How to manage costs when market volatility hits

Many categories, especially those related to construction and transportation have recently been subject to volatile price fluctuations due to a wide array of unique market conditions.  As a result of this volatility many organizations have seen their cost of goods experience an unexpected and rather drastic rise in price.  While predicting these market fluctuations can be difficult, many strategies do exist to help protect your organization against this unpredictability.  The following section below will help identify a few tactics to help protect your organization against market volatility:

Market Index Protection via Contracting

When entering into an agreement with any supplier, from a best practice perspective a “core list” of commonly used items should be populated in the exhibits portion of the contract with a negotiated price list.  This core price list should have competitive unit costs locked in for the entirety of the agreement.  Historically, when pricing is locked in language is populated in the agreement to protect the supplier from unexpected market disruptions and material shortages.  

For example, if a product you are buying is made from stainless steel, and the market price of steel increases at such a drastic rate that it results in a cost increase outside of your current negotiated rate, the goal in this scenario is to protect yourself from additional increases outside of the market index percentage increase.  To achieve this, your supplier must be contractually responsible to provide documentation in writing direct from the manufacturer and/or source that illustrates this price increase as a passthrough to you the buyer, with specific information tied back to steel’s price index supporting the reason for this increase.  This will help protect you from any potential increases outside of market conditions established within each commodity’s pricing index.   

Negotiate Pricing Rebates

Another way to protect your organization against market unpredictability is by engaging in end of year rebate programs associated with spend volumes.  For instance, you can structure your agreement with your supplier in a way to capture a year end rebate based off total annual spend.  Creating a sliding scale of larger rebates associated with higher spend volumes will help protect your bottom line against some of these unexpected increases, while also establishing organizational rewards for program purchasing compliance.  For example, structuring a contract with a 1.5% rebate for $1 million in spend, a 2% rebate for $1.5 million spend, and so on will create protections for your organization in unpredictable market conditions.  

Forecasting & Planning

It’s also important to analyze historical spend data to help identify trends to help get ahead of potential future-state needs.  For instance, if you properly analyze supplier usage reports while also holding discussions with stakeholders regarding organizational goals and objectives, this will help establish a strong understanding of future needs.  It’s also important connect directly with your key suppliers to understand what their market expectations are.  For instance, are they anticipating an unexpected increase in any cost of materials, or perhaps they have potential cost saving opportunities through bulk purchases that could benefit your organization from an economies of scale perspective?

In short, it’s impossible to forecast market unpredictability, but you can implement protections from a contractual and forecasting perspective to help mitigate risk for your organization.