With prices at the pump finally starting to ebb, it’s hard to accept the reality that we’re on tropical storm away from another ride on the petro-roller coaster. Yet the price dynamics of the last few years foretell just that type of volatility. Still, we are burdened with reliving our past as a result of our efforts to forget the pain of the last oil shock and the one before that, and the one before that . . . . It appears that Americans are at the whim of the market when it comes to the impact of petroleum prices on raw materials down to finished goods. As the world’s top per-capita petroleum consumer, we are every bit the junkie depending on their next fix simply to get through the day. The gas station is our street corner; the pump stand is our pusher, and all the product prices in the petroleum universe are driven by the pull of our addiction. So why bother? And the answer is . . .why not bother? What was that I hear about addicts curing what they can cure?

While it’s a fact that some components of unit cost are beyond our reach, some components are positively within our reach. One can bifurcate even the most volatile purchases into two categories of cost; fixed costs and variable costs. That’s the first step in how to crack the code of index driven prices to ensure to that while commodity dynamics (variable costs) may be unavoidable, fixed costs can in fact be managed. For those who doubt the notion that petroleum base stocks and finished good prices are non-linear, consider the immediacy and scale of price increases at the pump when oil prices inflate, and how much we get back (and when) they decrease. I’ll bet my house and car that the movements are not only non-linear, but rarely reflect inventory depletion as well.

Thus, the “how” of attacking petro-economics is basic; in one manner of thinking. The vast preponderance of purchasers who can’t manage variable costs, can work to manage fixed costs, and stabilize profit margins. The astute application of a market based index however, requires a sometimes detailed understanding of plant economics. For instance, one gallon of raw crude does not a gallon of gasoline make. Hence, the non linear price equation. Just like every cardboard box has a raw material cost component, a labor cost component and a capital cost component, so does a roll of stretch wrap. Depending on a firm’s volume and frequency of stretch wrap purchases, it may behoove the astute purchasing professional to explore the plant side economics necessary to bifurcate fixed and variable costs. While this approach appears rather complex for a typically downstream purchase such as packaging materials, a relatively small investment in time and money could yield a solid tool to control costs where they can be managed and ease the overall sting of petro economics.

If you would like to learn more about the fixed and variable approach to price control and sourcing, please contact Source One.
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