Protecting margins from highly fluctuating raw material prices

In the current economic environment raw material prices tend to fluctuate significantly and affect margins of many companies. A constant re-evaluation of suppliers and product specification optimizations are necessary to remain competitive. Now, what is the process to be put in place to protect your margins despite fluctuating raw material prices and proactively adjust sales prices? Here are the steps to take:

1. Have a clear vision on commodity prices

What are the top 3 or 4 commodities that impact your business most? The future prices of these commodities like wheat, oil, copper etc need to be forecasted on a monthly or quarterly basis to understand the potential impact on Costs of Goods sold (COGS) and margins. In some cases prices may have already been contractually fixed or hedged, but often this may not be the case and future purchasing prices will be subject to market fluctuations.

2. Forecast prices of your suppliers

Once a vision on commodity prices and their future development has been defined, a certain number of ingredients are key to forecast prices of your suppliers:

• Master data: existing and future vendors, required materials per plant/product line, their forecasted volumes and Bills of Materials (BOM’s)
• Contractual information (contractual prices, contract end dates, clauses that trigger price changes)
• Price transparency (what part of the price is related to transport, conversion costs, raw materials prices, packaging etc) and how each of these elements are affected by what is described under step 1

3. Estimate the Costs of Goods Sold (COGS) of your raw materials

A good visibility on future prices combined with required forecasted material volumes provide a sound basis to get a clear view on the evolution of the COGS per month/quarter, per factory or per product (line). Standard cost prices per product can be re-calculated.

4. Implications on sales prices

Once the clear view on the future COGS has been obtained, decisions can be taken on the product portfolio and their future prices:

• Maintain or stop commercializing products, depending on the forecasted margins
• Renegotiate prices at expiry of existing contracts with customers
• Consider changing the technical specifications of products by replacing the raw materials by cheaper / better alternatives

The force of the above lies in the development of mathematical models that allow to calculate with minimal efforts in a very short timeframe the impact of changes in commodity prices and simulate “what-if” scenario’s.