Managing risk for Buying teams: To hedge or not to hedge?
This year may prove to be another bumpy year when it comes to price volatility. If buyers have yet to remodel their procurement strategies, 2020 is the year to start.
The uncertainty is in part the down to a shift in trade agreements, regulations and tariffs. The fraught year-and-a-half-long trade war between the US and China is easing now the two countries have signed the “Phase 1” agreement, but there is tougher negotiating to come.
And free trade is still under attack - there are now fears US President Donald Trump will turn his protectionist policies towards Europe. At the same time, trade agreements are at the heart of the UK’s economic agenda as it prepares to leave the European Union and strike new deals with the rest of the world.
Buying teams clearly have their work cut out when it comes to managing risk around food products and commodity prices – and some categories may prove more of a headache than others.
Food categories in the UK that will be highly sensitive to the outcome of the Brexit process are fruit and vegetables, meat, dairy, grains, fish and oilseed, according to the Brexit Food Price Index, which helps buyers track how key commodity prices are changing. These six groups are hugely affected by fluctuations in currency as a direct result of Brexit, although other factors such as weather events (that affect harvests) and export demand also have a major impact.
For companies such as convenience food manufacturers Greencore Group, the risk around raw material costs has increased as a result of uncertainty around Brexit. It has made planning for Brexit a key area, focussing on reducing cost with suppliers, improved purchasing and drawing up cost transparency models.
Meanwhile, US cotton prices are also on the up (increasing 7.3% between the 2 December and 30 December, 2019) as a result of the anticipated breakthrough deal between US and China. They may continue to rise in 2020, as volumes of US cotton imported by China are expected to increase.
In such a stormy climate, buyers have a critical decision to make - whether to work with price surges as best they can, or hedge to counter future rises and mitigate risk. The former can have a profound effect on profit, particularly if exposure to raw materials is high and margins are tight. And while the latter can make costs and cashflow more predictable by locking in prices, if the hedging strategy isn’t right, it can lead to severe losses. Then there are decisions to make over what type of hedging to use.
The tools required to weigh up which decision is best for meeting business objectives and controlling spend start with powerful business intelligence. Teams that have a precise understanding of the market outlook for their sector or industry – and exactly how it will affect supplier costs - will be better able to decide on an effective strategy for managing price volatility.
The key data is real-time information on price fluctuations and price forecasting - across the board but also at category level - to give greater clarity on the extent of exposure to price spikes.
Being able to make comparisons with alternative markets for raw materials or commodities is also an advantage. Buyers need to recognise the factors driving price changes, stay up-to-date on relevant news and events, and understand future trends and patterns - and their potential impact on supply chains. This is the foundation of a procurement strategy that doesn’t just mitigate risk, but turns it into an opportunity.
The key data is real-time information on price fluctuations and price forecasting - across the board but also at category level - to give greater clarity on the extent of exposure to price spikes. Being able to make comparisons with alternative markets for raw materials or commodities is also an advantage. Buyers need to recognise the factors driving price changes, stay up-to-date on relevant news and events, and understand future trends and patterns - and their potential impact on supply chains. This is the foundation of a procurement strategy that doesn’t just mitigate risk, but turns it into an opportunity.
Managing risk for the Analyst: Taking control of volatility
The global recession of 2008 ushered in a new era of price volatility, but 12 years on it remains a relentless trend. Analysts have had to adjust to a new normal - becoming nimble and adept at staying ahead of market movements.
This is particularly true for manufacturers with significant exposure to raw materials. For food companies, for example, raw material prices can account for an eye-watering 30% to 40% of total costs and 60% to 80% of direct material costs, according to McKinsey.
Price swings can take place in response to a variety of forces including political changes and policies that change the global competition dynamic, such as trade wars, extreme weather patterns and natural disasters. The speed at which these events can strike adds further complexity for businesses.
Even in the context of geopolitical factors, the recent trade war between China and the US - played out via Twitter - demonstrated the pace and immediacy at which tensions can now be ramped up. Businesses were hit by unfavourable trading conditions, transforming their prospects in a matter of hours rather than weeks or months.
