Daily Archives: May 9, 2010

Get Your Metals Prices Under Control

AT Kearney recently released a short piece on Driving Down the Cost of Raw Materials: A four-pronged approach to managing input steel prices and commodity purchases that had some good tips for managing your metals spend. The report broke your opportunities down into four types:

  • Material Cost Recovery

    Up to 30% of inputs are unused and considered a waste by-product of the manufacturing process, but can be sold as scrap, melted down, and reused again. In peak markets, this scrap can be worth hundreds of dollars a tonne.

  • Sourcing Power Increase

    Going straight to the source and bypassing intermediaries can generate better prices and more power, especially if the metal needs (grades, gauges, sizes) etc. are bundled into a single buy.

  • Usage Optimization

    Reducing complexity (through standardization on gauges, grades, etc.) and segmenting suppliers (based on common needs) can lead to design and production cost decreases as well as unit cost decreases.

  • Supply Chain Management

    Optimizing the inbound (sourcing) and outbound (sale and delivery of scrap) can yield a number of process cost improvements.

Given the price volatility that follows every boom and bust in the economy, getting a good grip on total cost of ownership of organizational metal buys can save an organization 12% to 25%, which is well worth the effort. For more on how to save in specific metals categories, and when to lock in long term contracts, see the Metal Miner blog — the only blog focussed on helping organizations optimize their metals strategy.

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PPV is a Bad Measure of Procurement Performance

As noted in a recent brief from ChainLink Research, PPV (Purchase Price Variance) is a bad metric for Procurement, especially if your buyers’ performance is being based on it. Not only does this kind of metric encourage behaviour that may lower PPV but create a higher total cost, but it can cost your organization a bundle, and this goes for commodities that usually have low volatility as well as those that have high volatility. Here’s why.

Let’s say you were buying 10,000 barrels of crude oil in 2009 on a monthly basis. The OPEC basket price, which started the year at 40.44 on January 2 and ended the year at 77.16 on December 31, and which reached a low of 38.10 on February 18 and a high of 77.88 on December 1, varied, on average, by $7.20 a month, with a minimum variance of $2.91 in November and a maximum variance of $13.30 in May. If your buyers are being measured on PPV, and they are good at predicting annual pricing trends, chances are they are going to pay as close to $65.04 as possible, as this amount (and any amount between $64.00 and $66.08, to be precise) minimizes the average monthly PPV. (The PPV varies from 0 in July and September to $21.14 in February and averages out to $7.46.)

In this situation, your buyer would spend 7.34 Million dollars trying to minimize PPV, which would cost your organization 467,200. This is what your buyer would pay each month (buying on the day that was closest to the price point target):

Month Price Cost PPV
Jan 46.32 463200 14.82
Feb 43.90 439000 17.24
Mar 50.77 507700 10.37
Apr 52.26 522600 8.88
May 63.71 637100 2.57
Jun 66.08 660800 4.94
Jul 65.04 650400 3.90
Aug 68.04 680400 6.90
Sep 65.12 651200 3.98
Oct 66.81 668100 5.67
Nov 74.95 749500 13.81
Dec 70.64 706400 9.50
AVG 61.14 611367 8.55
SUM   7336400  

But if your buyer was focussed on cost avoidance, your buyer would only spend 6.87 Million dollars trying to minimize cost, saving your organization 467,200. If you ignored PPV, this is what your buyer would pay each month (buying on the day that allowed for the lowest purchase price):

Month Price Cost PPV
Jan 39.29 392900 21.85
Feb 38.10 381000 23.04
Mar 41.79 417900 19.35
Apr 47.15 471500 13.99
May 50.41 504100 10.73
Jun 66.08 660800 4.94
Jul 59.66 596600 1.48
Aug 68.04 680400 6.90
Sep 64.00 640000 2.86
Oct 66.81 668100 5.67
Nov 74.95 749500 13.81
Dec 70.64 706400 9.50
AVG 57.24 572433 11.18
SUM   6869200  

Still think minimization of PPV is a good idea?

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