Procurement Leaders White Paper

7/27/2019 Procurement Leaders White Paper

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PROCUREMENT LEADERS INSIGHTCommodities management

In association with


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InsIght cOmmOdItIes management

3

Commodity-based volatility is aectinga broader group o companies than ever

From fuorescent lamps toiPhones and wind turbines

to computer chips, the 17

minerals in the periodic table

of elements colloquially known

as rare earths nd their way

into an enormous array ofhi-tech products.

Today, most rare earths

come from China, where the

government has, since 2009,

tightened export quotas and

brought in anti-smuggling

regulations.

Chinas monopoly on

rare earths has led to a

huge amount of political

posturing. A diplomatic spatled to the country blocking

exports of the minerals to

Japan, with the latter having

since signed agreements

with Kazakhstan to ensure

future supply.

And its not just rare earths

that are causing concern. The

prices of many of the worlds

key commodities reachedall-time highs last year

and, even if they didnt, the

volatility across the markets

was more than enough to

create huge amounts of

problems for companies in the

industrial manufacturing and

engineering sector.

Welcome, in short, to a new

world order one where supply

and demand are more nelybalanced than ever before.

Whats more, that balance is

spread across a wide and

Raw emotions

procurementleaders

hvy ur

of rwrilace a hugechallenge.

During Q1 2012, copperincreased by 15%, zincby 16% and platinum by21%. Steel has been on aspiky decline since August2011, while aluminiumclimbed by 15% in Januarybeore alling by the sameamount almost immediately.These are just a handul oraw-materials used by theindustrial manuacturingand engineering industriesand a smaller exampleo the volatility they are

experiencing. But whileundoubtedly presentinga challenge, the smartorganisations are lookingto new ways o managingthe procurement o keycommodities. And these newtechiques are helping themsteal a signicant march onthe competition.

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growing range of commodities.

From arable crops, metals,

timber, oil and chemicals, its

not difcult to see startling

examples of price volatilitywhichever category you look

at. Nor is it difcult to see

the consequences of such

volatility in companies

bottom lines: time and again,

there are stark reminders that

sharply rising raw material

costs can knock protability.

In April 2012, for instance,

Swiss agribusiness company

Syngenta cautioned that its 2012results would be impacted by

unfavourable raw material costs.

Meanwhile spice and condiment

manufacturer McCormick saw

rst quarter prots hit by 3%,

because of higher than expected

raw material costs.

Yet remarkably, these

companies and many others

hit by the same difculties

are not always best prepared

for the challenges they face.While the raw materials

in question are highly visible

within and form a major

proportion of overall productcost, the processes and tools

they have are not always the

most sophisticated.

Instead, a small group of

leading companies who employ

experienced commodity experts

and make use of sophisticated

technology and processes

are creating a signicant

competitive gap on their peers.

But its a gap that can be

closed through the adoptionof widely available tools and

techniques a gap that a larger

number of companies than ever

are affected by.These days, commodity

risk affects a much broader

group of companies than

those that were traditionally

exposed to commodity-based

volatility, says Adrian

Done, associate professor of

As one o the worlds leading suppliers o ast-moving consumer goods, Unilever needs littleintroduction. The 171,000-employee business hasoperations in more than 100 countries and sales inmore than 190, generating revenues o 46.5bnin 2011.

But equally, its portolio o some o the worldsbest-known brandsincluding Knorr, Dove, Walls,Hellmanns, Vaseline, Omo and Signalsells into atough marketplace.

The result? Intense pressure to control input costs,

to preserve operating revenues and margins.Due to the economic environment and price

volatility, consumer companies have started torealise that procurement can help the business in astrategic way, sums up Patricia van Haaren,procurement director or commodities or NorthAmerica, Latin America and Europe.

Organisationally, she explains, Unileverhas responded by globalising its entirebuying operation.

Leveraging our scale is crucial to drive value

creation. For example, i you are responsible orthe cocoa portolio, you are accountable orwatching the entire market and making

decisions around global coverage.But as it became increasingly important to gain

transparency around its commodity procurementprogramme, Unilever sought to put a commodityplatorm in place.

