Absent serious contractual considerations, the time to source a requirement is now. The visible and even less visible impact of petro-economics is showing itself in higher unit costs and shrinking bottom lines. Thus, it is easy to shift focus to materials whose prices are driven by petro-economics regardless of their position in the supply chain. This “squeaky wheel” approach often drives un-empowered, adversarial price negotiations, worst of all, in a seller’s market. It behooves procurement teams to better prepare for the impact of commodity driven price movements by arming themselves with better understanding of two key components of cost. Product knowledge and market knowledge can go a long way in assisting procurement to structure empowered, balanced and effective negotiations regardless of market conditions. Further, detailed product and market knowledge can eliminate renegotiation by setting established price markers for ongoing purchases.

Bear in mind, though, that the leg work, the establishment of a complete and sophisticated baseline is challenging enough with plenty of time and sufficient resources. Working to establish sophisticated baselines under the pressure of a reactive environment almost certainly foretells a less than satisfactory job and disappointing results. Because price movements from market based crude vary from market place to market place (e.g., Canada, Venezuela, Persian Gulf) , and the effect of crude price movements on fuels and finished goods is non-linear, establishing a baseline can be complex and time consuming. The moral to the story is that if one is trying to build a successful negotiation in response to an upward market, it’s already too late to ease the pain of the impending price wave. As in all sourcing events, the construction of a detailed baseline and assembly of relevant market intelligence is best executed well in advance of actual price negotiations.

It’s the “where” of petro-economics that can extend a baseline in several directions. One common misconception is that America is overwhelmingly dependant on Persian Gulf oil supply. One might be led then, to chase Persian Gulf indices as a pricing barometer. In fact, though the US produces 40% of the oil it consumes, and imports the remaining 60%, 17% of which is supplied by non-Persian Gulf resources. Thus the use of Persian price movements as an index for change is a poor measure. The use of a relevant price index is critical to managing costs, and establishes a position of knowledge and empowerment with suppliers.

At the same time, the “where” of petro-economics takes shape as a component of cost in finished good pricing as well. Specifically, understanding where in the material and distribution chains that petro-economics have their impact. For instance, a purchase as simple as stretch wrap is affected in the raw material, production, storage and distribution chains. Even the non-descript ball point pen is touched in the same way. Almost every finished good suffers the impact of plant and distribution economics driven by oil, the comparative economics of natural gas, or electricity fueled by oil or natural gas. So the reach of petro-economics extends to many, or in some cases all, of the links in the supply chain.

In our next piece, we will address the why and how of petro-economics. Specifically, why we should construct sophisticated baselines and how to do so.
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