Every so often, I listen in on a conference presentation that floors me with its level of sophistication and expertise and because I know that much of what is being said will go in one ear and out of the other for at least 80% of the audience. Such was the case with a phenomenal break-out session with Del Monte's CPO Dave McLain at Ariba LIVE Chicago focused on cost management strategies for commodities. Over on Supply Excellence Justin Fogarty has already provided a short write-up that's worth referencing, but I'll go into a few more details in this post about how Del Monte uses a combination of Ariba technology and financial instruments (e.g., calls, forwards, etc.) to mitigate commodity volatility and risk.
Today, Del Monte uses a range of Ariba's toolset. They originally relied on Ariba for RFQ and RFI functionality (i.e., sourcing) but expanded their original solution set to include a full roll-out of spend visibility and spend analytics. Most recently, they also signed a P2P deal with Ariba, but that is an area greatly detached from the focus of the presentation (though in the future, they do plan to also incorporate "scorecards, data analytics and lean supply chain" into their buy-side technology arsenal).
But technology was not the only focus of Dave's discussion. Rather, it was how technology can play a part in a broader commodity risk management strategy. Today, Dave suggests, the key issue CPG companies face with commodity risk management is that "if you have pass through contracts that let suppliers push risk to you, you need to deal with [the volatility of the underlying commodity] costs". Del Monte's approach is "different than most" organizations, but like other CPG companies, they "wake-up in a short position everyday because they have or will have a requirement and will need to buy something to cover it". To address this challenge, Del Monte focuses on creating a cost volatility strategy that contains the following elements: defining the requirements horizon, identifying the top drivers of cost volatility, measuring correlation of price volatility with each item, segmenting spend into open and locked buckets, modeling open and locked against historical volatility and finally, simulating, reporting and managing each commodity in question.
How does this work in practice? Take the commodity -- or commodity options -- in protein for pet foods. Here, Del Monte has many competitors, including the feed industry. But they have options about the types of protein they use including corn gluten, soy, beef meal and bone meal. Because other companies and industries have substitute options as well, it turns out the markets for these commodities are "so tightly correlated, when one goes up, they all do".
To address the best option in each forward buying situation, Del Monte uses a range of tools, including scenario forecasting and modeling techniques like Monte-Carlo Simulation (using data from Ariba's spend visibility toolset to feed the analysis). Here, the Ariba spend input and other data information on volume from different Del Monte systems is tied directly into a forecasting toolset that looks at forward price curves, hedges, relative value and correlations. For example, if Del Monte "wanted to do a prediction of what we could spend on plastics, we could define a correlation of crude and plastics and then define a range of what crude could be" based on their own forecast and historical volume numbers.
Del Monte does all of this with an eye not to speculation like a Cargill trading operation, but with the "goal to minimize volatility to the business". In certain situations, choosing to lock via a hedge or direct futures contract with a supplier is not the right decision based on what their own data and forecasting tools are telling them. "Leaving something open is just as big a decision as locking it," Dave notes. But Del Monte does have numerous ways of locking should they choose to use volatility management tools, as Dave calls them. These include forward contracts with suppliers with contractual price locks, forward contracts with contractual price caps (e.g., with float down clauses that do not exceed a cap), supplier volatility assumption or supplier coverage, cross hedges, futures, swaps and options. Del Monte is also gaining access to greater and greater instruments on a regular basis as commodity markets become more fluid and global. For example, "Barclays is now trading a resin swap and we have gotten some suppliers to agree to use it".
These many instruments and approaches may prove overwhelming to companies just starting to look at managing commodity volatility. In a future whitepaper, I'll be teaming with Spend Matters affiliate blog, Metal Miner, to write a basic primer and analysis that explains all of these options in detail and how to use them in particular situations. But in the meantime, it pays to take the advice of partners. Del Monte suggests "starting with an over the counter" commodities investment partner. This will not only give you some ideas to start a commodities management strategy but will also help smooth internal politics (e.g., avoiding "margin calls that freak out treasury".)
Del Monte also strongly recommends using spend visibility applications to "provide access to critical spend information used to quantify variance at risk". Tying together multiple technologies to drive risk mitigation is nothing new. However, tying together tools from a Spend Management solutions provider and directly integrating these into a broader process to manage commodity risk as part of standard operating procedure across spend categories is. I suspect Del Monte is bleeding edge relative to 90% of Ariba's customer base in this regard and probably 95%+ of the broader market. Which shows that Global 2000 companies have a tremendous way to go when it comes to minimizing commodity risk from incorporating trading and hedging components into core procurement operations.