Even under the best of circumstances, raw materials represent a near-constant headache for manufacturers. With another recession looming and a global trade war growing more intense, volatile raw material prices have posed distinct challenges throughout 2019 and promise to do so into the foreseeable future.
Although four out of five respondents to the most recent Manufacturers’ Outlook Survey have at least a “somewhat positive outlook,” 2019 won’t be another banner year.
- 79.8% rank the cost of raw materials among the industry’s top concerns
- Raw materials and other input costs are anticipated to rise 3.1% over the next 12 months
While this represents a slight deceleration from Q1, this sudden rise is more evidence of just how volatile prices have become.
“Companies have a hard time correctly judging the risk of strongly fluctuating raw material costs,” explains chemical research publication CHEManager. With increasingly severe tariffs impacting commodities like steel and aluminum, this has only grown truer for manufacturers across the globe. CHEManager warns readers, “If they pass on increasing costs only minimally, delayed or too conservatively, or if increasing raw material costs coincide with decreasing sales prices, a margin squeeze is inevitable.”
Over time, this can leave the company struggling to survive; let alone maintain a competitive advantage. Managing volatility, A.T. Kearney notes, has never been more important. "For companies with significant raw material exposure,” they write, “mastering raw material volatility has become essential to short-term growth and long-term competitive advantage.”
Raw Materials Cited as Major Concern for Manufacturers
Following a period of particular volatility around the 2008 recession, raw material pricing has plagued companies for the last decade.
Back in 2012, Prime Advantage identified the cost of raw materials as the top concern for small manufacturers – and it remains the top overall concern among small and mid-sized manufacturers; more than 80% ranked it among their top three concerns reflecting deep-seated doubts about raw and direct materials markets.
Impacts of Raw Material Price Volatility
Price fluctuations and sudden shortages can have a significant impact on manufacturers. For original equipment manufacturers (OEMs), around 15-20% of total costs come from raw materials. Organizations in process industries can count on them to make up as much as 60% of their combined costs. This means a comprehensive strategy for addressing them is both a constant challenge and a distinct opportunity.
According to A.T. Kearney, "Firms that master raw material management can improve earnings margin by 2-5%, increase security of supply, and improve supply chain operations, among other things.” A particularly effective approach can even mean developing a competitive advantage.
6 Ways to Mitigate the Effects of Material Pricing Volatility
Want to minimize the impacts of changing pricing for your raw materials and its effects on your business? Taking a proactive stance can make a significant difference.
Here are some tips, inspired by AlixPartners, to help your organization and its procurement function take a more proactive approach to unexpected changes in raw material pricing.
1. Understand your true quantities:
Never assume you have a fixed material percentage for the commodities you purchase and the products you produce. Input costs for raw materials can vary widely. That means it’s important to assess the material composition of each product and stay tuned into price volatility for the relevant materials. Keeping this information in a database will help your team analyze the necessary data and make more strategic decisions for purchasing components, subsystems, and goods.
2. Establish contracts with clear terms
Each of your supplier contracts should include gross and net weights for raw materials. They should also include a cost basis with index, market-based, or published prices. Contracts should outline when prices will see adjustments or reviews.
3. Identify key commodity categories
Not every raw material requires a dedicated strategy. Pay particular attention to raw materials purchased in large volumes that tend to experience high levels of volatility, which might include steel, copper, plastics, rubber, or lubricants and hydrocarbons. Introduce specific commodity strategies that compel your procurement and engineering teams to stay ahead of trends.
4. Introduce a risk mitigation plan
Your strategies for managing and mitigating risk should focus on three particular areas: financial hedges to avoid price increases; operational hedges (like design changes) to control how raw materials are purchased; and price increase controls that depend on analytical and negotiation skills to consistently optimize costs.
5. Set savings goals
When establishing your savings targets, it’s important to draw a distinction between raw material costs and value-add savings costs. Each should have their own separate goals. Your raw material targets should relate to market pricing, while others should remain consistent year-over-year. This will enable you to tie performance to market conditions and discern where price increases might prove necessary.
6. Track pricing changes
While prices for individual materials can be monitored, it may be more useful to create and track an index for groups of raw materials that represent your key product lines. This provides an aggregate view of numerous price fluctuations and can yield insight on supplier cost management and discount policy.
Internal and external collaboration will prove crucial for addressing materials shortages when they occur. Risk Management Magazine advises a new, more open and inquisitive approach to engaging stakeholders. "Senior executive can gain an initial perspective on how well prepared their company is to manage raw materials volatility by asking a few simple questions,” it outlines.
- "Do all senior functional and business unit managers have a shared perspective on the current direction of commodity prices?
- Do their current responses to market conditions complement one another?
- How well do they coordinate or collaborate in making decisions that will have a significant impact on cash flow?”
Ethical Sourcing Also Increasing Raw Material Costs
Facing calls from non-profits and consumers, organizations in some industries have tried to reverse course and better support sustainability and workers’ rights through ethical sourcing. Investing in a more ethical supply chain for goods like coffee, palm oil, and textiles has seen costs go up alongside the standard of living across their supply chains.
Starbucks, for example, devoted a billion dollars last year to support its farmers and begin constructing a greener supply chain. Consumers are increasingly willing to pay more for goods they can feel good about. Businesses, it seems, will continue to meet this demand by doing the same.
Evolving Concerns
Remember, however, that keeping raw material costs at bay is just one of the challenges facing manufacturers in the global economy. Evolving risk and solutions demand a new set of skills and a new kind of perspective.
Volatile raw material prices were the top concern for manufacturers for the early half of this decade; they’ve since ceded this spot to talent and technology concerns. A recent Deloitte survey suggests that “skills gaps” will leave nearly 2.5 million jobs unfilled over the next 10 years. Volatile pricing and global trade wars mean these gaps can’t afford to stay open much longer.