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Raw Material and Commodity Purchasing – Key Concerns for Manufacturers

06 September 2018 Manufacturing Industry Advisor

On August 9, 2018, Original Equipment Suppliers Association (“OESA”) held its 2018 Automotive Commodities Event covering a variety of topics related to commodities purchasing, including strategies for price risk management, insights into future mixed material usage in the automotive industry, and legal strategies for navigating volatile commodity markets. Highlights of the issues discussed during the event include:

Commodity Pricing – Commodity markets are more global than ever, but remain defined by volatility. Prices can shift based on a variety of events around the world, including economic factors, force majeure events, political unrest, and government policies (including tariffs). Pricing trends vary by material. For example, steel is close to its seven-year high, while certain other metals, including aluminum, have seen pricing declines.

Trade Wars And Tariffs – The manufacturing industry can no longer ignore the fact that the United States is in the middle of a trade war on several fronts, leaving many manufacturing companies caught in the middle. The current tariff issues broadly fall into three categories: (1) Section 232 tariffs, including the 25% tariff on steel and 10% tariff on aluminum imposed in March 2018; (2) Section 301 tariffs (imposed in retaliation for unfair trade practices); and (3) commodity specific anti-dumping duties (imposed when products are being sold in the US at less than fair market value). The increased costs imposed by these tariffs are continuing to ripple throughout the supply chain, leading to increased commercial disputes between buyers and sellers over who is responsible to pay the increased cost.

Commodity Contracting Dynamics – Commodity purchasing presents a different set of dynamics than in other areas of the supply chain. In many sectors of the manufacturing industry, particularly the automotive industry, commercial leverage (and therefore contract terms) tend to favor the buyer. Buyers impose “buyer friendly” contract terms on their suppliers, who then impose similar terms on their own sub-suppliers. These dynamics often change when purchasing raw materials as many commodity companies have sufficient market power to push back and refuse to accept buyer friendly terms. This can leave manufacturers in a situation where they are subject to long-term buyer friendly contracts with their customers and short-term seller friendly contracts with their raw material suppliers.

Best Practices For Commodity Contracting – The biggest mistake manufacturers can make with respect to commodity purchasing is not having a strategy (or having a strategy but ignoring it). Although commodity purchasing presents unique challenges, manufacturers can mitigate their risks by employing strategies such as price indexing and hedging. In some industries (including the automotive industry) manufacturers may be able to take advantage of customer raw material resale programs. While the detail of such resale programs may vary, the principle is the same – use the customer’s larger market power to obtain lower prices and smooth out volatility in raw material prices.

Automotive Material Trends – Automotive design trends and fuel economy standards continue to drive shifts toward lighter materials, including aluminum, carbon fiber, and resins. Increasing use of electric and hybrid vehicles means that demand for lithium will most likely increase. However, global production increases may help control prices.

Commodity and raw material contracting has been, and likely will continue to be, an area of the supply chain that presents significant risks and unique issues for manufacturers. Volatility and discrepancies in bargaining power can leave manufactures exposed to significant cost increase without the ability to push these costs up the supply chain to their customers. However, with appropriate strategies, these risks can be mitigated.