Just Use of Raw Material Key to Sustainable Development

Prior to the outbreak of the recent economic and financial crisis, there was a sharp increase in the demand for raw materials. Although the overheating has temporarily disappeared owing to the downturn, access to raw materials remains a highly important subject. This is because our concerns not only relate to prices but also to availability and relative prices. These factors determine industry competitiveness. Pressure will mount as soon as economic activity starts gearing up. Metals and fuels are source of our prosperity but the supply of some of these is faltering. 

At present, over 40 thermal power stations have coal stocks that are barely sufficient to meet the demand for about a week. As many as 29 projects have less than four days of coal reserves. The government has asked coal companies to step up supplies to power stations facing shortage of coal to ensure that power generation is not interrupted. 

A slew of factors, including less production from CIL collieries due to heavy rains, floods in Orissa and Telangana agitation, have hit coal supplies to power units. The threat of a strike by miners comes at a time when the power situation in the country is grim as many plants of NTPC, the country’s largest power generator, are running below capacity levels due to paucity of coal --the key raw material for generating electricity. 

Fuel prices have almost doubled over the last year and their impact on manufacturing have been worsened by the current power shortage, which has forced most local manufactures to use expensive diesel-run generators to power systems for more than the half of their production time. Any distortions in pricing and access to feedstock have a direct adverse impact on competitiveness, given that feedstock can make up a huge part of the production costs. 

Since August, the steel and allied industries in Karnataka have been facing acute shortages of iron ore, following the imposition of a mining ban in the state by the apex court. The iron ore supply crisis at JSW deepened last month when its longterm supplier NMDC stopped supply of the raw material. The state-owned company was adhering to the apex court order for selling all its ore from the state through the e-auction route. 

Industries need predictability in the flow of raw materials and stable prices to remain competitive. Policy makers should be committed to improve the conditions of access to raw materials, be it within India or by creating a level-playing field in accessing such materials from abroad. 

Our preoccupation with short-term price movement often ignores the potential of a more circular economy to increase economic resilience. Over a period of time, the pressure on raw materials will increase substantially. Therefore, we will need to use raw materials in a much more sustainable manner as the present pattern of exploitation and consumption cannot be maintained and our production process, feedstock use, consumption patterns will need to radically change to ensure sustainable development. 

Published in The Economic Times

Look Beyond Annual Contracts in Commodity Buying

The prices of key commodities (raw materials) such as milk, palm oil (for soaps), coffee and copra (for hair oil) have risen in the past one year with a volatility that will strain the margins of many FMCG firms. These companies need predictability in the flow of raw materials and stable prices to remain competitive. They have extensive exposure on the buying side but far less volatility on the selling side because terms and prices generally cannot be linked to the material price spread. MNCs in the FMCG segment have taken brand building, distribution, product innovation and marketing to a very sophisticated level while they have kept commodity sourcing (under volatile conditions) out of the strategic game plan. 

Before the economic crisis, raw material prices knew only one direction: upwards. Now the situation has changed. They go up and down in an irregular fashion and without any discernible pattern (for example, tomato and onions, which are raw material for ketchups). Traditional commodity management had relied extensively on procurement via strategic sourcing and this was primarily viewed as a means to lower raw material costs. Companies may also use financial hedges to smoothen price volatility, a practice that can actually inflate average cost due to the cost of the hedges. 

Some large Indian companies which started operations during the last ten years in the FMCG segment are more aligned to handle the volatility of prices. The centrepiece of the approach is the integration of procurement and sales activities to help manage the net exposure. 

The Indian FMCG sector has a market size in excess of 1.3 trillion. It has a strong MNC presence (P&G, Levers and Reckitt Benckiser) which is characterised by a well-established distribution network and intense competition. Most of these companies’ positioning are still based on consumer behaviour. The commodity price volatility has resulted this orientation to be relooked at. 

More often than not, an enterprise approach to managing raw material risk varies from ad- hoc to intuitive to unstructured approaches in a majority of the cases. This has resulted in managements often committing mistakes when it comes to managing commodity (raw material)risks or finding themselves uncertain and lost when it comes to building resilient business strategies around the sourcing models. Moreover, with the exception of sugar and wheat, none of the commodities that are consumed by the FMCG sector can be hedged on the futures. That too with the sword of ‘sudden contract bans’ hanging on the head. 

On the flip side, successful enterprises of India today have adopted a more structured approach that encourages their management’s confidence in an integrated trading model. Facing increasing commodity volatility, companies must move away from rigid and fixed systems. Annual contracts are no longer appropriate or up-to-date with the currently volatile raw material cost. In a dynamic cost environment, market prices instead of annual contracts will allow companies to quickly and accurately assess the price opportunities and adapt prices accordingly.

Published in The Economic Times