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08/21/2012

Buyers Suffer from Blockades by Commodity-Rich Countries

Buyers generally don’t know how raw material purchase prices are broken down. To avoid becoming dependent on dealers, one should do own mining or extraction of part of the goods or buy them directly from the producer. Only up to a point will it make sense to fall back on other countries.

Raw materials or commodities such as precious metals, oil or rare earths are becoming scarce and expensive. This is a development that has been observed for years already. Although the price pressure for gold, silver and platinum is currently abating somewhat, further price increases are to be expected in coming years. That’s not only due to the increasing geological scarcity of these goods but also due to the export behavior of commodity-rich countries. China, for example, cut back its export by about three-quarters since the year 2000. That’s according to calculations provided by the Deutsche Institut für Wirtschaft (IDW – German Institute for Economic Research) in Cologne. Now, China is closing down entirely to cover its own demands and to strengthen its monopoly position.

This is a most unfortunate development for German companies. Rare earths cannot be substituted by any other material – whether in electric cars, solar cells, electronics or in the optical industry. To take pressure from the market, the World Trade Organization (WTO) instituted proceedings against China, and the development of new mining sites in other regions is supposed to ensure the security of supply for companies. But shifting to other countries is not an ideal solution. “If you want to be secure in the long run, you should reconsider your purchasing strategy”, is the advice by Dirk Schäfer, Managing Director at Kerkhoff Consulting. That means: The question would not be which country a company would shift to, but rather whether the company will buy from the manufacturer or the dealer or whether it operates its own mines. “That’s a bigger cost leverage than any change of countries.” However, it would need careful consideration to decide, in terms of corporate law, whether a company should get involved in any crisis-ridden regions.

Schäfer’s advice is not to put all one’s eggs in one basket when it comes to raw materials: ”Companies mostly buy from the dealer.” Usually, the buyer doesn’t know the cost breakdown – i.e. the actual raw material price and the dealer’s margins. “You should purchase a specific amount on your own“, Schäfer advises. For transparency, it would be irrelevant whether the buyer owns its own mines or negotiates with producers. “At least half should be purchased directly, and both should then be carefully weighed up”, according to Schäfer, ”a dealer certainly means less risk but also higher prices.” He also recommends a healthy mix when it comes to the question of whether the company should buy rather long-term or on the spot market to keep a balanced ratio of the dependency from suppliers and warehousing costs.

The European Union is also trying to provide more transparency when it comes to commodity markets, but for other reasons: Its primary focus is to disclose where profits from the business with oil, diamonds and metals will go to, and also to proceed against exploitation. In crisis-ridden countries, a major part of the money disappears in slush funds and in the weapons industry. It’s not only a question of ethics to steer clear of these countries as suppliers; but it also proves that raw materials are artificially higher priced and market prices are distorted, thus resulting in a negative effect on a company’s purchasing department and on its sales prices. This situation has a major effect on the margins especially in the fiercely competitive electronics market.

Now, the EU Commission wants to use transparency rules to take care that profits can be allocated to the respective parties involved. A noble objective because neither dictators nor raw material producers want to show their hands and play their cards close to their chest. The German government blocks the EU plans which makes it difficult for buyers to find the right countries and suppliers and negotiate realistic prices. This would only be possible if raw material companies and dealers were forced to disclose what they have to pay for exploitation rights and what they calculate as markups. Until then, buyers only have the option of tough negotiations and searching for alternative materials.


Inquired   

“Contracts and specifications must be harmonized"

Mr. Schäfer, what happened since the book from your company ”Milliardengrab Einkauf“ (Sinking Billions in Purchasing)?

The book is already eight years old, but the title is still valid. There are also still great potentials which are left untapped. The purchasing department should be seen much more as a value-adding function and should be integrated in the areas of engineering, development, materials flow, as well as sales and marketing planning.

• And why doesn’t that work?

Tools are lacking. The purchasing department often doesn’t even know who spends money where and for what. It is accordingly important to provide spending transparency and then set up centralized purchasing.

• Can you give us a few examples?

As a rule, maintenance and repair of machinery and buildings are managed in a decentralized manner at each location. Even for the same machinery, those responsible on location will agree on different contracts with different maintenance intervals. Some agree on contracts for services; others will pay according to time spent. Even the specifications are frequently different. With an overview of who buys what, many things can be harmonized and bundled. In our example, there are many service providers operating globally and being able to establish corresponding terms and conditions.

• Which lever can still be used to save costs without pushing prices down?

On the one hand, the manufacturing depth should be reconsidered. A manufacturer of snow cats need not produce the driver’s cab – just because it had so far been considered a core component. Purchasing the cab elsewhere may definitely be more economical. Strategic procurement management can help save 20 to 30 percent of the costs.

• So you advocate outsourcing?

No, that shouldn’t be done just as a matter of principle. Sometimes, in-sourcing is sensible, especially when the supplier virtually is a monopolist and can dictate prices. If such great dependency has already developed, one should bring back the production of these parts to the company’s plant. If the purchasing department meets with resistance on the part of management board or technical departments, buyers must demonstrate their calculation of savings and be adamant in maintaining their position.