Supplier Costs, Risks at Heart of EPA Clean Power Plan Compliance: Q&A

pierre mitchell headshot Pierre Mitchell

I sat down with our own Pierre Mitchell, chief research officer of Spend Matters, a bit ago to chat about how folks in procurement organizations should be thinking about regulatory risk – especially as the final version of the latest federal rule is about to hit the books.

The Environmental Protection Agency (EPA) has proposed the Clean Power Plan, the final rule of which is going into effect mid-summer 2015. (See the CliffsNotes of the nuts and bolts of the plan here.) In light of this, Pierre gave us an overview of how procurement should tackle the compliance-cost concerns, as pertains to manufacturers specifically. One of the biggies on the list? Supplier risk and supplier cost analysis. Below is an edited version of our conversation.

To get the full monty on how procurement can prep for EPA Clean Power Plan compliance, please register for an upcoming video webinar hosted by our sister site, MetalMiner: What EPA's Clean Power Plan Could Cost US Businesses (and What Procurement Can Do About It) – if only for Pierre's wicked-good video interview.

The Role of Procurement in Quantifying Regulatory Cost

Taras Berezowsky: What is the role of procurement in quantifying the cost of EPA regs in general, or this Clean Power Plan specifically, or the cost of sustainability initiatives and how they relate to a company's profitability?

Pierre Mitchell: I think one of the challenges that procurement organizations are dealing with -- like any regulation, not just within these -- is to actually understand, what is the impact on not just the procurement function, but also on input costs in general. What is that going to mean to our cost structures? And ultimately, what is that going to mean to profits? Because at the end of the day, folks are in business to make money.

And actually there's a lot of regs, not just the ones that are coming on in terms of clean power. It can be ones around LNG. It can be conflict minerals. There's certainly no shortage of regulations that are out there.

One of the biggest competencies that procurement organizations need to have, and that the best companies are really building, is this ability to really understand forward-looking cost, to be able to do cost/price forecasting, to be able to really understand their suppliers' cost structures, and what are their suppliers' input costs. Because one of the challenges in the supply chain with this particular example [EPA's CPP], is really ultimately the impact that you're going to have on electricity prices.

When you have coal-fired electrical plants that are being used by a lot of your top suppliers who have energy-intensive needs, that's going to be one of the key challenges. Certainly, at least a large procurement organization has some capabilities at its disposal to deal with its energy costs in terms of energy management programs and things like that to lower its cost.

But I think the bigger issue that procurement organizations are trying to deal with is, how are our suppliers going to deal with it? Because a lot of the suppliers may not have all the capabilities, and may actually have relatively very thin profit margins. So if they're going to face some costs on the input cost side on their side, those costs are going to get passed down. Because if you do your cost/price forecasting, and you see how that's going to increase, that actually might create some risk in the supply chain. At a minimum, you have to be able to anticipate that.

Cost management, cost modeling, cost prediction, profit prediction, tying into the business planning process -- that's probably the first kind of key competency, is really understanding what that cost impact is going to be, just like in any regulation.

TB: So we're talking about both costs and risks within the supply chain. Let's take supplier risk. And you mentioned forecasting, for example, and using other tools to "model out" that risk. Any other examples or just a little more detail behind how one models this type of risk?

PM: When you think about price risk, what you're talking about is, how do we protect the metrics that we have around cost, and not just the value of cost, but also kind of how do we protect those costs and make sure they're not spiking? And if they are, how do we deal with that? If you think about commodity management and price risk from a risk standpoint, it's first of all just trying to understand, what is the volatility, and what does that mean? The second issue is kind of, then, how do you mitigate that risk? And how do you manage that risk? One of the biggest challenges is, for procurement, to kind of work with the business and say, how are we as a business going to deal with this? Because there's a couple strategies.

One is we can try to beat the market. We can try to say, we're going to hedge. We're going to do long-term contracts. We're going to do all sorts of things to just eliminate that risk completely and beat the market. Placing bets can be a good thing. But you can also get really burned.

I think what most procurement organizations are trying to do from a supply risk standpoint on the commodity side is at least try to smooth those costs, and not having spikes to our cost structures and to our profit structures. Because Wall Street does not like being surprised. So when our customers on Wall Street are looking for that predictability, we have to look at the impact of that versus volatility on the input side.

But it's not just the input price volatility. But it's also on the sell side.

This is where a lot of the large manufacturers are really dealing with this input cost volatility problem. Certainly with EPA's Clean Power Plan, that may have an input on one kind of cost stream that's coming into it. But they also have to kind of look at it on the sell side as well. And what is the impact not just for them, but for their suppliers? It's not just the risk that I face, particularly as a large organization. I might be able to have enough market power to influence some of these things on the sell side, pass some of these costs on. But for some of our smaller suppliers, they're not going to be able to do that.

For some of those companies, their procurement organizations and their supply chain organizations may have to look at some hard choices and ask, how do we redesign our network? How do we actually push some more plants to Asia? And I think you see this in places like Europe where you have a very high regulatory cost environment. It's forcing a lot of those suppliers to move to other regions where there is a lower overall energy cost structure.

That is one of the big issues in terms of the risk side, is actually linking a little bit the supply risk side to the demand risk side and having some formal processes to do that. It starts within this process called category management, as well as we look at a process called supply risk management, which kind of plugs into that, and then, as we talked about earlier, being able to do the cost/price forecasting, and doing the cost management.

Here's the second half of the conversation.

In the meantime, go ahead and register for the upcoming video webinar, hosted by our sister site, MetalMiner: What EPA's Clean Power Plan Could Cost US Businesses (and What Procurement Can Do About It). Missed the live show? Register anyway, we'll send you the recording.

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