1) Limited understanding of commodity risk
Many companies are failing to quantify their risk exposure to commodity prices. They often rely on ambiguous assumptions about price volatility and how and when movements in commodity prices impact on their bottom line.
2) Monitoring and preparing for ‘black swan’ events
Only a small proportion of firms actively look to monitor emerging commodity price pressures and and put in place plans to address high impact low probability risks.
3) Inadequate commodity procurement performance measure
Most companies measure their own commodity price performance against their own budget, leaving them unaware of how they compare with their competitors. With tight margins and weak pricing power commodity price volatility offers an opportunity to gain a competitive advantage over your competitors.
4) Renegotiation’s driven by expiry date of contracts
Most companies leave commodity price renegotiation until their contracts are about to expire leaving them exposed to whatever commodity markets are doing at the time. Companies that carry some flexibility in their overall procurement spend may be able to utilise commodity market insights to gain a better deal and a competitive advantage.
5) Static hedging strategies
Many companies adopt the same approach to contracts and hedging risk whatever the conditions in the commodity markets they are operating in. A flexible approach may be able to better capture additional value taking account of market conditions and the balance of risks in terms of price direction.
6) Incomplete or biased information on commodity markets
Many firms do not try to get an overview of what is happening to commodity prices key to their business. Just as worrying a significant number of companies list their raw material supplier as their main source of opinion on how commodity prices may develop.
Related article: Commodity market insights give companies a competitive advantage
7) Buyers not taking account of full material cost breakdown
There can be considerable information asymmetry between buyers and sellers. Suppliers will have a full cost breakdown of the raw materials they supply, information which is difficult for the buyer to obtain especially when there is a degree of value add to the underlying commodity being supplied.
Related article: 6 ways manufacturing companies can manage commodity price risk
8) Not considering Cash at Risk (CaR) as well as Value at Risk (VaR)
The VaR is associated with the underlying value of the commodity that the buyer is seeking to manage in some way and is therefore a very short term indicator. By its very nature the VaR is very difficult to monitor and predict. However, since a commodity buyer will generally want to take delivery of the commodity at some point the business needs to consider the impact that its risk management strategy will have on cash flow. By considering CaR businesses should bear in mind both the value of the commodity that they are purchasing and the sales price of the product that the commodity will be manufactured into over the lifetime of the hedging period. By doing so they should be able to more effectively manage their cash flow and be able to adapt more easily to unforeseen events.