Deloitte economist: Link risk management and purchasing
Volatility impacts the entire supply chain, speaker tells Chemical Purchasing Summit attendees
By Alan Earls -- Purchasing, 9/19/2008 9:47:00 AM
John Schimelpfenig, senior manager, energy and resource consulting at Deloitte & Touche, has been weighing business risks and commodity transactions for more than 20 years. So it’s no surprise that the message in his presentation at the Chemical Purchasing Summit was simple: the volatility seen in the chemicals industry impacts all links in the supply chain and requires for a better melding of risk management and purchasing strategies.
Everything from stock price to the cost of end-products to consumers is influenced by volatility in the markets, Schimelpfenig said. As a proof point, he displayed the direct negative correlation between the Dow/AIG Commodity Index and the Dow Jones Industrial Averages over a recent time period. As commodity prices have risen, the DJIA has sunk and vice-versa.
“Our clients are between a rock and a hard place,” Schimelpfenig told conference attendees, adding that commodity prices impact transportation, feedstocks and raw materials, operations, and even consumer spending. Indeed, buyer push-back on price increases is making it difficult to pass along higher costs, which puts a fundamental stress on the entire supply chain.
Schimelpfenig said chemical companies need to focus on two areas in today’s market: protecting their profit margin and limiting the impact of volatility on their stock prices. “All of these things have an internal impact on organizations” particularly the “shocks” which make budget planning difficult if not impossible. Indeed, these factors can lead companies into situations where cash flow becomes a critical issue.
“These issues can end up influencing investment in plant capital equipment and, if investors pick up on your troubles, can result in loss of investor confidence,” he adds. And that’s not even taking account of consumer confidence issues, which can be further hurt by “asking for frequent price adjustments.”
The cure, or at least a start in the right direction, comes from developing more accurate models and gaining access to the right commodity expertise. “When managing commodity risk, people often fail to factor in things like global movements in interest rates and foreign exchange movements which can in turn impact credit, creating a very complex scenario.” Each of the many relevant risk factors, in turn, touches enterprise risk and commodity risk in slightly different ways.
All of a company’s responses to these challenges, in turn, need to be conducted in compliance with numerous rules and regulations. But, says Schimelpfenig, what it boils down to for most companies is the lack of a coordinated approach to risk at the enterprise level and inadequate visibility into supplier risk at the procurement level.
As an aside, Schimelpfenig noted that an important distinction needs to be made between price risk management (hedging) and simply getting the lowest price. In most cases, he noted, those goals may be mutually exclusive. “You need to sit down and figure out how to align your risk tolerance with your business strategy,” he added.
Q&A
Following his presentation, Schimelpfenig remained for an audience Q&A session in which he said that the degree of risk management sophistication in chemical companies varies widely. As might be expected, larger companies are usually more sophisticated. At the enterprise level what on the tactical side there are often dedicated risk managers working with other managers to make balanced decisions. However, he noted, there is often a weakness at the corporate management level in understanding the full impact of commodity risks to the bottom line.
On the other hand the adoption of exchange traded instruments as part of a commodities risk management strategy is helping to provide more flexibility and sophistication across the board.
“We are seeing an evolution similar to what happened in the oil industry starting in the 1970s,” he said. However, not all of these tools are appropriate for everyone. For instance, companies that buy primarily from converters rather than producers may not find them applicable. Still, says Schimelpfenig, there is room for more companies to reallocate risk internally and externally even if only through the use of relatively simple “contract optionality,” which can provide an opportunity to lock in supplies at a set price.
Schimelpfenig also went on to remind attendees that the stability and creditworthiness of suppliers is also critical, particularly in the current business climate. “It is important to have a credit risk methodology in place—you need to make evaluations based on the type of contract exposure you are facing.” Likewise, he added, it is important to consider how much your risk may be concentrated with one or a few suppliers, a situation that can increase supply vulnerabilities.
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