How Can Procurement Find Savings When Commodity Prices Are Going Up, Up, Up?

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Editor’s note: This is part of the Ask Spend Matters series, where readers send in their burning questions about procurement and supply chain.

While going through questions that our readers have sent us, we came across one regarding how and where procurement practitioners can find savings when commodity prices are going up. The reader, a senior procurement manager, had noted that procurement’s primary task of finding savings is becoming difficult.

This is an ever-relevant topic, and we enlisted the expertise of Stuart Burns, editor-at-large at MetalMiner, in coming up with some concrete tips for other procurement professionals facing this challenge. Read on!

Spend Matters: What are some best practices procurement practitioners can follow to find savings, even when commodity prices are going up?

Stuart Burns: Maximizing gains in a forward market requires the buyer to have some visibility on their forward demand. Clearly you can’t commit tonnage forward if you don't know how much material you are going to need, so for jobbing shops or companies heavily dependent on variable project work, it is tough. But assuming we are talking about manufacturing companies with a forward order book or regularity to their workflow, then there are a few things firms can do.

The first thing all metal buying firms should do regardless of the market direction is split out underlying metal prices from value add — for example the base or primary meal price component such as the LME or CME; the delivery premium such as the MW delivery premium in the case of aluminum; the grade or alloy premiums for aluminum or copper; or the alloy surcharges in stainless steel.

Then comes the form premium for the final semi-finished product. Different diameter bars, for example, will have varying form premiums depending on size and reflecting the equipment needed to make them.

Suppliers — mills or distributors — generally have a limitation on their ability to hedge forward. Three months are usually the norm for fixing base prices or underlying metal prices, but in a rising market that is a valuable lock-in period if you can get it. Delivery premiums can be hedged via the CME/LME or via a distributor but do require the buyer to commit some volume.

The part that few buyers do but that can pay significant dividends is to fix the value-add premium as far forward as possible. Up to a year is not unreasonable. Suppliers will often ramp up value-add premiums as base metals rise, and buyers become more desperate to place orders before prices rise further, so fixing the value-add can contain price increases to just those parts that buyers can’t control, like base prices.

Spend Matters: What should buyers know when going into a negotiation with suppliers? What are some good negotiation tips?

Stuart Burns: Create a cost breakdown of how suppliers build up their delivered price. By picking a supplier’s price apart, buyers can better understand what elements they can fix, what they can hedge and what they just have to follow. But even for elements over which they have no control they can hold suppliers to account for price increases.

For example, if the LME goes up by 10%, suppliers may well try to push through a 10% increase in finished prices, when in reality only the base metal element has risen, and the value add should remain the same. By understanding the cost make-up, buyers can keep suppliers honest and mitigate cost increases.

Spend Matters: Any other concrete tips?

Stuart Burns: I think there are a couple of suggestions. One is aggregating a whole year’s requirement and engaging suppliers in a competitive bidding process. Having three suppliers bid and then placing an order does not wring the best savings from suppliers. Nor does bidding out line item by line item or month by month. Suppliers are human and get excited about volume, so aggregate as far forward as you are able to make some kind of commitment and drive the best price by taking advantage of that volume.

The second thought is create a process and engage all suppliers in the process equally. Process and rigor drive savings. Favoritism of incumbents results in getting just more of the same.

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