Commodities Prices: Managing The Insanity
PurchTips edition #162
By Charles Dominick, SPSM, SPSM2, SPSM3
Are Volatile Commodities Prices Driving You Crazy?
On the Supply Excellence blog, Mike Petro - Ariba's Senior Category Manager for Metals - wrote "The days of holding annual negotiations to set fixed price direct material contracts are over" and stressed the need to increasingly use price adjustment clauses in contracts with raw materials suppliers (http://tinyurl.com/45tqj6). I recently had the chance to discuss with Mr. Petro some common questions buyers have in this time of volatile commodities prices.
Why Are Price Adjustment Clauses Necessary? More than ever, suppliers are refusing to honor their commitments for long-term fixed pricing. "There are cases of broken contracts all over the place," says Petro, who has observed that not even the threat of legal action deters some suppliers in this time of rising commodities prices. Petro also finds some suppliers refusing to quote fixed prices for new projects, saying "We are seeing suppliers that will actually drop out of a sourcing project based on the fact that they can't justify the risk of trying to lock in a fixed price and still be competitive."
What Should Price Adjustment Clauses Be Based On? Price adjustment clauses should be closely tied to the indexes of the applicable cost drivers for the commodity. A cost driver is "any cost that impacts the final price of a commodity," according to Petro. For example, he lists iron ore, scrap, fuel, energy, duties, tariffs, taxes, and currency exchange rates as cost drivers for steel. It's important to know how the cost drivers are changing and the proportion of each cost driver's impact on the final price for the commodities that you are buying.
How Often Should Prices Be Reviewable When Using A Price Adjustment Clause? "The time frame is dependent on the commodity and the volatility," Petro shares. "Most of the buyers we work with are looking at things quarterly," but monthly may be appropriate for some commodities.
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