By Ede Byatt and Simon Clarke
In recent years, there has been a surge in demand for various commodities, leading to price hikes and challenges in maintaining profit margins. For instance, steel prices have skyrocketed by 85 percent since mid-2020, lumber prices have surged by 119 percent, cotton has seen an increase of over 20 percent, and the cost of cotton yarn has risen by 35 percent. Furthermore, due to a combination of high demand and global container shortages, spot buying rates for freight from East Asia to the United States and Western Europe have soared by as much as 700 percent. This unexpected and record-breaking inflationary pressure is disrupting global supply chains, prompting businesses to reconsider how they can protect their margins while simultaneously mitigating risks and ensuring future resilience.
Based on MPKi’s extensive expertise working with diverse clients, industries, and regions, it becomes clear that despite its counter-intuitive nature, the current market volatility presents an authentic opportunity for manufacturers, resellers, and distributors to proactively reshape their supplier relationships. By doing so, they can effectively address the short-term margin squeeze, achieve substantial cost savings, and ensure a continuous supply chain.
Dis-aggregate cost components
When undertaking strategic sourcing projects, especially during periods of hyperinflation, gaining visibility into suppliers’ cost structures provides valuable insights that inform negotiation strategies. This involves designing request for proposal (RFP) documents that require suppliers to break down the various cost components of the final product, enabling us to understand their individual impacts on the overall unit cost. These cost components include raw materials or commodities, manufacturing expenses, labor costs, packaging expenses, freight charges, and duties for subassemblies and end products. By differentiating between core components that rely on commodities and standardized processes and those that offer value-add and can be competitively sourced independently of commodities, we can establish a clearer understanding of cost elements beyond our control and highlight those that can be influenced. This approach
challenges suppliers to optimize the controllable aspects of their costs while acknowledging that some index-based portions cannot be reduced.
For instance, the costs of certain fasteners may be influenced by steel prices, where approximately 30 percent of the total costs are driven by raw material prices. Despite recent significant increases in raw material prices, the value-add costs related to machining, labor, and overhead have not experienced a similar impact.
By breaking down global market-driven cost components such as raw materials and freight charges, we ensure that negotiations are informed and protected against market fluctuations. This approach allows procurement teams to focus specifically on the value-add portions of unit costs, making price negotiations more targeted and efficient. It also equips buyers with the necessary tools to mitigate risks associated with volatile market conditions, thus future-proofing their procurement strategies.
Review and rethink supplier partnerships
In a typical spot buying scenario, companies frequently switch between multiple suppliers based on the lowest prices available at a given time. While this approach may seem cost-effective, it fails to address the market conditions that drive price fluctuations and, in fact, leads to long-term instability in supplier relationships. Instead of cultivating deeper connections with suppliers and consistently receiving preferred pricing, spot buyers rely on suppliers’ valuation of their own capacity at a specific moment.
During challenging market conditions, it becomes crucial to reevaluate and redefine the organization of the supplier base. This involves establishing preferred supplier arrangements that leverage scale, ensure a stable supply, and maintain balanced pricing. To accomplish this, a competitive and comprehensive process should be implemented to identify a small group of preferred suppliers based on factors such as pricing, quality, capacity, expertise, and reliability. These preferred suppliers would then bid for individual purchase orders on a sprint basis. Ideally, these supplier arrangements should last between eighteen to twenty four months, and there should be clear visibility of the total potential and expected volumes.
Implementing preferred supplier arrangements brings several benefits. Firstly, it enhances cash flow predictability for suppliers, allowing them to allocate their capacity efficiently among their customers. Secondly, it enables suppliers to offer dynamic and competitive pricing within a narrower range, even considering potential material index movements. Thirdly, by nurturing stronger relationships with suppliers, buyers can protect themselves from potential price gouging or secure prioritized access to materials during shortages, consequently fostering a healthier and more resilient supply chain.
Additionally, buyers should consider developing local in-market supplier relationships, especially for items procured from third parties. Depending on the specific products in question, the total cost and demand volatility may tilt the balance in favor of local suppliers. For example, a Spanish food manufacturer that previously sourced all its garlic from China now opts for suppliers from France, effectively minimizing supply risks while maintaining competitive production costs per pound.
By effectively communicating a clear preferred supplier strategy, businesses demonstrate their commitment to establishing mutually beneficial terms and sharing both successes and challenges. This approach keeps suppliers engaged, fosters a partnership-based business environment, and ensures fair competition among preferred suppliers.
For instance, a US-based client in the metal component manufacturing and distribution industry significantly bolstered its resilience against spikes in steel prices by consolidating a substantial portion of its spending with preferred suppliers. Consequently, the company remained competitive, improving its EBITDA by five percent and ensuring a consistent supply throughout 2023, while many of its key competitors faced delays and product shortages.
Leverage Market insights to optimize pricing responses and margin
To optimize pricing responses and margins, it is crucial for purchasing and sales teams to closely collaborate in this highly volatile market. Purchasing teams can enhance their commodity strategy by leveraging stronger market intelligence and sharing this knowledge and expertise with sales teams. Several clients across various industries, from highly engineered automotive parts to commoditized items, have benefited from the creation of market intelligence platforms that enable sales and purchasing teams to consolidate and leverage market knowledge, ultimately driving profitable sales.
Final Thoughts
In conclusion, complexity and change always present opportunities. In our interconnected trade and supply-chain ecosystems, the challenges posed by hyperinflation continue to persist, with no sign of abatement until at least March 2024 (in the best-case scenario). To navigate this uncertainty effectively, companies should design and execute projects by identifying the right levers of impact and developing strategic relationships with trusted supplier-partners. This deliberate approach allows businesses to transform uncertainty into a tactical advantage and tangible financial gains.
