Getting Creative with Contracting: Lessons From Michelin

Whenever I talk to category managers or sourcing professionals focusing on direct materials, I'm often surprised how few are experienced in tying the underlying price elements of a contract to some type of index (and, in more advanced cases, exploring how suppliers will price or misprice the various elements of a contract when it comes to absorbing underlying pricing volatility). Some suppliers, however, are more advanced than their customers when it comes to mandating the sharing of risk and promoting transparency in pricing. According to a recent Purchasing article, Michelin appears to be one of these more advanced suppliers. According to the article, "with roughly 60% of the cost of making a tire coming from oil-based products, and oil prices on a seemingly endless incline, the world’s second largest tiremaker has developed a new pricing strategy that links the two." The result is that as of April 1, Michelin will "adjust its prices for tires sold to the auto industry based on a scale tracking oil prices."

The transference or sharing of risk in contracting is a topic that is just beginning to pique the interest of procurement organizations. But the key to figuring out whether or not these types of contracting arrangements make sense is not only to introduce the concept to suppliers in a sourcing process -- if they've not introduced it to you already -- but to understand how different suppliers price underlying commodity risks (and opportunities). After all, when it comes to supply risk management -- and commodity pricing risk is very much a part of the risk management equation -- knowledge is power. And procurement organizations should, given the size advantage of buying organizations over a typical supplier, have the upper hand when it comes to having the most information to make the best decisions.

- Jason Busch

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