Turbulent commodity prices are an opportunity to increase the bottom line

This article was first published in Finans, in Danish

With headlines about price increases in plastics, steel and food, it is natural that the fundamentals of most products, pricing and raw materials, have caught the attention of the executive suite.

Due to the large fluctuations in supply and prices of raw materials, there has been a lot of focus on how they affect prices across the supply chain from suppliers to customers, and the increased risk around delivery and the impact on the bottom line.

On the other hand, there has been far too little focus on how the increased prices can present an opportunity to strengthen the bottom line. It just requires you and your company to have control over your real exposure to the various raw materials and the processes needed and actively manage the situation in relation to both customers and suppliers.

Experience from retail to production shows that if you make a determined effort to better understand raw materials and how they affect profits across the value chain, and take that insight into collaborations with either your suppliers or customers, you can see really good results in the bottom line. I have seen examples of savings of 10-20 percent in the consumption of raw materials and just as many examples of how the increased insight into fluctuating raw material prices can be used at the sales stage to increase prices in a fact based and transparent way.

How do raw materials affect the value chain?

How raw materials affect the value chain is an issue that has rarely been discussed at management level. More often it happens down in the purchasing department when they have to absorb another price increase, or in the sales department, which has a hard time arguing with customers about why they suddenly have to pay more than they did yesterday.

As in so many other areas, this is primarily about increased transparency and understanding of which raw materials affect your products and what proportion they make up of the company's total purchasing and sales prices.

This may sound relatively simple, but for many companies, a number of semi-finished products are typically purchased, where the proportion of raw materials is not clearly stated, and where they may be the second, third or even fourth link in the supply chain. Therefore, it takes both a really good insight into your company's value and supply chain, and typically access to financial information products like Reuters and Bloomberg, to get the full picture of your use of raw materials and related financial products.

Once you have an overview of what kind of raw materials are needed - and how they affect your prices - we come to implementation, typically this is also the most difficult part of the exercise. You must now embed that knowledge in both the purchasing departments and the sales department, but just as importantly have the necessary discussions about what tactics you want to use to reap the benefits of the increased transparency, as well as which forums need to be involved to best manage risk and opportunities.

Like so many other opportunities that cross company silos, this is about creating consensus and a desire to participate rather than imposing it on people. At the same time, clear guidelines must be set from the top about which tools you are willing to use and which risks you want to take.

In this way fluctuating raw material prices can work to the advantage of your company if:

• You focus on how it affects your value chain and how it can best be passed on to either suppliers or customers in the most appropriate way.
• You ensure that the necessary management mechanisms are in place, which actively take a position on the authorisation and risk of raw material purchases and associated hedging.
• You avoid imposing too many top down management and guidelines, which stifle employees' desire to embrace the new opportunities, which is at the heart of good implementation.