INSIGHT: Buying small and local in changed times

14 November 2008 17:20  [Source: ICIS news]

By John Richardson

SINGAPORE (ICIS news)--Chemicals demand still exists, believe it or not, but the new economic order - one that could last as long as six years - requires new approaches.

Purchasing managers need to start acting locally as well as globally.

Who would want to be a financial controller working for a big company, or the jack-of-all-trades managing director of a small or medium-sized enterprise?

Every purchase order and every invoice, literally every single transaction, needs to be reviewed by whoever understands overall credit availability.

One small step out of line, one tiny error by an over-enthusiastic purchasing manager or sales executive and bang, you’ve exceeded your credit limit.

Even if you have a sound business model, your bank might have no option but to say “sorry, but that’s it - we are withdrawing all your credit”. But is there really such a thing as a sound business model these days?

This new economic order could have major implications for how chemical pricing behaves. Old understandings on how to read the direction of markets might need to be revised.

“There have always been two kinds of demand in the confectionery industry – long and short term,” said a plastics-wrapping manufacturer on the sidelines of the ICIS World Polymers Conference, which took place in Bangkok, Thailand, earlier this week.

For the next few paragraphs, the confectionery industry and upstream to polyolefins will be used as an example of how purchasing managers need to act differently. The same rules could also apply to other product chains.

“Nothing has changed when it comes to your big 1lb bar of chocolates. You can still ship large volumes of packaging material economically from, say, China to the US as these slow-moving items will sit on the shelf for months,” the manufacturer added.

But for your fast-moving confectionery – for example, discounted big bags of miniature chocolate bars placed in toddler-reach on shelves near supermarket checkouts – shipping wrapping material from China no longer makes sense.

“A big percentage of a confectionery manufacturers’ revenue comes from fast-moving and short-term promotional offers. The trouble is that these promotional offers are no longer as fast-moving because consumers are cutting back on spending.”

Much smaller quantities of wrapping material are needed and so for logistics reasons, buying locally adds up. If you make chocolate in a developed market, these small suppliers might have previously been ruled out because of their high labour costs and low capacity.

“It’s not economic to half-fill a container and ship it all the way from China. Local suppliers can also much more quickly respond to small day-by-day changes in demand,” the manufacturer added.

There are other reasons to buy in small quantities, and therefore locally.

Oil prices move in an almost perfect relationship with equity markets these days. Stock markets rebound as investors clutch on to some fleeting good news and crude rallies by a few dollars a barrel, only for the reverse to occur the following day.

So nobody at any point in any product chain wants to sell or buy big in case they end up on the wrong side of a shift in highly erratic energy prices. For example, why buy a big quantity of resin today only to see the WTI price tumble the next?

Your equally hard-pressed customers, even the ones you’ve worked with for years, will not be able to do you any favours if you plead that you made a mistake on crude.

Shortage of credit is a further reason to keep orders at a minimum.

“My MD is signing off every purchase order. You need to make your credit stretch. The other problem is that you need to very carefully monitor the credit situation of your suppliers and your customers,” said the manufacturer.

"Make sure you have enough of each in every region where you operate in case some of them go bust."

Buying locally also extends up this chain to polyolefins.

“Polyethylene (PE) and polypropylene (PP) exports from the States have declined because of the weaker dollar and the collapse in pricing that closed-off arbitrage,” said a polyolefins producer on the sidelines of the same conference.

“Another factor is that end-users prefer to buy local because retailers are placing smaller orders.”

A further reason to keep inventories low is the huge economic uncertainty out there. Nobody knows how deep this recession will be and how long-lasting.

“We keep looking further and further back into history for parallels,” said Matthew Sullivan, director of energy structuring and origination for Standard Chartered Bank, in a speech during the conference.

First it was the dotcom bubble crash of 2001, then the Asian financial crisis and next the global economy downturn of 1980-82. Now all the talk is of the Great Depression.

“Vehicle sales in the US, on a population-adjusted basis, have fallen to their lowest level since World War II,” he added.

“I hate to give you the bad news, but I think it could take five-to-six years to get through this. Most of the iceberg is still beneath the water.”

The dreaded consumer confidence feedback mechanism may have only just begun.

Banks might, theoretically, be in a better position to lend thanks to all the rescue packages – but at ground level in the chemicals industry trade finance remains desperately hard to obtain.

Inventory writedowns are huge because of raw materials bought before the crash in demand and pricing. This will affect financial results in the first quarter next year.

This will in turn lead to more job cuts in chemical and other companies.

When you are worried about losing your job, if you haven’t lost is already, you don’t spend; and as Japan found out during the 1990s, consumers are even less likely to spend if they think that prices will be lower tomorrow.

As consumers make even deeper cuts into their spending, this leads to even worse corporate results, more business failures and more job losses and so on and so on….

“People are reviewing their retirement plans [because of the collapse in equity markets]. They feel a lot poorer, which is another disincentive to spend - and they will have to add 5-6 years to their working horizons,” Sullivan added.

The next big banking scare just around the corner might be further writedowns on credit card losses

In the midst of economic calamity and the resulting shift in buying patterns, what does this mean for how chemical pricing will behave?

Chinese buyers used to periodically withdraw from markets en masse, in the case of polyolefins.

This would lead to big price declines because the volume of lost trade was big.

The guessing game would then begin over inventory levels and demand – meaning when they would need to re-stock.

When they did return, of course, volumes on the positive side were equally big, resulting in big price rallies.

But increments are these days as low as $20-30/tonne (€16-24/tonne) a time because of small-volume sales. Prices then quickly fall back.

When prices retreat, even more ground can be lost than had been gained because of worsening economic news.

Nobody can be sure when chemical-pricing markets will bottom out for good in this current cycle - just as nobody has any clue when the economic recovery will arrive.

($1 = €0.79)

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