Category Archives: Commodities

The Economics of Cheese


What every sourcing professional should know

When you read this week’s Wall Street Journal story A Cheese Glut is Overtaking America, after thinking about doing your part to assist with the report that every American would have to eat three extra pounds of cheese this year to work it off, did you think about the economic impact and why this story matters to sourcing, procurement and supply chain? There are many lessons that can be learned from agricultural commodities and understanding the economics, especially in strategy development and managing volatility and risk.

During my career I have managed agricultural commodities and I understand the value and role that economics plays in sourcing. Let’s look at a commodity cycle we’ve experienced in recent years. It’s not difficult understand that after a period of drought, many crops fail and grain prices increase significantly. Farmers then look ahead to a tough winter of feeding cattle with the high cost grain, which will have a negative impact on profitability. As a result, farmers send their cattle to the slaughterhouses and cut their losses. As consumer demand remains steady and exports continue to rise, there is little doubt that the limited supply will force prices to rise. As the weather becomes more stable and grain prices fall, it’s natural for farmers to increase their herds of cattle, production of milk (and cheese!), flocks of poultry and grains. This is the easy to understand supply and demand economic cycle.

In this recent cycle, the opportunity to capitalize on the high prices became apparent to many farmers, however, the failure to understand the impact of the high US dollar on exports and the collapse of the export market, has caused increasing inventory levels, plus the time requirements to flex the size of herds and flocks has built up to the glut of some commodities. Gluts, shortages, currencies, pandemics, weather, labor, regulation and government stability all contribute to agricultural commodity economics and add financial and capacity complexity across supply chains, requiring an increased understanding of the economics to gain control. Today, I’m wondering how many Midwest farmers will switch from planting corn to soybeans, since the USDA projects that soybean production in the US and South America will be tight over the next two years while global demand continues to rise. How much corn is planted, of course, will impact the economics of food supply chains, but it also will impact ethanol, alcohols, building products, plastics and even tires.

Sourcing professionals involved in commodities of any kind can make or break their company’s profitability. The skills required to manage the complexities of commodity sourcing are understanding economics, extensive research of the market, having the right tolerance for risk and volatility, maintaining a calm demeanor and building extremely strong supplier relationships at both the farm (producer) and broker levels. They also need an analytical approach combined with communication and quick decision-making skills to be effective in commodities. We can all learn much from understanding the economics of commodities.

Have you thought about the economics of low-priced Cheddar?

Reactions to new EPA regulations run the gamut

Reactions this week to the new EPA regulations to cut carbon pollution from power plants ranged from the most dire to the most delighted, depending upon one’s industry, state or inclination for all things environmental.

On one hand, the new regulations will result in lost jobs and higher electricity rates.  On the other, they will improve our climate, our health and ultimately lead to greater innovation.

The energy space is a complex one, and the effect of these regulations will not be as cut and dried as some might think.  For example, weren’t we headed in this direction already?  Industries have been shifting to natural gas because it’s cheaper, and wind and solar are bringing up the rear.  In addition, each of the states will be able to select their own method of implementation from a menu of policy options.

This is a long way out and we’re just getting started.  There’s a public comment period, and the regulations themselves could be challenged in congress as well as the courts.  States have two years to submit their plans to achieve the targets, and it’s always possible they could get extensions to their timetables.

I’d like to hear your thoughts on the regulations.  Is the sky falling as Chicken Little squawked or is this the best birthday ever?

Shock proofed supply chain?

Most Americans probably couldn’t locate Crimea without the help of Google Earth. (It’s the peninsula that juts south from the northern coast of the Black Sea.) Nevertheless, the actions of the Russian army in and around Crimea are sending shock waves through some key commodity markets, including oil. Here’s the Washington Post coverage of the story.

Have you felt any effects from the spikes in market prices? Even if you have not, this is another reminder that your supply chains likely have connections around the world that may not be obvious from your first tier suppliers. It’s good practice to map your supply chains and analyze scenarios for disruptions that could happen at any moment.

While the chances of any individual incident might be very small, there are so many potential disruptions that it is quite likely something will go wrong sometime. Smart supply managers build risk management strategies into their planning to accommodate them.

Five Predictions for 2014

The ISM Manufacturing Index this month showed that the overall U.S. economy has been growing for 55 consecutive months. The manufacturing sector has trended positive for seven straight months. Employment numbers aren’t terrific, but they aren’t terrible either. These are generally favorable signs for business — but they suggest higher pressure on buyers to contain costs. Based on our experience and work with current clients, here are five predictions for the year ahead.

