A Strategy for Managing Commodity Price Risk

This is an excerpt of the original article. It was written for the March-April 2012 edition of Supply Chain Management Review. The full article is available to current subscribers.

March-April 2012

New research from the Aberdeen Group under-scores the importance of spend analysis. The findings, however, also show a gap between those companies struggling to implement a spend analysis program and the best in class. Aberdeen’s Constantine Limberakis relates the lessons learned from these leaders that can move you up the competency ladder.

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As the global economy improves, managers are faced with increasing prices and greater price volatility for key materials and components, energy, and transportation across their supply chains. This article, which is a summary of our recently published book titled Managing Commodity Price Risk: A Supply Chain Perspective (Business Expert Press), describes a flexible approach for managing financial risk from commodity price volatility. When commodity prices are volatile, business decisions associated with developing budgets and profit projections, setting prices, deciding when and how much to buy, and negotiating contracts become all the more challenging.

The wrong decisions can cut into profit margins, reduce cash flows, and damage relationships with suppliers and customers. To cite one example, in 2011 Kimberly-Clark saw its profits and sales drop due in part to higher than- expected prices for wood pulp.1 As a result, the consumer products company was forced to raise prices on diapers, a product category experiencing declining sales and increasing competition from store brands.

Commodities are goods that are not differentiated in the marketplace such as metals, energy, and agricultural products. Commodity prices are influenced by supply and demand as well as by trading and speculation; thus, they can be highly volatile. To illustrate, from August 2003 to March 2004, world soybean prices rose from $237 to $413 per ton, an increase of 74 percent. They then fell back down to $256 over the next 24 months. More recently, silver was trading at around $18 per ounce in April and May of 2010. Less than a year later, silver almost tripled in value to $49 per ounce during the final week of April 2011.2 As global economic development increases the worldwide demand for commodities (many of which have a limited supply), prices and volatility will likely continue to increase.

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