Dealing with Price Volatility in the Food and Drink Sector

We are delighted to publish another thought-provoking post from Milan Panchmatia, Director  at 4C Associates, a well established procurement consulting and managed services firm, on how strategic procurement departments in the food and drink sector are changing their behaviours to deal with volatile commodity prices.

Early last year, 4C Associates ran a survey amongst attendees of The Economist’s CFO Summit. One of the questions we asked the finance leaders present was what constituted the single greatest business risk in the coming year. The majority (65 percent) answered price risk. Go back another year to the 2012 Economist CFO Summit and our survey again highlighted price risk as a major concern.

The principal reasons highlighted by respondents were volatile commodity prices and an inability to pass any subsequent increases on to consumers. This situation is of particular concern in the food and drink industry, where many commodities are subject to additional constraints in terms of availability.

So how do procurement departments in the food and drink sector manage volatile prices within a complex industry?

Long-term contracts

Commodities in the food and drink industry, be they traded such as coffee or non-traded such as milk, pose unique challenges to those working in procurement. These goods are vulnerable to a wide variety of threats including severe weather conditions or simply seasonal unavailability. Add to this vast supply chains and changing consumer tastes and it is clear that procurement departments in the sector are dealing with a complex beast.

At a recent discussion held by the Food and Drink Industry Procurement Forum, the majority of attendees advocated for the use of long-term, fixed-price or capped-price contracts. The last of these has the advantage of guaranteeing supply of the product, whilst maintaining a sustainable relationship with the supplier in question.

When negotiating this type of contract it is important to remember that the terms must be favourable to both parties. Bullying a supplier into accepting an agreement which could result in a loss, will either see the supplier go out of business or resort to questionable methods. The short-term nature of the contracts between suppliers and supermarket chains were blamed by many as the reason for the horsemeat scandal.

Long-term relationships also enable procurement to work with suppliers to deliver value which goes beyond pure cost. New methodologies can lead to better quality products, optimised inventory management and a wide range of more strategic benefits.

Vertical integration and other tactics

Another option for businesses looking to manage commodity costs is the vertical integration of supply chains. Integrating a key supplier will allow a company to align its needs with the demand for said product. This tactic’s main advantage is the strategic independence it grants a business, as well as the numerous opportunities to streamline and optimise costs.

Morrisons, the fourth-largest food retailer in the country, has long championed this technique. Back in 2010 the chain detailed plans to invest £200 million in its supply chain over the next three years. This led to the purchase of Flower World in 2011, Vion UK’s 105,000 square foot meat processing facility in 2012 and most recently a seafood processing plant in Grimsby.

Several other food and drink retailers have vertically integrated elements of their supply chain, however, none rival Morrisons in terms of complexity. The practice delivers a number of advantages including access to fresher produce than its rivals, a reduction in food waste and better control over the quality of products. It also provides additional security in terms of access and allows the company to support local suppliers. A fact which appeals to many consumers.

Determining what’s best for the business

There exist a number of other popular tactics for dealing with volatile commodity prices in the food and drink sector. These include a focus on SRM, or simply working to expand an organisation’s approved supply base. Two contrasting techniques, both of which can prove successful, but require a long-term commitment. Building solid relationships requires a certain level of investment, whereas it can take time to engage with new suppliers.

In this context it is clear that strategic procurement has much to offer a business in terms of value. As supply chains become increasingly complex and potential risks continue to magnify, there is a clear need for procurement to determine which tactic best suits the business’s circumstances. It could be that a mix of the above suggestions, employed across a range of suppliers, will provide the biggest competitive advantage.

When it comes to dealing with volatile commodity prices, a mixture of innovation and risk management is often the best option.

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