We wanted the system to provide bettercoverage o our positions and to integrate well withour other systems, says van Haaren. Unilever hadalready installed SAP globally, and we knew thatSAP integrated well with Triple Point. Jointly, TriplePoint and SAP provide Unilever with a scalable,

end-to-end solution or sourcing, selling, trading andlogistics processing related to commodities oany kind.

And the benets speak or themselves, sheexplains. We need instant visibility into ournancial position or commodity contracts overa certain period and the ability to compare it withthe market, she says. For example, i you havecoverage or the last quarter o this year against acertain price, youll want to knowhow much o that is against your internal sales

price and against the current benchmark priceover that same period. Then you truly knowyour nancial position.

Ulv u al t v valu at

Commodity risk aects a broader groupo companies than those traditionallyexposed to commodity-based volatility

procurementleaders


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production, technology and

operations management at

Spains University of Navarra

IESE Business School, and the

author ofGlobal Trends: FacingUp To A Changing World.

The companies in question

are those further along the

commodity value chain,

whose exposure comes

through often complex bills-

of-material involving self-

manufactured products and

components, as well as those

sourced from suppliers

that contain commodities,without necessarily explicitly

comprising commodities.

eb rikConsider the hundreds or

thousands of parts that go

into an automobile, domestic

electrical appliance, computer,

or item of electronics

equipment. On their own,

each individual component

may be worth just a handful of

euros. But each is comprised

wholly or partially of raw

materials with a growing

and signicant commodity

risk: steel, aluminium, copper

(for wiring), gold and rare

earths (for printed circuit

boards and their components

and semiconductors), petro-

chemical-based plastics and

so on.Termed embedded commo-

dities, these materials pose a

problem under two scenarios.

The rst comes into play

at relatively low usage levels.

As with rare earths at the

moment, or copper a few

years ago, even though the

amount of material involved

is small, price movements

suddenly become extremeenough to show up on

procurement managements

radar generally, because the

procurementleaders

movement in question is big

enough to precipitate concerns

as to product protability and

marketplace price elasticity.

The second scenario

impacts businesses when

price movements occur that

may be far less extreme,but with usage levels that

are far higher. The result is

exposure that is, in aggregate,

high enough to trigger those

same concerns as to product

protability and marketplace

price elasticity.

A manufacturer of earth-

moving equipment, for

instance, is heavily exposed

to movements in the price ofsteel: even a 10% increase in

steel prices, spread across in-

house production and bought-

in components, will have a

commensurate impact on

product costs.

Wk up llIn short, sums up Done a

former operations executive

at the Ford Motor Company,and the automotive division

of parts manufacturer GKN

more and more manufacturers

are nding themselves in

unfamiliar territory.

We are entering a new era

when stable, low-cost supplies

of commonplace, everyday

items cannot be assumed, he

warns. There are some major

systemic risks out there thatare capable of blowing such

assumptions out of the water.

Worse still, it would


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appear that many of the

businesses that are most

at risk from embedded

commodities havent yet woken

up to the fact.The only time most

businesses really take notice

of the problem is when prices

uctuate in an extreme range

and then, when they revert

to more usual levels, they

assume that the problem has

gone away, says Richard

Wilding, professor of supply

chain strategy at Craneld

School of Managements centrefor logistics and supply chain

management, and the worlds

rst full professor of supply

chain risk management.

In fact, the evidence is

that theres a global resource

decit emerging.

And its a decit for which

businesses are mostly

unprepared, he says and for

which few, if any, long-term

plans are in place.

Talk to companies and

what you nd is that most of

them are using a sticking-

plaster approach to the

problem: dealing with the

short-term issues raised by a

single commodity or category

and assuming that things are

going to be better tomorrow.

But the evidence is that things

wont be better tomorrow andthat this is the new normal.

That isnt the conventional

wisdom in most boardrooms,

though. There, the view is

that half a century of scares

over resource constraints have

proved to be just that: scares.

A common refrain is that

just as the concerns expressed

in think-tank The Club

of Romes 1972 Limits ToGrowth proved excessively

pessimistic, modern-day

echoes of such concerns

are equally unreliable and

unlikely to be borne out by

subsequent events.