Tyson Foods, the US’ largest meat producer, had to brace itself in 2018 when China imposed steep tariffs on imported pork and beef. It pushed down the company’s export growth and cut into profit margins. While Tyson managed these headwinds as a result of “diversifying its portfolio” volatility is still a key issue for 2020.
Effective commodity risk management is vital in these circumstances. But risk management tools have to be able to cope with a glaring incongruity – trying to make sense of uncertainty.
Procurement analysts employ various means, arming themselves with data-driven insights and intelligence on price to enable teams to monitor, analyse, understand and respond to fluctuations.
Analytics can also pinpoint the causes of price trends across total costs and at individual category level, help build cost models and highlight opportunities to generate more value in the supply chain. Customised quality information that dives deep to provide clarity and visibility can then inform – and potentially transform - purchasing strategies to mitigate price risk and maximise efficiency.
Artificial intelligence may further increase the usefulness of data by producing accurate forecasts based on a variety of risks from inside and outside the organisation – making predictions at a speed and scale that humans cannot.
In an era where change is becoming the only constant, harnessing data technology to boost knowledge and preparedness will be a critical differentiator for retailers and manufacturers. But what makes it truly crucial for businesses that want to remain agile is that it saves on two of the most finite resources - time and money.
Managing risk for the C-suite: Why data is king in an unpredictable era
Uncertainty will continue to loom high for 2020. That’s the outlook from the OECD 1 , and one that is echoed by economists and businesses. Ramping up volatility is a squeeze on free trade. The trade war between China and the US may be in truce mode but the process is an uneasy one and pressures on trade remain. This new decade will also see new deals negotiated between the UK and the EU as Brexit becomes a reality.
Such turbulence is wreaking havoc on firms’ abilities to plan. It is sapping resources at C- suite level, diverting their attention from decisions on strategy, growth targets, investment or expansion to dealing with increased risk around cost, regulation and potentially deteriorating profit margins.
For business leaders needing to understand changing trade agreements, there’s a complex set of factors to get to grips with including new tax or customs laws and quality and safety regulations. The effect on costs too can be wide-ranging, hitting areas such as warehousing, shipping and packaging.
Of course, tariffs have a severe disruptive impact on demand and supply. They threaten not just those businesses and retailers directly selling and buying tariff-hit products, but also firms with high exposure to targeted products or commodities, as well as their supply chains.
Tariffs had an immediate effect at Del Monte Foods, its CEO Greg Longstreet said last May 2 , “Canned costs went up 25% overnight,” he declared. Not only did metal prices climb as a result of tariffs on steel and aluminium, mandarin oranges imported from China were also hit by the levies. Cost cutting measures became imperative but the company also embarked on a strategy to double its non-canned products.
Finally, amid all this uncertainty, it is likely businesses will have to contend with fluctuating prices in commodities. In the case of Brexit, currency is proving a critical factor in price spikes. With such a variety of forces at play, boardrooms will have to remain agile and resilient to stay on top of fast-paced change, addressing key challenges around procurement and supply chain strategy, as well as considering cost-cutting across the wider organisation.
Manufacturers may consider diversifying their supply chains, moving supply bases away from a particular country to mitigate the risk of increasing costs, or at least reviewing supplier spend more robustly.
To inform decision-making, data will be king. Clear insights around price and price forecasts on everything from raw materials to transport or packaging, coupled with the market conditions causing price movements, will be particularly important. It is visibility on price that will allow senior managers to properly evaluate alternative supplier models or strengthen the negotiations processes, ultimately better managing risk.
For C-suite members having to deal with increasingly complex issues, analytics that present an oversight of the market outlook will also help them navigate potential disruptions and transform them into opportunities for their business. Most critical will be integrated digital tools that are easy to access, share and customise – freeing up C-suite executives’ time and equipping them with the knowledge they need to build a successful strategy.