Dealing with Price Volatility in the Turbulent Global Marketplace

In the Hackett Group’s recent insight on Taming the Inflation Dragon, we find out that the average company is facing a 9% drop in corporate profits this year due to rising prices and other inflationary pressures and that this translates into a 150 Million hit to the bottom line for a typical Global 1000 company with 27.8 Billion in revenue. Ouch!

Obviously, the company is counting on the supply management organization to control costs despite the rampant price increases in a market where commodity inflation has not only increased by 30% overall but where price volatility has increased nearly 60% since before the recession. Not an easy challenge, especially since speculation in commodity markets is having a major impact on 43% of companies and a moderate impact on 17% more. And with the majority of suppliers passing on increased cost, every company is feeling the squeeze. So what can a supply management organization do to improve the situation?

Use rigorous input price/cost forecasting processes
that integrate data from a large number of sources (public indices, private indices, third party market intelligence, etc.) and internal purchase price history. The processes should include years of historical data in the analysis and apply multiple forecasting models to arrive at most likely prices given current trends and models that traditionally work well under similar levels of price volatility.

Augment input cost forecasting with scenario-based business planning processes
that integrate input price/cost forecasts into a pro-forma profitability plan. The scenarios should consider the extreme cases where demand explodes or demand plummets so that the organization can also develop supply risk management contingency plans and estimate their associated costs so that the overall price/cost models are reasonable and capable of being rapidly adjusted if needed.

Employ advanced demand forecasting models
that create good demand forecast ranges to lock down supplier capacity and pricing. Given that one in four companies experiences significant price volatility by having to pull against limited supply, the last thing a supply management wants to do is have to spot buy in a tight market.

Centers of Excellence that use deep predictive analytics
to not only identify input costs that are likely to increase significantly or undergo increased volatility, but to develop detailed should cost models to support negotiations against undue supplier increases, to reduce supply needs of cost-inflated items by changing specifications or identifying alternate materials, and to identify non-price items that can be traded to off-set price increases (such as better payment terms, new business, or supply management support from your supply management organization). Analytics is a key technology for cost reduction and avoidance across the board.

Clear direction and strategy
for hedging and decision making. This needs to start with a cross-functional consensus on what the business objectives are. Is it to “beat the market”, even if it comes at the cost of establishing complex hedging processes? Is it to “smooth” supplier pricing? Or is it to “smooth” margins by the simultaneous optimization of sell-sie and buy-side commercial strategies. Supply Management and Finance must be aligned.