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09/22/2011

Interview on the subject of risk management: "No scenario of fear with regard to agricultural commodities"

FRANKFURT (Dow Jones)—A crucial risk for the food industry is the availability of agricultural commodities in adequate quantities, at reasonable prices, as well as in the required quality. In a talk with Dow Jones, Jürgen Pahl, Senior Partner at Kerkhoff Consulting, explains how the industry is handling that risk. Kerkhoff Consulting is a consultancy for procurement and supply chain management, and one focus is consulting for the food industry.

DJ: Studies show that especially the food-processing industry is not particularly well set up with regard to risk management, especially in terms of safeguarding raw material prices. It seems that this industrial sector tends to have a rather nonchalant attitude in this respect. Why is that so?

Pahl: I can confirm a certain nonchalance and carefree attitude in that industry and I attribute it to the fact that, overall, the resource supply is not jeopardized – despite the undersupply in some countries. There is no genuine scarcity of commodities, such as that to be expected for crude oil or rare earths, for example. Yet, should any negative balance for one resource actually come about occasionally, there usually is an alternative on the domestic or global market which will be able to fill the gap. Accordingly, there is no scenario of fear. It is important, however, to know the alternatives early on if any scarcity develops with certain suppliers. Because that's the only way for companies to react fast and as economically as possible.

Yet, in theory, especially scenarios of fear are excellently suitable to enforce price increases for foods.

In theory, yes. Existential fears can be instilled to announce upward price changes or movements. However, it's not always the agricultural commodities possibly getting more expensive; frequently, there are much rather other reasons such as increasing energy or packaging prices.

How do you convince your clients that risk management is still a good thing – even without any scenario of fear?

Most companies do know that on their own. There are, of course, different possibilities of risk management when purchasing agricultural commodities. The most frequent one will certainly be in the form of delivery agreements at specific terms and conditions. For example, with market participants of the dairy industry, such agreements are oriented on a milk price index which will offer them orientation. According to the motto: When the index changes, I'll also adjust my prices and my delivery conditions. In general, that will be transparent and plausible. And there'll be no need for a third-party opinion. In that case, third-party would be a commodity exchange for example.

That might be one explanation for the reason why milk powder and butter futures issued by the German stock exchange are not as accepted as had been expected. So, is there just no need for safeguarding at the exchanges because everything mostly proceeds in all fairness and indexes provide sufficient orientation?

Not necessarily. As soon as somebody in the course of bilateral negotiations  has the feeling that prices are not fair market prices, he or she will take different routes so that the elasticity of prices can be adequately assessed again. And in that case, it might even be the commodity exchange. Then there are natural shortages in the course of the seasons – for example, for fruit and vegetables. You cannot take precautions against such seasonal fluctuations by securing yourselves prices at the exchanges since these products are not publicly quoted. However, you can keep more money on hand so that you'll be the first to be supplied and thus receive the commodity.

In concrete terms, tell us what you will do for your clients when Kerkhoff Consulting is becoming active in a company?

We help them improve their purchasing. Companies are frequently lacking transparency in terms of their own market position. What's missing is a retrospective: How am I set up? Many companies give up added-value potential, perhaps by paying excessively high prices for a commodity. Kerkhoff returns this potential because we will show that this commodity is to be had not only around the corner but elsewhere as well. Or, it might also happen that a company can no longer use a commodity because it developed so excessively in terms of prices that the client will need a new business model on the basis of other commodities. We'll also help in that case.

So, a company cannot go bankrupt at all because of greatly fluctuating or extremely increased commodity prices?

No, it can't actually. Any bankruptcy will definitely have to do with many other factors as well – it would be wrong to make increased commodity prices the culprit.

Sibylle Schmidt conducted this talk.