Last year and the beginning of 2015 has shown that volatility on the commodity markets is far from over. The dramatic slide in the price of oil has been headline news in the past months. Base metals prices have dropped as supply has overshot demand. Also on the currency market the volatility is back. The recent drop in oil prices has revealed the vulnerabilities in countries like Russia, with their high dependence on commodity exports.
Structural vulnerabilities with regard to commodities can be revealed as a result of the recent volatility. The most important issues that companies have with commodities are the unpredictability of prices and uncertainty in availability. A recent study by Capgemini Consulting among 23 mainly industrial companies with significant exposure to commodity risks, gives an overview of the status of the different risk mitigation strategies that are in place.
Figure: Analysis framework for risk mitigation strategies
The study shows how businesses have organized themselves after the recent turbulent years to cope with the supply chain risks regarding commodity availability and price volatility. I would like to share some insight on the current status of risk mitigation and on potential for improvement.
Insights on organizations mitigating risks
- In 30% of companies studied, executive management leads the development and execution of the commodity risk strategy. In the other 70%, procurement leads this initiative.
- Around 70% of participating companies indicated that commodity risk management is part of their company’s performance management system; meaning that commodity risk management is monitored on a regular basis via KPIs and compared against predefined objectives.
- 50% of participating companies uses financial hedging through futures and forward contracts in a significant way.
- Overall, the possibility to transfer the commodity price risk to customers is expected to slightly rise in the future; around 30% of companies expect an increase, against 15% who expect a decrease in the ability to transfer the price risk.
Potential for improvement
Participants in the survey indicated that further development and implementation of risk migration strategies is needed to be able to deal with more turbulence in the market:
- Around 45% of companies have a uniform risk management process in place. The others report that they have either a non-standardized management process in place or that the risks are managed by executing risk assessments on a regular basis.
- Although 70% of companies have structural KPIs for commodity risk management in place, only 35% rate their insight in how well commodity risks are being managed as “good”.
- 45% of organizations indicate that lack of knowledge and capabilities about sourcing mechanisms is the main bottleneck for further development.
Our Point of View
Further development and implementation of commodity risk management requires a more integrated and cross-functional approach:
- Most companies have a traditional approach where sourcing is by far the most important perspective in defining risk mitigation strategies. We expect that a more integral approach will be required, taking into account more extensively sales aspects in shaping demand and sales prices, along with supply uncertainties.
- A risk analysis should be cross-functional to reveal the most important vulnerabilities in the current organisation to price volatility and availability of commodities. In some cases, important risks have been found in error-prone administrative processes, and in the lack of information available for timely decision-making.
- We see potential in the improvement of integral planning and decision making for commodities. It is key to define supply positions based on demand requirements with different levels of uncertainty. Especially Sales and Operations Planning (S&OP) processes are well equipped to facilitate the timely decision making, taking into account relevant sales and procurement opportunities and avoiding surprises in raw material shortages or surpluses.
Volatility on the commodity markets will probably not be over soon. No excuse not to prepare for it.