Why Buying Commodities Requires an Un-Commoditised Approach

Mike Jones, Group Managing Director, Optimum Procurement, shares his expert knowledge on commodities procurement and what makes it different from 'regular' categories. Mike builds on two previous posts published on energy and fleet category management. 

In most cases, category sourcing is primarily about the application of sound best practice. But there is a small number of categories which are ‘irregular,’ for example, energy, which we wrote about in "Why Gambling on Price Alone Represents a Risky Strategy for Energy Category Managers," and fleet, "Duty of Care: the ‘Elephant in the Room’ for Fleet Category Managers?" which require more specific knowledge and skill from procurement in order to be managed effectively. Furthermore, it is the sourcing of commodities (including energy procurement) that requires possibly the most non-commoditised approach to management of all.

The commodities markets are by their very nature complex and volatile beasts, impacted by many different factors, some naturally occurring and some triggered by human behaviour. As a result, it’s common for the true opportunities that come from sourcing commodities to be overlooked and for organisations to pay far more than they need to, even if they think they are getting a good deal and working their buying decisions around indices-based trends.

The reason why organisations fail to get best price on commodities is because their decision to purchase is too heavily driven by their own demand trends and needs. Rather, it should be led by what is happening in the market. Buying at their point of need puts them at the mercy of the market and significantly narrows their best price and negotiation opportunity. They may be getting best price on the spot but this may actually be a very weak price, considering a broader buying window that could be taken into consideration with deeper understanding of market trends.

Beyond this challenge, most commodity buying also doesn’t even consider that there is an opportunity to actually ‘play the market’ and influence trends, for example, by becoming a seller as well as simply a buyer.

So how do you go about this? First of all, it’s vital to do the necessary groundwork required to get under the skin of the varied and complex cost drivers in the marketplace. These can be regular - things which happen again and again over time, potentially in a pattern, as well as irregular - one-off occurrences which trigger an opportunity or threat. Doing this requires procurement professionals to analyse data and trends and then use the intelligence gleaned from doing so to buy at the most opportune times. Even irregular cost drivers can provide intelligence. Whatever event has happened, it may never do so again in the same way, but analysis shows the magnitude by which the market can be impacted.

Really understanding and spotting all market fluctuations is essential to finding and being ready for the prime buying times – some of them predictable, some not. This involves deep analysis of markets, over many decades, plotting different time intervals in order to spot patterns and question what has caused the big fluctuations in the market over time.

One example of a regular trend would be where, each year, a major market sells off a commodity surplus to the international market, quickly and at extremely reduced prices. The strategy behind doing this would be to throttle domestic availability, therefore creating a local commodity deficit and increasing local price points. For the international buyer, knowing when the tiny window of opportunity may happen again, could be a huge opportunity to reduce the purchase price.

One example of an irregular trend could be a major natural incident such as a drought, which limits supply of a product to way below the norm. Demand outstrips supply and thus the price rockets. For the procurement professional trying to spot the best time to buy, they need to be looking at layers of data to see if any patterns, for example the weather, led to these occurrences. Good commodity purchasing is as much about avoiding sudden upward price fluctuations just when you need to buy, as it is about taking advantage of the lowest prices when they occur.

Aside from analysing and monitoring markets with precision, procurement also needs to ensure that the business is primed to support a price-driven approach, rather than one led purely by need. This often involves a changing attitude to risk and access to cash, as well as making procurement an integral part of strategic business decisions, rather than just a ‘buying arm.’ For example, a strategic decision to seek shared cost and risk with supply chain partners may be necessary to accommodate this new approach.

As a category, commodity sourcing is anything but a commodity skill amongst procurement. In my opinion the wise businesses will be those on top of their own commodities data and research, ready to negotiate hard with the market at the right time to buy, not at their time of need.

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Voices (2)

  1. bitter and twisted:

    Why would the hypothetical commodity expert slum it as a procurement salaryman when they could be a rockstar trader instead?

  2. Jorge Rios:

    Most procurement professionals in Manufacturing organisations still consider covering full contract volumes at “acceptable” prices as best practice. The consideration of market efficiency and drivers, risk/benefit analysis should be taken seriously considering the number of buying mechanisms available to a well prepared commodity buyer.
    It is worth it investing in skills and becoming a risk taking enabler than a fearful cost fixing department.

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