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November 20, 2017
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Procurement Priorities

Cheaper oil has procurement rethinking strategies

Comment
With oil and other commodity prices lower than they have been in over a decade, procurement leaders are reassessing contracts with suppliers.

One of the biggest business news stories of the past 12 months has prompted many procurement leaders to rethink their strategies for sourcing commodities and manufactured parts—or at least it should.

That story is the collapse of commodity prices due to a sluggish Chinese economy and cheaper energy worldwide. Chinese manufacturers are using less steel and nonferrous metals (aluminum, copper, lead, nickel, titanium, tin, and zinc), which means there's now more than enough supply to meet demand, keeping prices down. As a result, the Standard & Poor's commodities index has dropped by 80 percent to its lowest level since 1999.

Add increased oil production in North America and reduced prices due to a glut, and manufacturers are paying less to run their plants and transport materials and finished goods to customers.

By many accounts, these commodity and energy prices are expected to continue well into 2016. This is welcome news to procurement leaders at most manufacturing companies, except, of course, for those in the oil and gas industry.

Procurement's response
In many cases these pricing changes are encouraging procurement departments to go back to the negotiating table. Let's look at what buyers at oil and gas companies are doing, and what they should be doing.

Learning that their companies are not performing as well as they had been is causing some buyers to panic and demand that suppliers drastically reduce their prices simply because business is bad. These buyers are reacting to news and not really thinking about the products and services the suppliers are providing. Observers who have been watching procurement transform from a tactical to a strategic operation over the years are disappointed in this reaction, with some saying it's taking the profession back 30 years. Procurement leaders who are strategic look ahead, value relationships with suppliers, and take a total cost of ownership (TCO) approach to sourcing. Instead of pressuring suppliers to reduce prices, then, procurement leaders from oil and gas companies should work with suppliers to closely examine costs and search for innovative ways to add value or increase top-line revenue, perhaps by becoming involved early on in product development activities or suggesting improvements to existing processes. According to consultants at Anklesaria Group, such collaboration can result in savings of up to 30 percent—which is far more than the savings that buyers would receive from demanding price cuts.

Meanwhile, buyers at manufacturing companies in most other industries are taking advantage of lower energy and commodity prices. And, as contracts come up for renewal, some may be benefiting from the results of new negotiations with suppliers of steel, nonferrous metals, chemicals, plastics, and other commodities.

In fact, if manufacturers have not had the opportunity to renegotiate with suppliers in the past few months, they should put that high on their agenda for early 2016, otherwise they might miss opportunities for significant savings. These buyers now have access to data that will prove invaluable in negotiations with suppliers.

In his steel pricing forecast, John Anton, principal economist at IHS Pricing & Purchasing, suggests buyers negotiate contracts with suppliers now using late 2015 prices, or an average price for the year. That's because he sees prices of some steel products rising modestly in 2016, due to the possibility that the U.S. will impose tariffs on imported steel from China. Howard Rappaport, senior director for chemicals at IHS Pricing & Purchasing, recommends buyers of polypropylene do the same: Renegotiate contracts with suppliers before possible price hikes in 2016.

As for procurement leaders who are responsible for sourcing components, those who take a strategic approach to sourcing and have contracts expiring this year will be using lower commodity prices when figuring the cost of manufacturing the components in early rounds of negotiations with suppliers.

Procurement leaders have worked long and hard to attain the position they now hold at most companies. Hanging tough and managing supplier relationships when business is bad is a challenge, especially when top management is looking to procurement for relief. But if procurement plays it smart and shares information with suppliers, the two should be able to come up with cost-management strategies that will help both over the long term. The same is true for buyers who now have an opportunity to renegotiate pricing agreements with commodities suppliers.

Sitting down at the table with the facts will help procurement take advantage of current prices. Being smart about prices, negotiations and relationships is what strategic procurement is all about.

Susan Avery is a business journalist with 30 years of experience covering the procurement profession.

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