Commodity Price Inflation is Hitting Hard — But Options Exist

Virtually all readers of Spend Matters have either faced commodity price inflation directly (i.e., in your day jobs) or indirectly (i.e., through customers) in the past two years. But in some commodity market environments -- especially those which are closely linked with petroleum and petroleum derivative products -- the inflation pain is about to get a whole lot worse. Purchasing recently reported on Dow's June price increase which will range as high as 20% for its 3200 products. The company is blaming the increase on "surging costs for energy, raw materials and transportation." And the CEO, Andrew Liveris, is also pointing fingers at the "US government's lack of a comprehensive" energy policy which could lead "Dow to spend up to $32 billion this year" on hydrocarbon feedstock (up from $8 billion in 2002).

Whenever I see a CEO point fingers like this at the government -- and believe me, I'm no fan of our current administration, including our President and especially the free-spending legislative branch -- I can't help but wonder whether or not shareholders should begin to wonder whether or not they have the right leader at the helm. I mean, shouldn't a company like Dow take risk off the table through more aggressive hedging strategies in the core areas which are driving up cost? The answer is absolutely -- just ask Southwest, who continues to pay significantly less than all its large rivals for jet fuel. But if you're Dow, you have pricing power to pass on costs to customers -- which makes the costs of upfront hedging and risk reduction strategies less palatable, I reckon.

Still, it can pay to at least try to pass the buck onto the government when things I wrong (I'm sure some suckers will buy it). But what Dow -- and other companies in Dow's shoes -- should be asking themselves are what are the fundamental ways that they can redefine procurement to compete in today's commodity price environments. More aggressive hedging on the financial markets is one idea. But that's just a start. What about entering into longer-term pricing agreements with key suppliers (and agreeing to higher volume levels) in exchange for price concessions on all of the value-added portions of agreements? Or what about examining how suppliers price various risk elements when it comes to different commodity and total cost drivers? I'm guessing that Dow's suppliers will sometimes incorrectly price risk (e.g., future transportation and commodity costs) but the procurement team at Dow would need to be astute enough to know when to take advantage of their superior access to pricing intelligence based on options pricing models.

In short, Dow could be taking action rather than pointing fingers. If you're a shareholder or customer, don't just take their whining and price increases blind. They have options (which they aren't talking about to the public). And so do you.

- Jason Busch

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