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Growing volatility in commodity prices has exposed industries reliant on pure commodities to significant risk.
Accenture believes that this challenge constitutes a huge opportunity for procurement departments in these industries to manage commodity risk proactively. Companies in pursuit of high performance should note the three drivers for successful commodity price risk management.
Commodity prices have become permanently volatile, creating a massive risk for industries reliant on pure commodities. These industries include agricultural products, commodity processors, and manufacturers of semi-finished goods.
At the same time, 24/7 news media and easy access to information online are making consumers more sensitive to commodity prices. This creates a challenge for producers because the price they paid for a certain commodity during manufacture could be substantially lower when the product hits the shelves: passing on price increases to consumers can thus be extremely difficult.
This situation provides a unique, greenfield opportunity for industries that are heavily reliant on pure commodities to develop the capability to hedge against price volatility. To date, though, few have taken up this opportunity.
A company’s position in the value chain, the type of raw materials it needs and its corporate strategy determine the impact that managing commodity price risk can have.
For example, a commodity processor such as an ethylene producer can significantly mitigate its price risk since it relies heavily on a base commodity. For a manufacturer of bottled water, on the other hand, this approach would have less of an impact. Although the bottle and cap may be a large part of the product’s costs, the bottled water producer has little influence on the value chain points where commodity costs play a large role.
Embedded commodities need to be taken into account as well. Market conditions also drive the potential of efforts to manage commodity price risk. Base commodities, such as iron ore, copper or grains, are widely traded in liquid markets and subject to global market price swings. They may also require costly logistics such as transport. Opportunities to influence costs on such commodities is significant.
On the other hand, a reworked specialty, such as color pigments for the fish industry, is a byproduct in a smaller market. The potential to influence costs is limited. Nonetheless, the risks can be high since there may be only a few suppliers. The more finished the product, the more variation there is between suppliers.
When building these types of risk management capabilities, it is also important to take corporate strategy and risk appetite into account. An organization may not wish to pursue hedging strategies for crude oil aggressively, for example. It may feel comfortable with $25 to $70 per barrel and only hedge for prices above $70. The corporate strategy may also mandate the use of hedging or other risk management strategies.
Based on our experience, Accenture has identified three success drivers for building a powerful function to manage commodity risk. They are:
Develop a new mindset. Because markets change so quickly, the procurement mindset needs to shift from a long-term and reactive stance to one that is more short-term and proactive. It must reflect a constant understanding of how commodity prices can affect the bottom line.
Engage the entire enterprise. Robust commodity price risk management will need the support and input of multiple functions across the organization. Procurement must develop an efficient interlock between it and other key functions such as category managers, operations and manufacturing.
Establish the optimal structure. Depending on the desired transactional model for commodity price risk management activities, companies may choose different degrees of centralization.
Alex Chandy is a senior executive and global lead for Accenture’s Commodity Trading and Risk Management group. The group focuses on helping clients become high performers in commodity risk management, in the areas of procurement, operations and supply chain, and financial reporting. He has helped several clients blueprint and implement commodity risk management capabilities to deliver tangible savings to the bottom line. Chandy is based in Houston, Texas.
Armijn Verweij is a senior executive in Accenture’s Operations Consulting group. He leads the Sourcing & Procurement unit in the Netherlands, with a focus on direct material sourcing. Verweij has helped clients in many different industries with procurement transformation projects aimed at cost reduction, efficiency improvements and organizational redesign.
Ingrid Scholten is a consultant in Accenture’s Operations Consulting group. She specializes in sourcing and procurement and has worked on procurement transformation projects aimed at cost reduction across the chemicals, high-tech and retail industries.
July 31, 2012
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