Managing Cost of Goods and Impact on Operating Margin in Plastic Sourcing

Spend Matters welcomes this guest post from Matt Stanfield, senior director with Alvarez & Marsal Business Consulting in Atlanta.

As with any commodity, plastic sourcing introduces a high degree of complexity to managing your cost of goods sold and the subsequent impact on operating margin. The sources of this complexity are rooted in four primary areas that need to be actively understood and managed:

  1. Is the plastic positioned as a cost-plus or market-back price?
  2. Who are the alternative suppliers and what is the cost to migrate supply?
  3. Is there transparency in the operational efficiencies created by the selected plastic?
  4. Are your plastic price mechanisms correlated with price adjustments to your customer?

In a typical plastic sourcing situation, we see conflicting perspectives across the company. Finance often cites significant supplier pricing volatility, praising large price drops and grimacing when price increases.  Purchasing generally selects the lowest cost option at the time the material was awarded, incorporates pricing mechanisms to “lock in” the supplier’s relative competitive position, as well as periodically price checks the market to make sure the mechanisms  are still “the most competitive.” Behind the scenes, engineering or operations works directly with the supply base on the next “must-have” plastic. As a result, finance struggles to manage projections and is dubious of purchasing’s efficacy, while purchasing will find false solace in the pricing mechanism because it was the best option when the parties agreed to it.  Engineering and operations groups unknowingly signal to the supply base that they are irreplaceable and commercial competition is less likely.  

A recent client’s CPO communicated a need to improve the company’s relative cost position and ensure there was sustainability with the cost structure in their plastic purchases. To begin this process, we start by identifying what polymers they buy, quantities, modes, prices and buying cycles. We then construct a pricing simulation over time that documents price change against both market and the underlying cost drivers. The difference between the two curves indicates the amount of opportunity to target. An example of this output is below.  

Click to enlarge

In the simulation above, the pricing and cost plus model were aligned in 2014 when.the pricing continued to increase and decrease over time, but at a disconnected rate from the cost drivers. This result suggested the original mechanism was no longer valid or competitive.  

Following our calculated value, we will assess the additional supply options, quality of the supplier relationship(s) and determine if the cost to transition is lower than the identified value. When determining value, it is critical to look beyond just the price per pound. A grade of plastic can alter the operating performance of your business as it relates to quality, throughput and product performance. A cost up and down assessment is conducted to establish a total cost of ownership (TCO) model.

Equipped with a TCO model, we worked with R&D, operations and purchasing to engage the suppliers, define our pricing management expectations, as well as present the company and RFP opportunity. Now the suppliers know the opportunity and that the client is ready and willing to transition business for the right proposal.  

After receipt of proposals, a negotiation was conducted to integrate a pricing mechanism that aligns customer pricing movements with the plastics that were being purchased. Supply transition was necessary for our client due to the incumbent supplier believing their position was not truly at risk. The net effect was an improved plastic price cost structure, a sustainable margin effect and increased credibility with the supply base.  

In summary, to comprehensively source plastics, it is imperative to look beyond the price per pound. A quantitative point of view must be developed regarding your price as it relates to the market and available suppliers. To prepare for this, multiple functions must be part of the process to verify an accurate total cost assessment is constructed and aligned with needs from the finance community. Lastly, move in a unified manner with the supply base so the same message is heard from operations, through R&D and from the voice of the purchasing lead. Executing the sourcing process in this manner ensures the greatest leverage applied against the supply base, the total cost performance efficiencies are optimized through each node of the supply chain and the stakeholders of the business will enjoy greater financial benefits.

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