Indeed, theres a temptation

to see price volatility asexclusively supply-side

based oil price shocks due

to civil and political unrest;

agribusiness commodity price

rises due to natural disasters

and exceptional weather; and

movements in metal prices

as merely the rise and fall

of the appropriate sector

super-cycle.

mor iBut is such a view realistic?

Like it or not, supply-side

issues must be supplemented

by demand-side issues. And

here the facts make for less

sanguine reading.

According to the latest

United Nations estimate, the

planets population will not

level off at around nine billion

by 2050, but carry on growing,

surpassing 10 billion people.

Improved healthcare, fertility

declining in Asian and

African countries more slowly

than expected from AIDS

treatments to contraception,

and from safer drinking water

to improvements in pregnancy

and ante-natal care, the

inevitable consequence of

more births and fewer deaths

is a larger global population.

And its also an

industrialising and increas-

ingly afuent population,with a growing appetite

for those very commodities

where supply and demand are

already nely balanced.

Take China, for instance.

According to estimates

prepared by the UN population

division and investment bankGoldman Sachs and reported

in Forbes, China will have

approximately 1.4 billion

middle class consumers by

2030, compared to 365 million

in the US and 414 million

in western Europe. Even

today, around 300 million

Chinese have adequate

disposable income to purchase

discretionary items that wereimpossible a little over a

decade ago.

India, another rapidly

industrialising nation, is next.

There, the same estimates put

the number of middle class

consumers at 1.07 billion

over the same timeframe.

Latin America, Australasia,

sub-Saharan Africa, indeed

everywhere you look, the

middle classes are on the rise,

demanding and with the

disposable income to back those

demands consumer goods in

unprecedented numbers.

The problem faced by

the manufacturers of those

consumer goods, and the

manufacturers of the capital

equipment on which those

consumer goods are produced,

is the ability to obtain secure

and stable supplies of the

critical raw materials that go

into their manufacture.

Clearly, commodity pricevolatility on the scale in

question does pose a risk

that is difcult to manage

Talk to companies, and what you nd isthat most o them are using a sticking

plaster approach to the problem

procurementleaders


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procurementleaders

l

Michael Schwartz is chie

marketing ocer o Triple PointTechnology. Here, he talks toProcurement Leaders about thescience that lies behind goodcommodities management

Hw bg a pbl th u utal auatu?Its the next big problem thatmanuacturers need to solve. Risingprices and volatile prices

present huge challenges related tomeeting orecasts and maintainingprotability. Over the pastseveral years, businesses haveocused intensely on supplychain eiciency with initiativessuch as Lean Manuacturingand Just In Time. At this point,companies have wrung mostexcess costs out o the supplychain, so commodity volatility hasto be dealt with dierently - andraising prices has limited viabilitybeore it creates demanddestruction.

But hw awa th pbl yu thk pa a?Are they aware o it? Probably.But, do they misunderstand thenature o the problem? Denitely.Huge numbers o businesses thinkthat the extreme volatility o

commodity prices is a temporaryblip and will pass. The recent pastis not a temporary phenomenon,but the new reality, and its a caseo take action now or be letbehind.

A gaatfgug ut what t ? Atall, th a pt at whhalty ha t bt.

Its happening to some extent,certainly. Look at early adopters,and you see an appreciation that

the game has changed. Talk tosome o the larger and moresophisticated manuacturers companies such as Unilever,Nutreco, and Grupo Bimbo, thelargest baker in the world andyoull hear that they have identiedcommodity management as astrategic unction, and as a key tosuccess. In short, they seecommodity management as astrategic issue, and not just aprocurement challenge. Those arethe early adopters, o course. Mostbusinesses are behind the curve some o them considerably so.

What a th a u ahw a Tpl Pt hlp?

For manuacturers looking to addresscommodity management, we ndthere are typically three mainchallenges. First is visibility ortransparency into commodity risk.Their commodity exposure is buriedin subcomponents or ingredientsand urther obuscated acrosscategories, divisions, andgeographies. Second, access tokey inormation is not available or

days or weeks when it should bereal-time. Its shocking how manycompanies recognise commodity

risk as a big issue, but rely onspreadsheets as the corporatetechnology solution. They usehuge, multi-tab, error-pronespreadsheets that take weeks tocollect and enter data, and thatare out-o-date by the timemanagement has the inormation.And lastly, companies lack theanalytical tools to turn data intoinsightul inormation or ast,accurate decision-making. Allthese issues are solved when amanuacturer adopts Triple Pointsfagship Commodity XL solution.

