Commodities Are Sizzling: Tips For Staying Out of the Procurement Frying Pan (Part 2)

Given how many commodity markets have shown significant upward price trending in recent weeks, it's imperative that procurement organizations take the threat of rising prices seriously. Fortunately, for organizations that have not adequately prepared for commodity volatility and price pressure in the past, it's easier than ever to come up to speed quickly. Below, we feature a quick list of tips we've observed anecdotally from interviewing best practice organizations when it comes to managing commodity volatility (not to mention our own experience at Spend Matters and MetalMiner on the sourcing/hedging front). In no particular order, here are a handful of tips for staying out of the procurement frying pan through better commodity risk management:

  • Make sure you have the right skill sets to handle commodity volatility within procurement or the finance organization. Or, if you have a trading group within your company, learn more about what they're up to and coordinate efforts accordingly. At least a few individuals in this group should have a good understanding of the financial tools they that are available today, such as hedging using traded options/futures contracts, virtual hedging (e.g., through certain ETFs), more complicated swaps/derivatives, etc. In addition, these individuals should understand both how to price commodity risk as well as techniques for exploring how suppliers may price/misprice risk.
  • Investigate technology that may help control/price/mitigate/manage commodity risk. Platforms (e.g., Brady Solutions, EKA Software, Triple Point, SolArc), some of which were originally designed for commodity trading arms of companies, can provide an invaluable complement to the e-sourcing platforms that so many procurement organizations have invested in. Yet I find that few sourcing organizations are even aware of these companies. Stay tuned to MetalMiner as we begin to investigate these platforms in more detail.
  • Before doing anything, please take the time to fully understand the potential accounting costs of commodity risk management strategies (e.g., when you can use hedge accounting versus not). Spend Matters has spoken with CPOs with a deep familiarity of commodity risk management strategies who were not able to act when they wanted to, due to concerns over the quarterly earnings balance sheet impact of certain hedging strategies. If a forward hedged position moves against you temporarily and you can't use a hedge accounting treatment, you could find yourself with a successful commodity risk mitigation strategy in the long run, but one that proves quite costly from a GAAP accounting perspective in the interim.
  • In cases where there is a named source of supply, look to new potential financial alternatives for risk mitigation in the case of potential disruptions or price increases (e.g., supply risk insurance products).

Jason Busch

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