Below is a cache of http://www.atkearney.com/res/shared/pdf/Managing_Supply_SECURE.pdf. It's a snapshot of the page taken as our search engine crawled the Web.
The web site itself may have changed. You can check the current page or check for previous versions at the Internet Archive. Yahoo! is not affiliated with the authors of this page or responsible for its content.
Managing Supply Volatility
Managing Supply Volatility
Create a Competitive Advantage through
Commodity Risk Management
Less than
one-third of
industrial
sector companies
in Europe are
suffi ciently
prepared to
handle supply
volatility.
Caught off guard by the current tense situation in many commodity
supply markets? A recent study by A.T. Kearney and the Austrian
Institut für Unternehmensführung found that less than 30 percent
of industrial companies in Europe are prepared to handle volatile
material prices. Many companies are ceding too much control to
external price trends. The study indicates that there is signifi cant
room for improvement for companies that adopt certain best
practices and take specifi c actions to manage supply price volatility.
While it is true that commodity
prices have skyrocketed in the past
three to four years, with a few excep-
tions these prices are not at an all-
time high. Nor is there evidence that
prices have become more volatile
recently, as volatility indices have not
gone up over the past decades. Still,
more companies today than ever are
caught off guard by commodity price
trends. According to a recent study
by A.T. Kearney and the Institut für
Unternehmensführung (IfU), less
than 30 percent of European indus-
trial (manufacturing) companies are
managing the volatile material prices.
A.T. Kearney estimates that the
negative impact of price increases in
the industrial sector is between 5 and
15 percent of the total purchasing
spend from 2003 to 2006a loss
that must be compensated for either
on the sales or purchasing side.
Those companies that cannot pass
additional costs on to their customers
have had to swallow a bitter pill of
price increases.
In our study, we aimed fi rst to
fi nd out how companies handle
supply-related risks, and then iden-
tify success factors for dealing with
these risks. We identifi ed four critical
success factors for handling supply
risk. Although the study showed that
on average there is room for improve-
ment along all four factors, a handful
of leading companies excel in some
or all activities. These companies take
an active stance and infl uence both
the demand side, by minimizing the
companys own use of resources, and
the supply side, by exerting infl uence
on the supply markets as much as is
feasible. They hedge residual risks
through risk management, and they
communicate their overall risk strate-
gies to the fi nancial community. The
rest of this article is devoted to a dis-
cussion of these companies and their
best practices. 
Measuring the Risk
Effective management of raw materi-
als prices begins with measuring the
risk involved. Unfortunately, this is
often easier said than done: Currently
only 19 percent of companies use
metrics to quantify risk. Moreover,
only 28 percent of the companies
surveyed use scenario planning to
anticipate commodity price move-
ments. When did your company last
analyze its exposure to raw materials
prices? Or when did you ask: How
do the changes in copper prices affect
our overall profitability, including
our contracts? What prices can we
expect for steel in 2008 and how are
we set up to cope with or take advan-
tage of these prices?
Executives often take a long time
to answer such questions and even
when they do, the answer is often
incomplete because they lack key
data or insights. Few people are
comfortable predicting future devel-
opments for fear that they might
be wrong not because of a faulty
prediction but because of the impact
of unforeseen events. It is far safer to
follow the mainstream and listen to
financial analysts than to make risky
predictions.
With this in mind, we developed
a multistage approach to measure
risk and anticipate price and product
availability trends. It involves the
following:
Estimate the overall spend on
raw materials.
A rough initial spend
analysis is sufficient when estimat-
ing what is spent on raw materials,
but it should cover all major com-
modities and span the entire breadth
of a companys portfolio of offerings.
Keep in mind that while data for
raw materials should be readily
available, it is more difficult to
estimate hidden raw material spend
within intermediate products. For
example, what is the value of the
steel in a manufacturers major ma-
chined components? If a company
lacks automated IT support in this
area, it should follow a pragmatic
approach to the spend analysis.
Otherwise, the ensuing complexity
could easily overwhelm you.
Analyze supply and sell-side
contracts.
Review contractual
arrangements with major suppliers
and customers to ascertain whether
they use price indexationand if so,

how. This information will be vital
as you structure deals with suppliers
(see later). Also, compare both sup-
plier and customer contracts to find
out to what extent these agreements
cover risk.
Model and forecast supply and
demand dynamics and anticipate
the resulting pricing.
For intermedi-
ate categories, identify the most im-
portant factors for supply and demand
in your companys value chain and
cost structure, and forecast their ef-
fect on prices. This includes verifying
analysts price predictions and work-
ing out your own predictions. As you
make these predictions, be sure to ex-
amine the underlying assumptions: An
unanticipated factor or circumstance
could quickly compromise your pre-
dictions and render them useless. Se-
nior management will help to develop
different scenarios and assign a proba-
bility of occurrence.
The best companies use the infor-
mation to model future short-, me-
dium- and long-term developments in
supply and demand dynamics. For ex-
ample, one automotive original equip-
ment manufacturer (OEM) developed
price models for polyethylene and
other petrochemicals, complete with
feedstock input costs, and logistics and
conversion costs along the value chain.
Instead of using a cost-plus analysis
(calculating the cost and then includ-
ing an additional amount for profit),
the company makes its conversion
forecasts from the marginal price.
Marginal prices directly reflect the
dynamics of supply and demand,
giving the company a better means
to balance the two forces at given
total plant capacities. Some of the
developments affecting this forecast
are predictable, like planned plant
overhauls, but others are subject to
macroeconomic factors as well as nat-
ural catastrophes and geopolitical in-
stability. Obviously it is not possible to
foresee price developments with abso-
lute certainty, but probability tech-
niques come as close as possible and
are essential to calculate a risk posi-
tion. 
Figure 1:
Secure a competitive advantage by managing commodity risks
Management of
residual risk Align purchasing and sales
agreements Hedge financial risks Balance seasonal demand/
shift to low seasons Eliminate waste Pursue breakthrough innovation Relax specifications Increase demand flexibility
Strengthen
demand power
Weaken
supply power
More strategic levers
More short-term levers Close tolling agreements Co-source Set up an intelligent deal structure with
suppliers Take advantage of market framework Vertically integrate Create and develop new suppliers
imperfections and political
Source: A.T. Kearney
Quantify the risk position through
scenarios and sensitivity analysis.
By consolidating the results from the
previous steps, the company arrives
at an overall risk profile and can an-
ticipate the effect on profitability of
different scenarios. The results are
very powerful in terms of buy-in and
aligned expectations, and most im-
portantly they provide an effective
basis for action. When A.T. Kearney
set up such models for the steel
category for an automotive client,
the company completely shifted its
procurement strategy and commer-
cial policy.
Managing the Demand
and Supply Balance
To create true competitive advan-
tage, the best companies use their
information on risk to establish
a commodity risk management
strategy. According to the study,
many companies still have a long
way to go in this area. While the
majority of companies strive to
transfer the price-related risks
to the purchasing and sales sides
(91 percent and 79 percent respec-
tively), only 9 percent of the com-
panies surveyed think about vertical

integration and strategic make-or-
buy. Even fewer companies consider
the whole array of strategic me