Bottom of the Barrel

With demand for raw materials soaring, securing supplies is now a key battle. Malcolm Wheatley reports on how procurement executives are approaching the challenge.

Just back from two weeks in India and China, Hans Elmsheuser is in sombre mood. The head of global procurement at agribusiness giant Syngenta reckons something unprecedented is taking place in the chemicals and commodity markets in which the Basel-headquartered company sources its raw materials.

“Demand is genuinely starting to outstrip supply,” he says. “It’s a paradigm shift. China used to be a low-cost country for us to buy chemicals from, but now it isn’t. In chemicals, there are no low-cost countries any more.”

And consumers, he reckons, although already experiencing pain in their pocketbooks, have yet to be exposed to the full impact. As stocks in the supply chain run down, further price rises and shortages are inevitable.

Writ large, the supply constraints that Elmsheuser and Syngenta are experiencing are being felt around the world. ‘Peak oil’ – the notion that the world has passed, or is about to pass, the peak level of oil production – was a phrase almost unknown a few years back. Today, TV pundits use it every time petrol prices go up. China, a prodigious consumer of petrol resources, was rebuffed when its government-owned China National Offshore Oil Corporation tried to buy America’s oil-reserve rich Unocal Corporation in 2005, but remains watchful for similar opportunities.

Nor is oil the only commodity in short supply. The price of basic foodstuffs such as rice has also rocketed. China, once again, has repeatedly condemned BHP Billiton’s proposed takeover of Rio Tinto – which would give the combined entity control of 40% of China’s iron ore imports, and take 3% of the world market. The only other producer large enough to supply the country is CVRD in Brazil – thousands of miles further for China’s bulk ore carriers to sail.

In an era of supply constraints, just what are purchasing executives supposed to do? In many ways, the whole lexicography of the profession is built on the premise that supplies are plentiful, and purchasers can use the richness of resource to drive down prices.

Perhaps the first piece of advice, readily familiar to devotees of classic 1970s British sitcom Dad’s Army, is simply this: don’t panic. The tightening of supply markets is very real, but that isn’t to say it will turn out to be permanent.

“If you’re old enough, you’ll have likely seen all this before,” says Neil Deverill, the former head of purchasing at mining company Anglo American and electronics giant Philips. Just as stock markets go through cycles of boom and bust, commodity markets – from which most industrial production is ultimately derived – are also cyclical in nature. Deverill himself recalls two distinct periods of commodity shortage: the oil-based ‘plastics crunch’ of the early 1980s, and the electronic component shortages that beset the electronics industry in the 1970s.

As in the height of the dotcom boom, when all sorts of theories were given to support the notion that ‘this time it’s different,’ Deverill suspects the world economy still has some way to go before long-term scarcity, as opposed to cyclical factors, become a real concern.

Bring on the subs
“Economic theory suggests substitution will take place,” says Matthias Holweg, director of the Centre for Process Excellence and Innovation at Cambridge University’s Judge Business School. “That was the fault with the limits to growth analysis in the 1970s, which has strong echoes of today’s peak oil notion. You can’t simply extrapolate present-day trends. If plastic packaging becomes unaffordable, companies will switch to glass or cardboard. There will be changes in demand, and one commodity will be substituted for another.”

And it’s always possible that the real constraint isn’t the resource at all, but the investment dollars required to turn it into shippable product – a possibility not helped by the credit crunch.

“In some cyclical sectors, suppliers don’t necessarily invest in scaling up to meet the peaks in demand,” says Dominic Jephcott, managing director of UK-based sourcing and e-auction specialist Vendigital. “They build capacity to meet average demand, remaining fat and happy, and with a cost base suited to a level of demand that’s somewhere between the peak and trough.”

And when demand is high – as it is presently in the aerospace- and defencerelated markets, for instance, with both Boeing and Airbus reporting near-record order books – supplies of everything from specialist machining to lightweight titanium-based and nickelbased alloys become scarce.

Feeling the hurt
But whatever the long-term prognosis – and the jury is still out, and will be for years – the pain being felt in purchasing functions is real enough. Supply constraints are very real in a very wide range of markets, some of which, like metals, are unrelated to oil.

Whether supply constraints are longterm or temporary, doing nothing is not an option. Certainly, procurement professionals like Syngenta’s Elmsheuser acknowledge that dialogues with suppliers have undergone a transformation. “These days, I don’t talk so much about price,” he says. “Instead, I talk more about securing supply.”

Elmsheuser has first-hand experience of the dangers of not keeping that focus sharp. In his own industry, low-cost competitors at the ‘generic’ end of the spectrum, accustomed to buying on the spot market, simply have no supply at all. Syngenta itself has had to make some difficult choices. When, thanks to a 100% rise in the price of phosphorus, the price of the company’s phosphorus oxychloride product went up 25% this year, the issue was whether the end product was a viable proposition any more.

“We’re seeing purchasing people face a very different set of constraints from those that they’re used to,” says Robin Shahani, managing director of the supply chain advisory service at sourcing consultancy EquaTerra. “Suddenly, they are dealing with customers they have never bought from before, and finding that it adds both cost and complexity.”

