Hedge against rising prices

Few things in life are guaranteed, but increased prices do not have to be one of them.

April 1, 2011
by Shawn Casemore

There are few commodities, if any, in which pricing has trended downward over time. Outside of unforeseen events, such as changes in the economy and world events, there are often pressures created by producers that lead to pricing volatility. Unsurprisingly, any one or more of these factors is in play at all times, with the result of driving higher prices and increased returns.

Think about electricity prices 10 years ago. They soared once electricity was placed on the open market. Over time, the price has slowly eroded as a result of government subsidy, reduced demand and increased supply. If we look at electricity prices today, they are once again climbing for reasons not clearly understood or predicted during the past decade.

If your company purchases commodities, or any product that relies directly on the consumption of a commodity, then you are exposed to rising prices. To reduce this exposure and improve profitability, hedging and price offsets are necessary, all of which make up part of an effective procurement strategy.

Here are five steps to develop an effective procurement strategy for commodity price protection:

  • Monitor commodity pricing. Numerous websites provide insight into pricing trends, both historic and future. Monitor these sources of information on a frequent basis to determine the best time to buy;
  • Negotiate long-term agreements. Move away from transactional purchasing, and instead extend agreements. By entering longer-term agreements with volatile commodities such as oil, you can provide price protection and the ability to plan and align within budgetary objectives;
  • Build relationships. Get to know senior executives within the supplier’s organization. Build relationships which will, in turn, provide further opportunity for insights into market challenges and potential capacity restraints. During my time in the pulp and paper industry, I learned a tremendous amount about future pricing trends and challenges the industry may experience, simply as a result of developing strong relationships with suppliers;
  • Manage inventory. It is important to closely monitor consumption, and use market dips as an opportunity to increase and bank inventory. The methodology here must be the same as applied in the stock market—buy low, sell high. Proper management of inventory can provide short-term relief during pricing volatility; and
  • Avoid sticker shock. Educate stakeholders on the volatility to be expected, and maintain your own forecast supported by research. Information on pricing trends, predictions and future challenges can easily be located on the web and through review of industry publications.

Build a strategy using the above techniques, and you will have greater confidence in the longevity of pricing, thereby mitigating risk and protecting the financial viability of your organization.

Shawn Casemore serves on the board of directors for the Ontario Institute of the Purchasing Management Association of Canada (OIPMAC) and contributes to the advancement of the profession through his teaching with Humber College in the supply chain program. His experience in supply chain management includes leadership roles with companies such as Magna International, Arvin Meritor, N.C.R. and Bruce Power. E-mail Shawn with any questions or comments.

About this blog
From basic commodities to complex services, Purchasingb2b’s Procurement Value blog will provide you with best practices and tools to make your purchasing department more cost-effective, strategic and efficient. For more information on contributing to this blog, contact the editor.