Hw that th talatt bttl bft?Across a broad spectrum o

commodities, volatility hasaveraged upwards o 30%. Thiseasily translates to a 15-20%risk to most manuacturersbottom lines. As I mentionedbeore, commodity managementis the next major issue orcorporate management totackle. Commodity volatility isnot going away and those thatput the appropriate technology

and processes in place rst willsecure a large competitiveadvantage.

Q&A: mATeriAL science


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procurementleaders

So is there a better way? Reassuringly,some o the worlds leading businessesare pioneering just such a solution

Gartner Research supply

chain team, with specic focus

on procurement, sourcing and

supplier management.

Short-term commitmentswere typically spot buys or

agreements with strategic or

secondary suppliers that were

less than one year in length.

Another strategy tackles the

problem from the perspective

of material usage. Here, Alan

Braithwaite, chairman of

supply chain consultancy LCP

Consulting, and a visiting

professor at Craneld School ofManagement, points to the role

played by innovation, product

design and value engineering.

Once a material becomes

expensive, ways to use less of

it can often be found through

substitution, or making items

thinner, lighter or smaller, he

says. While there arent any

easy answers, using 50% less

of a material is equivalent to

a 50% price cut and one that

is permanent.

Hedging is another

strategy: buying a contract to

lock in a price for a xed termand a xed volume, a hedge is

a strategy for mitigating the

effect of price rises.

While it is by no means

a silver bullet a hedge is,

by denition, a short-term

solution, and more suitable to

reducing volatility and price

spikes than stabilising, or

even reducing cost hedging

is a hugely important tool in acompanys arsenal.

Neither is hedging without

risk which means that

mastering the process through

investment in the right people

and tools has become a key

competitive differentiator for

heavy users of commodities.ERP systems dont really

lend themselves to breaking

out underlying commodity

and raw material volumes

especially in the context of

purchased parts, says Craig

Zawada, senior vice president

of pricing excellence at

consultants PROS Pricing.

Companies are used

to dealing with spikes inraw material costs on an

intermittent basis, as they

happen and now theyre

having to do it on a weekly or

even daily basis, he says.

Finally, the process of

hedging raises governance

and communication issues,

says North Rizza. Its often

undertaken by nance

functions particularly in

the US, where accounting

rules call for hedging

transactions to be reported

yet dialogue between nance

and procurement is limitedand often characterised by

suspicion on both sides.

The result is that the

procurement function might

know the usage level and

future demand, but nance is

hedging in isolation, seeing it

as a nancial transaction, not

as part of a buying strategy,

she says.

So is there a better way? Theanswer, reassuringly, is that

some of the worlds leading

businesses are pioneering

through traditional supplier-

based or category-based

techniques. Nor, in many

instances, is it possible to take

the easy option and fully passon the increase to customers

in the form of price rises.

Fii bkTalk to experts, though, and

its clear that manufacturers

have a number of weapons in

their armoury. In short, there

are ways to ght back.

Jim Pearce, a partner in the

energy and process industrypractice at consultants A.T.

Kearney, for instance, talks of

end-product pricing formulae,

based on raw material input

price movements, in order to

inject greater transparency

into supplier-customer negot-

iations. Similarly, forming

strategic alliances with key

suppliers can help.

Both tactics, he reports,

have proved useful in an

assignment for one of the big

ve oil majors in the context

of steel purchasing, where

global steel volumes were

in the range of two to three

million tonnes a year.

Indeed, research from

analyst rm Gartner, probing

the raw material sourcing

strategies of 31 companies

across ve industries, found thatall of them had improved their

long-term supplier relationships

in recent times, developing

twin-track, long-term and

short-term strategies.

Long-term commitments

were orchestrated based on

pricing formulas, market

expectations and ination

or deation adjustments

with the most strategic andpreferred suppliers, reports

Mickey North Rizza, former

research director in the


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9just such a solution and in theprocess highlighting the art of

the possible.

