Waiting for Inflation -- And What to Do About it in the Mean Time
Even though producer prices fell in March, it's only a matter of time before inflation rears its ugly head. Seriously, while I don't know what the timing will be, I see no way that the combination of incredibly loose monetary policy the Fed is following combined with the Obama spendathon and China's declining interest in getting paid pennies on interest for our debt can add up to anything but serious commodity price inflation sometime later in 2009 or most certainly in 2010. Even short of a recovery, it has to happen, at least in some key commodities, sooner rather than later (perhaps not for some commodities that China is amassing in quantity such as aluminum that the government is stockholding and taking off the hands of producers who can't find actual customers for their production).
Truth to tell -- there is no way short of a massive natural disaster or catastrophe that sets us back decades that inflation won't enter the headlines at some point soon. But how can we prepare for commodity price inflation from a sourcing and contracting perspective? Herb Shields, who has bylined for this blog before and is in the same TEC group as my wife, has some ideas over on Supply Chain Digest (this article is reprinted from last year). Personally, I'd recommend two quick suggestions to get started planning for inflation. First ensure that all of your contracts where the underlying material price should not be floated can be tied to underlying commodity price indexes that are in fact tied to such indexes (in local markets) -- and use escalation and de-escalation clauses to give the contracts teeth. Second, discuss the ownership of commodity price risk with your supply chain (at multiple tiers) -- and conduct price discovery exercises to see if your suppliers are accurately or inaccurately pricing risk premiums (talk to options pricing folks on this one if you need help -- even a few MBA finance interns should be able to help out if you want to do it on the cheap). And if someone is mispricing a forward risk premium, consider taking advantage of it.
- Jason Busch
Truth to tell -- there is no way short of a massive natural disaster or catastrophe that sets us back decades that inflation won't enter the headlines at some point soon. But how can we prepare for commodity price inflation from a sourcing and contracting perspective? Herb Shields, who has bylined for this blog before and is in the same TEC group as my wife, has some ideas over on Supply Chain Digest (this article is reprinted from last year). Personally, I'd recommend two quick suggestions to get started planning for inflation. First ensure that all of your contracts where the underlying material price should not be floated can be tied to underlying commodity price indexes that are in fact tied to such indexes (in local markets) -- and use escalation and de-escalation clauses to give the contracts teeth. Second, discuss the ownership of commodity price risk with your supply chain (at multiple tiers) -- and conduct price discovery exercises to see if your suppliers are accurately or inaccurately pricing risk premiums (talk to options pricing folks on this one if you need help -- even a few MBA finance interns should be able to help out if you want to do it on the cheap). And if someone is mispricing a forward risk premium, consider taking advantage of it.
- Jason Busch
You're asking for it with this one! ;-)
Didn't you see my recent post on Fixing the Price with an Index-Based Model <http://tinyurl.com/d8lvln> where I got raked over the coals publicly and privately for suggesting that maybe, just maybe, such a contract could allow you to safely lock in long term agreements without having to worry about being off by more than a fraction of optimal?
After all, even appropriately priced escalation and de-escalation clauses based on should cost models can apparently cost you 40% because procurement apparently lives in some strange universe where the rules of economics, and math, do not apply ...
I saw the post and decided to stay away from commenting on it. There are some very specific ways of doing escalation/de-escalation clauses correctly and then implementing and monitoring the underlying indices such that they have teeth. Even better, there are ways, in some cases, of pulling the underlying active clause content into contract management, execution and payment systems (in progressively more customized implementations as you add more systems to the list, making the entire process one that you can manage by exception with automated triggers). It might take a decade for most companies to get there, but they will.