It is that time of the year again. The inevitable period every year or two in America where gas prices get high, but seemingly never too high that we can't collectively buckle down and get through it. High gas prices can be caused by speculation, refinery output adjustments, and there is no doubt that interruptions such as what we've seen recently in the Middle East can have a huge impact on world markets as well. In any case, commodities markets are subject to many changes that are out of your control. If you are purchasing goods or services that are based on commodity markets or indices, it is important to be aware of where they are moving in general when formulating a strategic sourcing plan or negotiating pricing.

Suppliers may offer a pricing structure for goods or services that adjusts along with a given commodity index, consumer price index, or producer price index. For example, I have recently been looking at the market on a product which is heavily reliant on polypropylene. Polypropylene pricing moves along with petroleum (traded on NYMEX, ICE, etc.), one of the most visible and important commodities traded in the world.

When evaluating pricing structures based on an index, the pricing should work in favor of the market characteristics and expected market direction. This can be accomplished by including the following in due diligence with commodity sourcing:

  • Risk Factors to Market Volatility - What factors primarily impact the index pricing, and what factors, if any can you have an impact on? If the price of the commodity built into your pricing varies wildly, it can impact budgeting decisions and cash flow.
  • Pricing Date & Time Period - Will your pricing utilize a moving average, specific date, or another time period in the market as its basis? This may lead to an opportunity to lock in pricing when the market is towards its bottom or smooth out the volatility using an average.
  • Cyclical Markets - Markets can be up or down for long periods based on seasonal supply & demand factors. Negotiate commodity pricing in periods of lower than average demand or oversupply.
  • Technology & Innovation - Technological advances may have a permanent impact on a commodity price. For example, a recent advancement in genetic engineering or harvesting technology may increase yields on a certain grain crop, lowering its price. If commodity pricing is expected to be significantly lowered by a coming innovation, locking in pricing before this may be detrimental.
  • Index Weighting - Different price structures may heavily rely on a commodity market index or not. In some cases a supplier may base your pricing on the actual cost per unit of the material, then factor in a markup or margin. Alternatively, the index may only constitute a small portion of the final unit price. Further processing, overhead, and other fees or expenses may then make up the majority of the price.
These may seem like common knowledge but having commodity market intelligence as leverage for negotiations can provide significant cost savings. A Procurement Service Provider like Source One can provide the expertise and resources to properly evaluate your procurement profile as it relates to commodity markets and indices.
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Scott Decker

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