Procurement — Commodity Risk Management Matters as Much as Sourcing

Purchasing recently ran a useful little number outlining the key points from a presentation that Deloitte Economist John Schimelpfenig made at a chemical's industry event. Even if you're not in the same industry, the points are telling. The article suggests that "the volatility seen in the chemicals industry impacts all links in the supply chain and requires a better melding of risk management and purchasing strategies." In fact, the financial performance of companies is directly correlated with underlying commodity pricing pressure. Consider, for example, the "direct negative correlation between the Dow/AIG Commodity Index and the Dow Jones Industrial Averages over a recent time period. As commodity prices have risen, the DJIA has sunk and vice-versa." Unfortunately, while it may be difficult to identify a similar level of transparency in the discrete manufacturing sector, I have no doubt a similar correlation must exist (especially in industries such as automotive where passing on the full impact of price increases is difficult to say the least).

One of the major challenges companies face is that few in procurement have exposure to the big risk picture. According to Schimelpfenig, "When managing commodity risk, people often fail to factor in things like global movements in interest rates and foreign exchange movements which can in turn impact credit, creating a very complex scenario." Despite the global meltdown in the financial markets this past year -- based in large part on the exposure of financial institutions to complex derivatives and financial instruments surrounding the mortgage markets -- there remains a significant role for the securitizing and trading of risk in the procurement field. As the article suggests, "the adoption of exchange traded instruments as part of a commodities risk management strategy is helping to provide more flexibility and sophistication across the board." But among the companies I speak to on a regular basis, few have the requisite trading and financial acumen in house -- or at least tied to the procurement function -- to take full advantage of these approaches.

- Jason Busch

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