An integrated approach to commodity risk management separates those who react to volatility from those who manage it.
When volatility hits the financial markets, investors shudder. When volatility hits the commodities markets, corporations shudder. The recent U.S. drought reinforced this message as it affected the price of corn, soybeans, animal feed, and other inputs to the food supply. The drought and its impact on future commodity prices are expected to have serious repercussions on all food prices.
We recently surveyed 21 chief procurement officers (CPOs) and heads of the commodity risk management functions of major food and beverage companies. This is the first in a series of studies to assess the impact of rising commodity prices and gauge corporate approaches to commodity risk management. Study participants were asked a range of questions, including: What impact is the rise in commodity prices having on your company? What are your expectations for the future? How do you approach and manage risk? How is your company positioned for the future if commodity prices remain volatile for the next several years?
Overall, our participants know that increased volatility in commodity pricing is not a short-term phenomenon. In a global marketplace, weather shocks—hurricanes, tsunamis, floods, or drought—are recurring events that will increase price volatility. Other factors such as increased global demand, geopolitical conflicts, and biofuels are causing a host of new headaches.
They have largely relied on hedging to manage their risk, maintain costs, and ensure a more predictable source of supply. Now, however, given the size and scope of the influencing factors and recognizing that commodity volatility cannot always be controlled, they say hedging alone is no longer a sufficient risk management approach.
Most CPOs believe volatile commodity prices will affect consumer pricing, and 43 percent believe the volatility will also impact company profitability (see figure 2). Most believe that the impact will not go away anytime soon—80 percent think the price hit will last more than a year, and 60 percent say they should increase their buying coverage. Tight supplies at the end of 2011 and lower than expected yields mean that stock will be depleted going into the 2012-2013 marketing year.
No good risk management strategy begins without discussions with senior executives about expectations and appetite for risk. Is the company inclined to ride out the market or more interested in predictable costs? Is the objective to beat the competition or to dominate the market? In our work with clients, we often recommend the following:
- Understand market dynamics and what “value” is at risk. Know your markets, your position in them, and your value drivers.
- Have a mitigation strategy in place. Have a plan in place that outlines the potential risk mitigation strategies—deflect, transfer, hedge, or operate—for all commodities.
- Reach market-driven decisions. Make decisions about risk factors and mitigation tactics with your markets in mind.
- Manage execution and governance. Manage major risks cost-effectively while also considering the residual risks, such as foreign exchange.
The secret to building a prosperous, value-driven procurement organization is a procurement transformation.
During the 1980s, procurement's main focus was on building a well-structured strategic sourcing process. Since then, procurement has made great strides in developing sophisticated strategies, working across functions, and delivering value to the larger organization. However, while procurement leaders in a variety of industries have tested and applied many of the popular business models and frameworks to further improve this function, only a few have succeeded.
We decided to look more closely at the best practices of the procurement leaders—those we call Procurement Champions—and compare their strategies to the "also-rans," companies that simply do not measure up. We found three main areas that influence power and success: the procurement function, which serves as the main anchor point for internal and external effectiveness, and which must build a powerful departmental structure, particularly internationally; other functions that must be closely interlinked with purchasing, including R&D, finance, and production; and, finally, suppliers, whose importance is dictated by their market power and a need for their products. The Procurement Champion must be strong in all of these areas to achieve both internal and external effectiveness.Close
- Assessment of Excellence in Procurement Study, 2011
Procurement professionals are more important to business strategies than ever.
Value chains are bending so rapidly that procurement professionals are more important to business strategies than ever before. It's not only volatility in commodities but also dramatically new ways of working that are creating challenges.
That's what 185 leading companies told us in this year's Assessment of Excellence in Procurement (AEP) study. But if there is one place we all know we can drive real money to the bottom line, and value to the top line, it's through procurement—and the AEP results show seven ways the leaders produce results. It's not just business as usual, it's business as unbelievable. There is another wave of new thinking on the way.
A.T. Kearney's 2011 Assessment of Excellence in Procurement (AEP) study finds corporate procurement functions becoming a more vital, strategic corporate player. In the past three years, 90 percent of study participants—procurement and supply chain executives from more than 185 leading companies across 32 different industries—have increased procurement's role in developing and executing business strategies. At the same time, procurement leaders are extracting more benefits and using better governance to improve performance both internally and externally.
The findings are clear: Procurement has greater stature, more influence and a wider reach than ever before.Close
The AEP study provide insights into how procurement and supply chain leaders can produce results.
A new metric, Return on Supply Management Assets (ROSMA©), measures procurement performance.
Procurement is the last best place to gain professional stature, increase management visibility, and improve bottom line results. With purchased goods and services comprising the lion's share of the value chain across most industries, why isn't procurement laying the groundwork for supply management optimization and driving enterprise economic performance? How do we replace those awkward moments of silence on analyst calls with discussions of how procurement is a critical indicator of corporate performance? How do we build a performance-driven procurement organization?
The answers, in part, lie with a new framework called the Return on Supply Management Assets or ROSMA©, which provides procurement professionals with the ability to finally—and fully—tap into opportunities that have largely been hidden.
For procurement, the importance of creating value is growing twice as fast as the importance of cutting costs.
Companies face unprecedented global volatility. We see wild fluctuations in prices for agricultural products, petroleum products, and other fundamental building blocks. We see the increasing fragility of globalized networks in the face of catastrophic natural disasters and sudden shifts in macroeconomic or geopolitical forces. We see increasingly empowered and informed consumers, some of them motivated by issues of sustainability. And despite the challenge of addressing these issues in the lingering aftermath of a global recession, we actually expect more from our supply chains. It's no longer enough to lower costs: Successful companies must seek high-impact performance improvements. According to A.T. Kearney's latest Assessment of Excellence in Procurement (AEP) study, more senior executives are asking their procurement organizations, and specifically their CPOs, to deliver value well beyond cost reductions. Indeed, the study finds that the importance of value creation in procurement is growing twice as fast as the importance of cost reduction.Close
Buyers with limited negotiation leverage can use strategic chess moves to advance their position.
Suppliers often own the power position as they dictate prices while enjoying unusually large margins—leaving buyers with limited negotiation leverage. Buyers are not completely powerless, however. It is possible to restructure the supply market to advantage using the A.T. Kearney Purchasing Chessboard®. The Chessboard examines factors that determine the supply-demand balance of power for each procurement category and identifies strategies applicable to every market situation. Using strategic chess moves, companies gain the flexibility to deal with challenges in this new age of purchasing.
Supply-chain integration is blurring the lines between companies and their suppliers; this close collaboration is healthy when the relationship is mutually beneficial and a balance of power exists between both parties. But when markets change and options for renegotiations dwindle, buying companies can lose the upper hand.
In some cases, the balance of power is so uneven that firms acquire their suppliers to prevent a competitor from doing so, and crippling the supply base. The Purchasing Chessboard offers a way to combat this imbalance of power.Close
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