Magic mirrors and crystal balls work very well in fairy tales but have little application in business commodity forecasts. Supply and procurement managers are tested on their ability to forecast price. Maintaining a consistent source of supply at stable prices will add more value in the current seller's marketplace than the traditional skills of achieving price concession from the supplier.
How then are we to forecast future price ranges for such commodities as steel? One of the most effective methods of predicting price rate increases has been the use of leading indicators. A leading indicator is tracking the movement of some commodity which correlates with the future change in a related commodity. For steel, a traditional leading indicator has been the price of iron ore.
Two factors now make it increasingly difficult for companies to plot and project steel prices based on iron ore prices. First, the majority of iron ore is produced by just four countries—Brazil, Australia, India, and Russia. In particular, the companies Rio Tinto, BHP Billiton, and Brazil's Vale have enough volume to set iron ore prices worldwide. The second factor is that China is now the largest consumer of exported iron ore. In August 2007 China signed a long-term purchase agreement with those four countries committing to upwards of 35 percent of annual production. The fear was that China’s actions (by locking up a third of the output from these four major countries) would send steel prices skyrocketing within the next three to nine months. And it did.
Now China has achieved 33 percent price reductions on imported iron ore for 2010. What will the impact be on steel prices next fall? Unfortunately the impact will be increased iron ore prices, subsequently increasing prices for steel for the rest of the world in 2010.
What's the solution? For some companies they've created a new role usually informally titled Ms. Iron Ore or Mr. Steel—an individual or team with responsibilities for tracking and understanding the marketplace for these dynamic commodities. Mike Prado, the CPO at Stanley Works, has a Mr. Steel team. Mike's commodity team, led by Peter Valaris, tracks and projects commodity prices based on detailed analysis of the commodity and the market plus the underlying socio-economic and political conditions that will impact what can be expected from steel. The team has been able to aggressively and actively manage commodities. The commodity team knows what's happening in the world markets. Using both their own analytical tools and readily available economic indicators, they are able to provide Mike the information to understand the options and allow Mike to make better commodity purchase decisions.
An understanding of the risks and rewards of commodity tracking management has produced significant cost savings for Stanley Works and, more importantly, has achieved consistent and reliable source of supply at predictable prices. Mike states, “…having a strong commodity team is invaluable; it forms the nucleus around total cost improvements in all areas at Stanley Works including impact on both Components and Ready to Sell Products and the value adds to managing gross margins across the business groups.” That investment is rewarded many times over—not only by price reductions, but more importantly, by the ability to keep track of market directions and being on the leading edge of decision-making.
The question is will you wait for the marketplace to make your decisions and then react or will you take a page out of Mike's playbook and start now to understand and predict that marketplace so your procurement managerial decisions are easier, with more options available, and the reward far outweighing the risk and investment.
The decision is yours unless, however, you do have a magic mirror or crystal ball.