08 March 2013 09:28 [Source: ICB]
Pic credit: Purchasing managers can find prudent ways to deal with volatility in both supply and demand. Understanding your markets and devising a strategic plan are key elements
Copyright: Rex Features
In most cases, the business is a small minnow in a huge economic sea. Even in the largest ocean, it is possible to find a small safe harbour in which to weather the storm. Saying this is easy, but what practical steps can be taken? One approach that minimises the turbulence is strategic purchasing.
Adopting a strategic purchasing plan requires three basic steps:
1. Understand the markets and have a forecast to help see potential storms (and opportunities) coming.
2. Plan strategically using the latest market intelligence and best resources to find your safe harbour.
3. Have adequate project management/execution procedures in place to allow you to navigate your operations to the safe harbour.
UNDERSTAND YOUR MARKETS
First a business must fully understand the basics for key raw materials, their components, feedstocks and the alternative value streams that compete with them, as well as the global supply and demand picture (such as that available from ICIS' Supply and Demand Database).
Good market intelligence that lets you know what has happened in the recent past and what is coming ahead in the near to mid-term is critical.
But having the data alone does not help with managing volatility; you also need the necessary expertise to translate this in to meaningful information that can used to benefit your bottom line.
A good price forecast as shown in the chart (right) is an example. It shows the history and predicted range for the next 12 months. From it, we can also see a seasonal nature that, despite conventional wisdom, might give us opportunities to "time the market" and buy ahead. With a range of $0.20/lb, a buyer of 10m lb could save up to $200,000 by timing annual purchases.
Perhaps we cannot take advantage of the full potential, but obviously we do not want to be engaging in long-term purchases of this product in April.
In this case, however, given industry feedstock changes - of which many may not be aware - the market is expected to change and a different strategy may be required.
But many firms do not see these types of opportunities because they can not - or will not - justify the internal resources needed to analyse market intelligence, and this often is where third-party experts and consultants can help.
Having worked in a number of medium-sized businesses to help reorganise them, I often found that a fraction of the resources are managing the lion's share of the cost.
In one business, for example, 3% of the salaried personnel (procurement staff) were managing the raw material costs, which represented 40% of the cost of goods sold.
Often the procurement staff were also fighting fires, attending numerous meetings, planning, expediting orders and perhaps even handling supplier quality issues.
In small companies, it is common that these people have proven to be the most reliable and trustworthy employees, who know the business well and moved up through the ranks, but often they have done so without analytical, economic, negotiating or professional purchasing training or experience. Training for these people and/or additional professional resources can raise the skill level of the whole team and deliver big returns.
Think about what $0.01-0.20/lb of improvement on raw materials would do for the bottom line. Many purchasing managers would say: "There is no way to get this much off our raw material cost." And if that is their mindset, they are right.
But having been involved in integrating the purchasing of four similar companies with 10-plus locations and purchasing managers at each firm, I have heard this before. In this instance, it was a classic case of the old saying, that "you don't know what you don't know".
These purchasing managers had no idea for how much less some raw materials could be purchased. Each buyer was getting good pricing on a few raw materials, but only average prices on most, and higher than average on a few.
The savings potential from just allowing the site that was getting the best price to order for the whole organisation was huge.
Classic strategic planning is too involved and diversified to cover here, but three key actions to consider when weathering volatile markets are:
Make the involvement of a strategy team part of your company culture.
Use tools such as a formal opportunity analysis, which considers potential project savings, probability of successful achievement, effort/cost required and adjusted savings based on these. Prioritise by the adjusted savings to get the biggest return on investment.
Consider that a set of fresh outside eyes (or several) can see things you cannot. So get some fresh perspective, be it via consultants or through brainstorming sessions with sister operations - or, even better, both.
A cold-eye review can:
help you see things you might not have seen - i.e. missing the forest for the trees;
tell you how your practices compare to best practice;
recognise wasteful practices, excessive reporting or even under-reporting; and
help you objectively prioritise resources and efforts for the best delivery to the bottom line.
The grid (below left) provides guidance on evaluating resources and prioritisation. The 80/20 rule holds true for most circumstances: you can achieve 80% of the value improvement by focusing on 20% of the issues.
Chasing that last 20% often means you are in the lower left quadrant of chasing low-importance, low-urgency issues. The opportunity lies in identifying those high importance issues that may have a low sense of urgency, but are hiding great value.
Assign dedicated resources to reviewing pricing, terms and conditions, and develop your strategy with a cross-functional team.
Recognise that change will be necessary. Your competitors are running, so there is no standing still. You are either moving forwards or you are moving backwards. It is common to want better results but still be reluctant to change from the successful way we have always done things. It is not that people are being difficult. They just lack vision beyond their experience, which is another reason outside resources and perspectives can help.
It is one thing to create a comprehensive strategic purchasing plan; it is another to take the steps necessary to adequately execute it. Projects fail primarily for two reasons: one is weak planning and the other is weak execution. You can plan carefully and take steps to compensate for some weak execution.
The key is to devote enough time and resources to the planning phase and be realistic on timing. Do not fool yourself into thinking it can be done in half the time.
Another challenge is not to over-plan. At some point you must start taking action. It is often better to make decisions earlier rather than later, formally considering risks. That way if you make a mistake, there are still other options - plan B - and time to recover. Wait too long and your options are limited; this happens too often when there are difficult decisions, backing business managers into corners.
Have a detailed action plan to make it happen, with a single point of accountability for each major phase or task. If you use consultants or outside resources, be sure they are available for the execution phase and periodic follow-ups. At a minimum, have them available for a one-hour call each week until the plan is in place and then for monthly calls to ensure sustainability and to measure results. They can keep an independent focus on the goals and objectives that your staff may not be able to with the day-to-day operations of the business.
In the end, there is no "cure" for volatile markets, but dedicating time and resources commensurate with purchased goods' influence on the bottom line to strategic purchasing can pay big dividends, and there are ways to manage volatile raw material markets to minimise their impact - and even capitalise on them.
Think about it: for every dollar you lose because of volatile prices, someone else gets that benefit. How much would it be worth to turn it in your favour? But that is another story.
ICIS Consulting can provide an alternative view of the global chemical and energy markets. In global and complex commodity markets, ICIS helps business leadership teams around the world understand how current and projected market conditions affect their businesses. For more information, visit ICIS consulting online
James Ray is a senior consultant for ICIS, based in Houston, Texas, US. He has worked for private industry (primarily capital management), with a focus on reducing raw material costs using market intelligence and establishing more favourable contracts throughout the supply chain. Sectors include manufacturing, converting and recycling polymers for blow moulding, extrusion and injection moulding, as well as textiles. Contact him at firstname.lastname@example.org
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