It’s possible to detect something of a sea change in tactics as companies try to reconcile the twin goals of a supply that is both reasonably priced and available in the quantities required.

Ariba, for example, is seeing its optimisation technology – hitherto largely used to handle complex multi-vendor sourcing decisions based on price – pressed into service to optimise quantity allocations instead, as buyers try to guarantee supply by sourcing from multiple vendors. As shortages bite, adds Garry Garcia, European managing director of Ariba’s spend management services division, Ariba’s marketplace “is seeing shorter-term contracts, with raw material cost index clauses being more common”.

Garry Mansell, president of Sweden head-quartered Trade Extensions, another optimisation platform, reports a different phenomenon: the use of ‘conditional offers’, where vendors and buyers agree complex bundles of buying and selling packages based on the premise that, ‘If you do this, this and this, then I’ll do that.’

In short, relationship-building is now of prime importance. “In times of scarce supply, if you’ve built closer relationships with suppliers, you’re in a better position than someone who hasn’t,” says Richard Wilding, professor of supply chain risk management at British business school Cranfield School of Management. “You won’t need closer relationships with every supplier in every purchasing category, but you want to be thinking about which suppliers you do want to get closer to.”

And in these particular relationships, stresses Deverill, the relationship needs to have depth.

“From a continuity of supply perspective, your relationship with your supplier is only as good as their relationship with their suppliers,” he warns. “Talk to your suppliers; visit them; do what you need to do to make sure that you’re in the top three of their preferred customers. Many companies make the mistake of overestimating their own importance to their suppliers. The very time not to make that mistake is when supplies are tight and look to get tighter.”

It’s easy enough to say ‘become more important to your suppliers’, but how practical is it to put that advice into effect? Deverill offers some suggestions, based on his own experiences of running purchasing operations through periods of constrained supply in one or more critical resources.

Push the growth button
The value a supplier places on a given customer, he says, isn’t as simple as the combination of unit price and volume that purchasers tend to assume. Yes, it plays a part, but so too does a sometimes more compelling trade-off: that between unit price and growth. The logic? As suppliers grow their business, selling more output to existing – and valued – customers makes more sense than seeking lower-value customers.

"Low unit price, low value and low growth isn’t a sweet spot,” Deverill warns. “Unless in some way you’re seen as prestigious, or as a technology testbed, the danger is that you’ll find yourself further down the pecking order than you would wish.”

A second tactic is perhaps easier to wrestle with, at least in the immediate term. Businesses often fail to appreciate the role that personal visits to key suppliers play in those suppliers’ perception of whether a given customer is preferred or not, says Deverill. Such visits, he says, “are a hugely important and undervalued tactic”.

He tells an anecdote to illuminate the point. When the market tightened for the sort of digital displays found in household appliances and consumer electronics devices – customers were put ‘on allocation’ by suppliers – Deverill’s response was immediate.

“I got on a plane, and flew to Tokyo,” he recalls. “I met with the supplier, and talked about our requirements and the importance of continuing supply. Then I got back on the plane and returned to Europe. In the face of severe shortages, the visit was hugely successful.”

That element of immediate response is also useful if your organisation is faced with contractions in supply that are very sudden. It’s a distinct possibility when supply and demand are finely balanced, and unforeseen events transform a supply that is just adequate into one that is no longer able to meet demand.

Pointing to the well-known instance of a lightning strike-induced fire at a Philips semiconductor plant in Albuquerque, New Mexico, in March 2000, which decimated capacity, Cranfield’s Wilding says that, in such cases, “Fortune favours the fast.”

Nokia, which bought a significant proportion of the plant’s output, reacted – appropriately enough – with lightning speed. When the company’s attempts to secure an alternative supply failed, Nokia demanded that Philips divert capacity from other facilities, chartering executive jets and flying troubleshooters to the plants in question.

Ericsson, a direct rival to Nokia, was more sanguine. One report quotes the head of the company’s consumer electronics division saying he did not learn of the problem for several weeks. The results, Wilding points out, speak for themselves. “Today, Ericsson is no longer in the mobile handset business, while Nokia continues to prosper in it.”

Cultivate your suppliers
Yet the wider lesson isn’t just about speed and reaction time. Yet again, it’s about relationships and communication and being seen as a preferred customer. Whatever Ericsson’s failings were, Philips’ stance is crystal clear: one was disappointed; the other, satisfied.

It’s the sort of lesson very much front of mind at Switzerland-based pharmaceutical giant Novartis. As a company, Novartis is better placed than most to weather the tricky times ahead, says Sammy Rashed, the company’s head of sourcing for global sites. After all, Novartis’s direct material costs account for less than 20% of spend.

Even so, he knows the balance of power is shifting. “We’re undeniably moving from a buyer’s market to a seller’s market,” Rashed says, “and we’re having to switch our focus away from paying less, and looking instead to ensure that we have a consistent supply at a reasonable price.”

A few years ago, such sentiments were unthinkable. It’s a sure sign of the transformation that’s taking place that they are now commonplace.

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