We typically see companies deploy a variety of procurement strategies to manage their aluminum purchases. Generally, a buying organization evolves its strategy coincidentally with the dollar amount of the category. As US manufacturers grow their revenues, they tend to add new capabilities to their procurement strategies, such as price forecasting.
Where Does Your Company Fit In?
Below, we place manufacturers in three different categories, representing their buying sophistication as aluminum spend increases:
Category 1 Manufacturer (Small)
Purchases tend more toward a spot-buying strategy (e.g. monthly or as needed). The company might place an occasional forward buy based on a market indication that prices might increase. The company may not use long-term contracts to hold fixed value-add processing/conversion costs.
How are Categories 2 and 3 different?
Category 2 Manufacturer (Medium)
These companies typically have a documented strategy for making aluminum purchases and more often use fixed contracts for value-add. Generally, the decision to “lock” a price forward, or “float,” when prices may fall lies with the sourcing manager. The buying organization takes a subjective/educated approach to the sourcing decision based on whether he/she feels the market will rise, fall or trade sideways. The buying organization occasionally makes use of a price index and/or forecasting tool(s).
Category 3 Manufacturer (Big)
We tend to see companies in this category deploy more formal hedging strategies that typically focus on smoothing volatility with the greater goal of reducing the average price paid. The buying organization tends to take a longer-term view examining volumes and costs. The decision to hedge tends to rest on pre-identified “buy” signals articulated and documented in the formal hedging strategy.
However, the exceptions within the above model lie in the nuances of each individual buying strategy.
For example, as much as US manufacturing companies typically quote customers on a “job to job” basis, the purchasing strategy on the opposite side of the equation tends to rely heavily on spot market pricing. But a reliance on spot market pricing leaves the company potentially at a market disadvantage for a couple of reasons.
First, the company can’t compete effectively against the competition on the aluminum portion of the spend. Second, the quote validity period often creates risk and price exposure for the quoting organization – what happens if prices increase dramatically within the quote validity period? What happens if prices drop?
In the final installment of this series, How to Embed Forecasting Capability into Aluminum Sourcing Practices, we show you how using a short-term price forecast can reduce overall category costs.
Raul de Frutos Tinoco is MetalMiner’s lead forecasting analyst. Hear Raul and other experts speak at our upcoming commodity conference: