Bleeding on the Bayou: Procurement Near-Misses in Times of Price Volatility (Part 1)

Editor's note: This post kicks off a new Spend Matters series of personal narratives from practitioners in the field. Know someone with a procurement story to tell? Tell us in the comments below!

Fred Farmer’s interminably slow drawl echoed off the rickety galvanized siding of his Louisiana based hot rolled steel tube factory, unfortunately located on the banks of a bayou threatened by frequent floods and the occasional alligator infestation.

“2-3/8 pipe...4-1/8 pipe...6-3/8 aluminized...6-3/8 anodized...6-3/8 black vinyl coated...6-3/8 green vinyl coated…”

Farmer’s proud and emphatic articulation of his exhaustive product catalog called to mind a veritable Bubba Gump of the steel tube industry. He was born and raised in a rural Louisiana town called Ponchatoula about fifty miles outside of New Orleans, and rose up the ranks from maintenance, to line supervisor and ultimately CEO after his uncle Willy succumbed prematurely to a heart condition (most likely brought on by decades of fried alligator and beignets consumption).

In his second quarter 2008 earnings conference, Farmer introduced his third-generation family business to its new owners, an investment company represented by a team of Boston based former management consultants with a strong affinity for 2x2 matrixes, Porter’s Five Forces diagrams and Starwood rewards points. The acquisition had barely closed a month before this distressed middle market enterprise with flagging sales experienced a precipitous rise in raw material costs, driven largely by China’s insatiable appetite for iron ore.

After Farmer finally exhausted all possible combinations of product sizes and features, he “saw a 4% decline of topline year over year combined with rising operating costs leading to a 15% decline in EBITDA.” The tone and content landed as nothing short of a death knell to those of us responsible for turning this ship around, and one of the most critical concerns for the remainder of the year was when to purchase raw materials given that rising commodity costs had contributed significantly to Farmer’s margin compression. Over the course of my time spent advising on supply chain matters at this new acquisition, I learned how important it is to resolve questions on how to purchase as much as or more than those dealing with when to purchase.  

I invoke these memories of my time spent on the bayou resolving Farmer’s supply cost issues because there are some striking similarities in today’s environment and lessons learned that may be helpful to recall after years of declining metals prices. Since the results of the U.S. election, commodity prices, building materials, MRO materials, and in some cases currency exchange rates have taken roller coaster rides, driven largely by less-than-rational market signals like tweets on potential cabinet picks and job creation slogans.

Market speculators have been responsible for the significant gains in some base metals, but neither market moving hedge funds nor those of us in the field of procurement know with certainty what 2017 will bring and how much of Trump’s ten-year $1-trillion infrastructure plan will come to fruition and further bolster prices. It is very easy in times of intense market volatility to develop tunnel vision around the movement of indices with the intention of swooping in at the low or hedging against a perceived downside. Unfortunately, this intense focus on the uncontrollable often comes at the expense of addressing the most important procurement related costs of a manufacturing or distribution enterprise.     

Farmer’s first mistake was to contribute a continually increasing share of his working capital into raw material inventory purchases because in his view, prices were likely to continue to rise. In Farmer’s defense, this rationale was echoed by many of the steel industry analysts and forecasters at the time who could not imagine a world in which China and other developing countries slow their respective consumption patterns.

Whether one calls this hedging or hoarding, Farmer’s aggressive purchases ultimately put undue pressure on the enterprise’s credit facility and resulted in a massively bloated stock of things like nickel pellets and zinc slabs during the soft market following the financial crisis. It should not be surprising that fire sales and write-offs were soon to follow. In fact, during the period leading up to my entrance into the business, Farmer negotiated “take or pay” style contracts with several key vendors with the effect of locking in “great prices” but requiring substantial volume commitments. Farmer fell into a trap of irrational exuberance or perhaps paranoia with respect to material unit costs, and it took over a year to unwind his damaging practices.

My first order of business after arriving to the plant was to renegotiate the web of contracts that were draining the company of its reserves. No longer focused solely on purchasing arbitrages, my team worked to unlock sustainable savings in labor through product line simplification, vendor integrations, decreased use of spot purchases and electronic invoicing.

Read on in Part 2.

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