive Advantage in an Age of Volatility
There is every indication that high volatility is here to stay for some time. Growing populations, the continued industrialization of developing and frontier economies, and the emergence of a huge new middle class all signal rapidly rising demand against a far more fixed production base, which will mean a market far more sensitive to hiccups in supply.
For manufacturers, this is a game-changer. Most manufacturers will have high exposure to commodity prices one way or another through their supply chain. During periods of low volatility, material procurement for these firms is largely a routine matter of buying to budget, squeezing vendors, and eking out efficiencies in the supply chain where possible.
High volatility changes all this, transforming material procurement from a humdrum efficiency game into a major source of risk – or, if managed properly, a major competitive advantage. Firms that can take advantage of price volatility to acquire materials at a lower cost than the market rate can get the jump on rivals, affording an opportunity to eat into their market share.
Managing Price Risk
There are three basic ways manufacturers can manage commodity price risk to this end.
- The first is to buy and hold inventory at a favorable price, in the expectation of an upward price swing. However, the trend in manufacturing has been to lower inventories as far as possible for other reasons, and most will not want to go backwards.
- The second option is to negotiate fixed prices with suppliers. However this also comes with problems: most suppliers are smaller and less able to manage commodity risk themselves; meaning most will likely build in high risk premiums to any fixed price, defeating the point.
- For most that leaves the third option: financial hedges. For a company with capability to do so, this is by far the best option in a volatile market.
However, effectively managing financial hedges requires the right tools.
The problem is that manufacturing as a sector remains very low-tech when it comes to managing commodity price risk. Almost all firms still manage risk manually and in a very crude fashion, usually across a number of disparate spreadsheets. During periods of lower price volatility this made sense: infrastructure investment was rightly focused on improving efficiency across the supply chain through ERP systems and the like.
This era of high volatility, however, demands a new set of priorities. ERP systems do not have the capability to properly manage physical and financial commodity contracts. For this, a sophisticated commodity management system is needed.
The Benefits of Commodity Procurement Software
Commodity procurement software can help manufacturers deal with commodity price risk – and turn that risk around into a competitive advantage – in a number of ways. Companies relying on spreadsheets to manage price risk will find themselves at a severe disadvantage in a highly volatile market as these spreadsheets will typically be updated once a month, twice at best. Commodity management systems, by contrast, will ensure that procurement forecasts and decisions are based on daily or intraday price curve feeds, allowing for proactive management of market shifts. A commodity trader in today’s market would be considered mad to update forecasts only once a month, yet the logic is no different for a manufacturer.
»»» Download app sheet on Eka's procurement solution. «««
This allows for smarter decision making across the entire supply chain. A good commodity management system will allow a company to make better procurement decisions based on predictive analytics. As forecasts change and markets move, a company needs to run ongoing scenario analysis to determine the best options available to it. Advanced analytics take into consideration historical procurement patterns, updated demand forecasts, supplier performance and current price curves, and uses visualization tools to parse this data and quickly answer difficult questions. The system will allow optimization across the entire business, taking into account supply, capacity, inventory, and cost constraints, and propose strategies for improved procurement decisions, including comparisons involving spot and forward commodity prices.
The bigger and more sprawling the manufacturer, the more the benefits of such a system will be felt. A large multinational organization with a diverse array of plants and divisions selling into a variety of markets will require a sophisticated system to ensure a consistent and effective risk management policy across the entire organization. A good commodity management system will afford a company flexibility to manage said risk in either a centralized or decentralized way. This will also pay dividends when it comes to mergers and acquisitions. Without such a system, reconciling the commodity risk management systems of two separate businesses will prove a Herculean task.
Manufacturing has been slow to adopt commodity management technology. (Learn more in "Benefits of Procurement Analytics for Consumer Products Companies.") The new era of volatility, however, will render the status quo a major business risk. For those forward-thinking companies with the wherewithal to move first, it also presents an exciting opportunity to gain a competitive edge and gain market share from rivals.
Eka's Procurement Solution
Eka's next-generation solution provides a new approach for manufacturers to manage raw material price volatility by integrating procurement, supply chain, and risk in one single solution. Eka's Procurement Analysis solution captures, analyzes, and manages demand, budgets, forecasts, position, coverage, procurement, and hedging while providing real-time scenario and intelligence capabilities to optimize decision making.
