Commodity Management Blog

Innovative Ideas and Thought Leadership for Volatile Commodity Marketplace

Michael SchwartzA new trend is emerging in the manufacture of automobiles. Faced with fundamental changes in the metals, chemicals, plastics and energy market environment, global organizations have begun to look at energy companies and commodity houses and wonder whether they could benefit from the types of technology platforms deployed by these institutions.

For years, the world’s most successful energy companies and global commodity houses have relied on sophisticated commodity management platforms that enable them to proactively manage purchasing, demand/supply balancing and risk management of raw materials and financial derivatives. These systems also provide logistics tools, accounting and decision support that create a complete commodity management platform that enables companies to optimally balance between cost, profit and risk.

Automotive manufacturers and suppliers are now recognizing that these same systems can help manage raw material risk and preserve profit margins in the face of today’s unprecedented commodity volatility.

The new normal: volatility, volatility, volatility

The focus for supply chain groups over the past fifteen years or more has been on efficiency (and speed). Manufacturing and supply chain techniques such as just-in-time, inventory management, demand-driven supply networks and total quality management were introduced to eliminate waste, reduce inventory and improve quality.

These efforts have led to a striking reduction in buffer inventories, bringing them down to the bare minimum. At the same time these leaner supply chains have become more global as organizations look for lower cost suppliers and new markets in which to sell products. A side effect of this is that the ability of businesses to handle unforeseen shocks to the system such as sharp raw material volatility has been significantly limited.

We are experiencing unprecedented levels of volatility in all kinds of commodity markets. The vehicles that roll off today’s assembly lines contain hundreds of raw materials – as do the machines that make them. Automotive companies therefore have some of the most diverse and complex procurement portfolios, which represent equally complex supply networks and a broad series of commodities markets – any one of which can be experiencing severe volatility at any given moment.

Tightening demand/supply equations

Geo-political events continue to cause supply-side disruptions, but now the problems are compacted by long-term demand-side trends. Analysts generally agree that demand-side growth fueled by an aspirant middle class in non-OECD countries is here for the foreseeable future – tightening an already precarious supply/demand equation. The slightest alteration on either side brings wild swings in commodity prices.

Clearly volatility is a source of risk, especially for organizations not used to running their day-to-day operations amid such rapid fluctuations in prices. But it’s important to remember that volatility also brings opportunity. Those that embrace the ‘new normal’ and put the processes and systems in place to better manage volatility and risk will do better than competitors.

Profitably managing commodity procurement

To preserve margins, industrial manufacturers have to take a different and more proactive approach to commodity procurement. Many industrial manufacturing organizations still acquire commodities in much the same way they procure non-commodity supplies. But this does nothing to protect a firm from volatility in multiple markets, and denies them the opportunity to maximize opportunities presented by that volatility. Traditional procurement methods have to change: this is the next breakthrough in supply chain management.

Automotive companies will have to start taking on some of the characteristics of commodity management houses, learn the lessons of turning a profit in rapidly fluctuating markets and adopt the risk management processes, tools and measurements required to optimize their acquisition of raw materials.

This is undoubtedly a risky proposition without the right tools. In fighting price risk, manufacturers can open themselves up to earnings risk. Again they will need to turn to the world of commodity management for the tools and solutions that ensure compliance with the regulatory demands for disclosure and hedge accounting. It may be tempting to shy away from this new reality, and to opt to remain in what feels like the relative security of the status quo. But the risks are real, and need to be addressed head on. By using sophisticated systems, energy companies and commodity houses are able to participate fully in the markets, buying and selling physical commodities and their financial derivatives and then managing the logistics of their transport in the most advantageous way. This is the unavoidable world that automotive manufacturers are now entering, and they must equip themselves accordingly. By taking the lead from their commodity and energy peers, they can follow a time-tested, market-proven path to more profitably and manage the commodity acquisition process – regardless of the volatile market environment around them.