In short, look at some

of these commodity-heavy

businesses: Unilever, Reliance

Group, Bunge, Rio Tinto,

Allaint Energy, BKW, Gavilon,

SABMiller, Campbell Soup,

Valero and 400 others in more

than 35 countries and its

possible to see an intriguingly

innovative technology platformin use.

sui uThe platform in question is

Commodity XL, from Triple

Point Technology.

Simply put, explains

Triple Point Technologys

chief marketing ofcer

Michael Schwartz, in its

20-year existence, the rmhas parleyed expertise in

commodities, accounting,

compliance, risk management,

procurement and scheduling

in order to develop a suite of

solutions that can be leveraged

to mitigate the challenge of

embedded commodities.

Our Commodity XL suite of

solutions is the only commodity

procurement, trading, supply

chain and risk management

system that works across

multiple commodities in real

time, he notes.

And underpinning the TriplePoint platform is an innovative

blend of risk management and

nancial engineering, adds

Kris Timmermans, global head

of the sourcing and procurement

practice at Accenture.

Anyone can do hedging:

its a xed price, for a xed

period, at a xed premium, he

explains. Triple Points hedge

optimisation is different,combining hedging with deri-

vatives, giving protection when

the market price moves up, as

well as when it moves down.

The trick, explains North

Rizza, is to exploit technology

to identify what to hedge,

combined with technology to

identify how and when to best

hedge it.

The Triple Point platform

integrates the workows

between procurement and

nance, providing visibility

into what needs hedging and

providing the means to hedgeit effectively, she says.

And all within a tightly

controlled environment, says

Accentures Timmermans.

With the Triple Point

platform, people in your buying

organisation are effectively

[given the capabilities of]

traders but are operating

within very constrained

volume and risk policies, heexplains. Theyre trading

within very tight value at risk

controls and with full

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Triple Point is a provider o cloudand on-premise commoditymanagement sotware thatdelivers advanced analytics tooptimise end-to-end commodityand energy value chains.

Triple Points CommodityManagement platorm enables

over 400 customers in morethan 35 countries to protablymanage exposure to energy

and raw materials in industriesincluding energy, metals,minerals, agriculture, transport,shipping, consumer goods,industrial manuacturers, and bigbox retailers. Triple Point wasnamed a Leader in GartnersETRM Magic Quadrant or its

completeness o vision and abilityto execute in 2009, 2010,2011 and 2012.

ctatTriple Point Technology301 Riverside AvenueWestport, CT USA 06880Tel: +1.203.291.7979Email: [email protected]

Procurement Leaders in no way endorses theproducts or services provided by our sponsor

ABoUT oUr sPonsor

nance function oversight.

Whats more, he says, the

transformative power of the

approach can extend through

the supply chain, withmanufacturers carrying out

hedge optimisation on behalf

of suppliers, securing not just

top-level raw material prices,

but prices for tier-1 and tier-

2 suppliers. Manufacturing

and engineering company

Caterpillar, he points out,

operates in just this way in

respect of steel.

Wk-up llThe problem of embedded

commodities is one that many

businesses are starting to

wake up to, but one for which

very few have formulated

a strategy.

Yet, its already possible

to see that finely balanced

levels of supply and demand

look set to deliver significant

price volatility in the years

ahead especially so as the

consumer classes in newly

industrialising economies

enter the global marketplace.

Are there solutions that

can at least mitigate against

the difculties that this will

cause? Yes, at least in part.

But sophisticated, holistic

solutions, backed by

technology and governance

controls, are fewer in number.

Triple Point Technology,

a name with which few

industrial manufacturers

with embedded commodity

challenges will presently

be familiar, looks set to

achieve greater prominence

because, like many of the

most complex challenges,

its a combination of people,

processes and technology

that will help to dif ferentiate

the winners from the losers.

As Roy Williams, managing

director of sourcing platform

Vendigital observes, the

challenge is one that is

relative, not absolute.

The issue with raw

material price volatility

is dealing with it better

than your competitors,

not eliminating its effects

completely. And if youre out-

doing the competition, youre

ahead of the game.

Make no mistake, those

manufacturers who dont

manage the problem will see

the results on their bottom

line. And its a that will get

worse if ignored.

Malcolm Wheatley

procurementleaders


Make no mistake, those manuacturerswho dont manage the problem will seethe results on their bottom line


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