I sat in on an interesting presentation on Tuesday when Christopher Stockwell, VP of Procurement at Heinz North America, spoke about Heinz’s supply risk strategies. The portion of Stockwell’s presentation that I found most thought-provoking was his philosophies on handling commodity pricing in a volatile market.
There are two primary approaches to handling pricing in such an environment: tying price changes to an index or negotiating fixed prices.
As Ariba’s Mike Petro recommended in our podcast and article entitled “Commodities Prices: Managing The Insanity,” many experts are advocating the increased use of index-based price adjustment clauses in contracts. Yes, they say, they can result in unplanned cost increases and a decreased ability to accurately budget, but they also prevent the common scenarios of suppliers refusing to honor contracts or putting you on allocation. Plus, they can result in price decreases, too.
But Heinz took the opposite approach. Heinz opted to pursue fixed prices.
And, based on Stockwell’s presentation, it has worked out for them so far. He reported that while their prices rose about 7%, the market rose over 11%. And while the currently declining market has Heinz paying a little more today, overall the approach worked out.
But it wasn’t so much the fixed price strategy that I found most educational. After all, I can guarantee you that blindly choosing a fixed price strategy would undoubtedly bite some procurement departments in the you-know-where.
What I found most helpful was how Stockwell communicated the implications of the strategy to the management team and his functional peers.
He said – and I’m paraphrasing here – look, we can either (a) have cost certainty for budgetary purposes or (b) we can tie ourselves to the market, making sure we don’t overpay relative to the market, but it will result in potentially extreme variances from the budget. If we choose budget certainty over market price, you have to understand that sometimes we will have better-than-market pricing, but there will come a time when we will have worse-than-market pricing. We can’t overreact when the inevitable worse-than-market pricing time comes.
Heinz chose to go the fixed price route. And despite the current commodity price drops resulting in Heinz paying a little more today, Stockwell says no one is beating him up over it because of his clear words of caution.
I think that his warning was brilliant. But I also was impressed at the detailed measurements his team keeps. This may come in handy the next time this great commodity price strategy debate comes up. The Heinz procurement team will be able to say “Here’s the strategy we chose last time and here’s how it worked out. Should we do the same thing – and take similar risks – this time, or choose the opposite strategy?”
Great “food” for thought, eh?
To Your Career,
Charles Dominick, SPSM
President & Chief Procurement Officer
Next Level Purchasing, Inc.
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