Strategies to Minimize Raw Material Volatility

This post is adapted from one on our sister site, Metal Miner. Though metals-specific, it provides some great insight into spend management for all spectrums.

After having spent some time out of the office last week, the one desk activity I enjoy involves going through the mail (yes, I'm talking about the non e-stuff that we tend to collect). Most of it makes its way to the trash bin but a story in the Institute of Supply Management's latest magazine Inside Supply Management caught my eye with its title, "Managing Risks in Volatile Raw Materials Markets." Always trying to pick up a trick or two whether it comes from other industries and commodities or metals, I thought this article highlighted some interesting risk management strategies, although at the end of the day, I'm not sure how many of the strategies haven't already been extensively deployed by metals buying organizations and/or have very limited applicability.

For example, one strategy calls for "deploying a new technology in the production process can enable a manufacturer to quickly switch between alternative raw materials as prices fluctuate, freeing it from relying on a single feedstock or sole supplier." Stainless steel product substitution represents a good example of how companies shifted from nickel based alloys to non-nickel based alloys but I'd be hard-pressed to think of how a manufacturer can quickly shift from copper to say aluminum. The product development process within metal intensive industries can hardly be deployed quickly or on the fly as commodity prices fluctuate. For some industries (think aerospace or automotive), the notion of deploying new technologies in the production process to quickly switch between alternative materials appears challenging at best. Other suggested strategies include "upstream risk transfer to suppliers," which effectively limits the ability of suppliers to pass down costs. Sure, that strategy may have short-term merit but a long-term strategy of allowing the supplier to "eat the costs" won't help during the next rising commodity cycle.

On the other hand, the article suggests four strategies that do have merit for metals buying organizations. These strategies include:

  • Supplier specific strategies – (think indexes or as suggested by the authors, "diversifying the supply base across regions")
  • Customer specific strategies – (think pricing strategies)
  • Third party strategies e.g. hedging (we feel this area represents quite a large opportunity for metals buying organizations as more and more products come to the market, these tactics, we predict, will become more pervasive in the sourcing toolkit, so to speak)
  • Internal strategies – these include physical hedges (the article even discusses swaps with other manufacturers or the sharing of raw materials with other manufacturers)

Through our own consulting experiences, we have seen little if any hedging activity, likely more to do with the overall size and type of buy (for example, diversified distributor semi-finished metal spend remains a less obvious candidate for hedging). On the other hand, the growth of ETFs and in particular, base metal ETFs, may begin to open the market for alternative hedging strategies. Tools such as receivables insurance may also become more prevalent as companies look to reduce risk in the event that a company's customer fails to make good on an order in which raw materials had been previously purchased. We have also seen limited experimentation with swaps or strategic sharing of raw materials, though that strategy may have quite a bit of merit depending on the industry and metal in question.

Does your firm deploy any other strategies/tactics to manage raw material spend? Drop us a line at lreisman (at) aptiumglobal (dot) com. We'd love to hear from you!

Lisa Reisman

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