Strategic commodity sourcing—March/April print edition

Whitepaper helps optimize sourcing of commodity-driven categories

May 10, 2013
by PurchasingB2B Staff

While procurement can spend much time and effort on tenders and negotiations, organizations can see prices increase shortly after the ink dries on the contract. Justification from suppliers often focuses on rising commodity prices affecting their bottom line.

Buyers rarely challenge this reasoning effectively, according to a recent whitepaper from London-based Efficio Consulting, entitled Commodity Management in Strategic Sourcing: How to optimise the sourcing of commodity-driven categories. The paper explains the value of treating commodity-driven categories differently and explores strategic sourcing for commodity management.

A commodity component exists within the value chain of most products and services, the whitepaper says. While the influence those commodities have on final price varies, their significance is often overlooked. Buyers seldom investigate the cost of materials or services and their relationship to established commodities. Without a commodity management strategy buyers fail to benefit from falling commodity prices while increases are often transferred to suppliers.

The whitepaper notes several factors underpinning this. Buyers must diffuse sourcing efforts among several categories and likely give higher priority to some raw materials than others. Conversely, suppliers have full insight into cost breakdowns and are closer to the information.

Some commodities are more volatile, says the whitepaper. Unless commodity prices are monitored and managed closely, price fluctuations might mean lost opportunities. Fluctuations have bearing on the final price if the commodity represents a high proportion or weight within the make-up of a good or service.

Successful commodity management emphasizes certain steps in strategic sourcing, the whitepaper says. Buyers often jump into RFPs and negotiations without laying the groundwork for the tender process, which can become detrimental due to a lack of data 
and category insight. One study of tier-2 suppliers showed over 20 percent of the cost was traceable to a commodity, the paper notes.

The whitepaper recommends category profiling to gain an understanding of the category and related supply chains and stresses the importance of investigating the upstream supply chain for commodity components. Some benchmark and spend figures may be internally available, and incumbent suppliers should be the key contact for gathering that data.

Another step is supply market analysis, with commodities identified during category profiling then analysed by trading currencies, supply sources, price trends, volatility and so forth. The paper recommends establishing a market index or price reference to benchmark purchase price. The commodity content must be considered within the cost of ownership and treated as any other purchase cost element.

Buyers should be able to speculate on the suitability of various sourcing levers, like formal tendering, long-term contracts, 2nd-tier agreements or low-cost country sourcing. If the goods are commodity-driven, for example, the whitepaper recommends focusing on either long-term indexed agreements or spot buying. Well-structured tenders count when evaluating a supplier’s bid, and a superior RFP eases the stress of response analysis while showing the buyer’s competence.

If a strategy involves indexed agreements for commodity driven goods and services, the RFP should solicit inputs on criteria including the weight of a commodity within total price, the proposed index to be used and the agreed spread of commodity price fluctuation. If spot buying is the strategy, the whitepaper recommends minimizing negotiation costs while maximizing their effectiveness. Automated tendering tools are recommended to shorten process time, reduce costs and boost negotiation effectiveness.

With long-term agreements, a sound RFP gives buyers an apples-to-apples comparison of submissions. By fixing the commodity component as market-dictated, the remaining cost constituents become the bid differentiator. The increased transparency creates negotiation opportunities on cost components, especially if the pricing of individual suppliers shows irregularities.

A contract for a long-term agreement should include special emphasis on indexing, the whitepaper recommends. A commodity’s weight, chosen index, price spread and review period should be incorporated into the final contract along with monitoring and reporting mechanisms, the paper says.

In conclusion, the whitepaper says, securing market prices for commodities is a substantial achievement for organizations, as market prices represent a transparent foundation for buyer-supplier relations.