1) Buyers will see increasing pressure on pricing as industries with tight capacity or depressed margins attempt to improve margins.
2) Buyers will find longer lead times and reduced capacity as suppliers have left industries as a result of recession and remaining suppliers are enjoying higher margins based on high demand and low supply.
3) Talent management and development will be critical to the success of supply chain management success.
4) New government regulations in health care, energy, banking and other sectors will increase complexity, compliance and cost.
5) More procurement and supply chain leaders will reach the C suite.

How does this match what you are seeing?

Purchasers Suffer When Aluminum Shuffles

We might like to think that basic metal materials markets have enough producers and buyers around the world that they are generally pretty efficient — prices aren’t distorted by the actions of a few producers or buyers.

Then along comes an article such as this one in the New York Times on Sunday, July 21, which describes how Goldman Sachs owns an aluminum warehousing operation that reportedly shuffles huge aluminum ingots from building to building, in part to boost rental costs that can be passed on to purchasers.

A Shuffle of Aluminum, But to Banks, Pure Gold

According to the report, the activity is all legal but aggravating to aluminum processors. Since the practice involves a significant share of aluminum on the market, it may also be incrementally increasing prices.

If that’s the case, it’s time for some kind of action to end a cozy scheme and clear the market. I’m no fan of over-regulation, so perhaps the solution might be in creating more competition. There might be a business opportunity here.

Scott Sturzl CPSM, C.P.M., Vice President – Certification, Diversity & CSR for the Institute for Supply Management(tm), cautions “Looking beyond Goldman Sachs many in the Western world continue to believe market completion is alive and well and not being impacted by others. The big picture of this subject makes it difficult to connect the dots in ways that are useful to supply professionals. Category managers and senior execs of all types needing raw materials to create/develop/manufacture product for sale would do well to discuss and plan potential business impacts in the medium and longer term.”

It’s critical to understand how market prices are set and plan accordingly. Perhaps knowledge can lead us to market price transparency.

Seeing is (Barely) Believing

The ISM Report on Manufacturing showed signs the economy as a whole and manufacturing in particular are continuing to grow at a more-or-less steady pace. The Manufacturing PMI was 51.7, up slightly from last month, an indicator of slightly faster growth. Based on past experience, the PMI data also suggest that the overall U.S. economy has been growing for 37 consecutive months. The same for growth in manufacturing employment.
One would expect that survey respondents would be providing cheery comments to go with those numbers, but consistent with all the uncertainties of these times, the quotes went more like this:

  • “The slowing of capital expenditure in Europe and China has lowered our backlog for Q4.” (Computer & Electronic Products)
  • “We see a general softening in the steel and automotive markets in the fourth quarter.” (Fabricated Metal Products)
  • “Cuts in healthcare reimbursement rates continue to negatively affect top-line revenue.” (Miscellaneous Manufacturing)
  • “Sales and order intake have slowed.” (Primary Metals)
  • “Europe is still very much a concern. Global recovery is still fragile.” (Chemical Products)

Here’s the summary chart for some of the sections of the report.

PMI™ 51.7 51.5 +0.2 Growing Faster 2
New Orders 54.2 52.3 +1.9 Growing Faster 2
Production 52.4 49.5 +2.9 Growing From Contracting 1
Employment 52.1 54.7 -2.6 Growing Slower 37

The World is Moving Faster Than the SEC on Conflict Minerals

Three years after Congress passed the Dodd-Frank Act, the SEC this week finally adopted rules requiring public companies to report on the sources of so-called conflict minerals in any products they manufacture (or control the manufacturing by others).  Here’s the SEC link to the news release and full final rule.
The testimony, studies and lobbying has been intense, so adoption of the final rule was almost anti-climactic. That’s probably a good thing.  The fact is that even without the rule itself, pressure from NGOs (non-governmental organizations), news reports and consumers themselves are pushing manufacturers to take responsibility for their entire supply chain – from the extraction of raw materials to the distribution, packaging and sale of their products (and in some cases — to their post-use disposal).
The issues also go beyond mining that finances violence. Bloomberg/Business Week is reporting on the safety and environmental threats posed by small tin mines in Indonesia. It seems pretty clear that momentum is still towards more scrutiny, not less.
So the smart strategy seems to be the one that some electronics manufacturers such as Apple and Intel are taking — developing industry standards for determining chain of custody, appropriate due diligence and other matters related to socially responsible sourcing. That’s because the answer, “we don’t know” is no longer acceptable in that arena. Reporters and consumers are simply taking that reply and firing back, “Why not?”

Drought shock — are you prepared?

No big surprise to anyone who has been baking in record temperatures and drought conditions anywhere in the central part of the country, but today’s US Dept. of Agriculture food price forecast projects increases in the range of 2.5 to 3.5 percent for the remainder of 2012, and uncertainty about the full effect of the drought.
If grain or livestock is a category you source, are you prepared for “drought shock?”
How about the short term dip in beef prices as farmers sell off stock rather than pay higher costs for feed?