Download Raw Material Insight

material insight
– a key differentiator for bottom-line results
Many raw material prices are at an all-time
high. Producers who can quantify raw material cost as a ratio of product cost (e.g. steel
price as a ratio of steel-based components),
will have a key information advantage over
other producers that do not have this insight.
This newsletter explains how raw material insight can
assist to obtain and sustain cost saving targets. To
enhance existing product data with raw material cost can
for example help the purchasing function to negotiate
effectively with suppliers, the sales department to get an
early warning of price increases, and product owners or
executives to understand profitability of products and product lines. This newsletter also investigates the steel and
iron ore markets, and how to get started with existing data
to reap first benefits.
Supply & purchasing
Best-in-class companies regularly analyze spend data
on item level and enrich the data with for example
raw material spot market price, labor cost, and currency exchange rate. Thus, with the right analysis and
expertise, best-in-class companies have been able to
specify detailed product cost structures as part of the
negotiation preparations. The increased understanding
of product cost structures has made it possible to turn
supplier price negotiations in their favor, and realize significantly decreased component purchase prices. Raw
material insight has also assisted to seize other opportunities. Such opportunities exist in product development,
operations, and sales, as described below.
Product development
The choice of a product’s raw materials impacts the
future product cost and profitability. With knowledge
of raw material prices, trends, and associated quality
and logistical risks, product development teams can
pro-actively test and suggest components that build on
alternative raw materials. Choice of raw material can
impact product lifetime, quality, appearance, and cost.
Triathlon has for example seen successful replacements
of aluminium with plastics.
scrap is a potentially untapped gold-mine in many companies today, both in terms of volume reduction and as
an additional source of revenue. Triathlon has also seen
successful examples where heavy processing equipment
has been replaced with more reliable and less expensive
process steps as a consequence of a revised raw material
strategy.
Sales
The profitability of a product is to a large extent influenced by the cost of the items in the product’s Bill Of
Material (BOM). With knowledge of the raw material type
and weight for each item in the BOM, one can summarize and understand the ratio of raw material cost as a
share of product cost. With additional parameters such
as future price trends, annual purchased volumes, and
geographical markets, Triathlon has simulated profitability scenarios and optimized product and product line
strategies.
NEWSLETTER
Raw
Cost reduction is always on top of the
agenda of senior executives. To achieve the
increasingly challenging goals and objectives, procurement savings and effective
negotiations with suppliers are considered
top priorities. One key success factor in
negotiation is to build arguments from a
fact-based understanding of raw material impact on the products and the entire
company. This is elaborated on below.
A database with internal and external data is the foundation to any raw material strategy. Successful implementation builds on establishing a cross-functional team
working towards common goals, broken down for each
function.
First step: Collect external market data
Triathlon and ISEA are distributing a quarterly report
– Raw Material Watch – with raw material prices
and future price indications. The content includes
e.g. industry metals, energy/electricity, oil, and currencies. We believe that raw material insight is a key
driver to sustain bottom-line results.
Operations
Insight in raw material prices and properties can enable
significant operations improvements. For example, steel
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– and price volatility
A market of steel
Raw materials needed to produce steel are not
scarce in terms of natural reserves, but the
mining industry is largely concentrated both in
terms of geography and in number of suppliers that control availability and prices. The
main raw materials needed to make steel are
iron ore and coking coal. 1 ton of steel needs
1,6 ton iron ore and 0,6 ton coking coal.
Over the last decade there has been an immense increase
in steel demand, notably driven by China. The increase
in demand has been larger than the industry could anticipate. This, combined with the fact that exploring new
capacity and opening new mines requires significant
time and investment, has led to a lag between demand
and supply. Therefore the price of iron ore and steel have
significantly increased during the past decade.
Today, there are several ongoing investments to increase
the iron ore mining capacity. Those are mainly located
in Oceania, Latin America, and Africa. New coking coal
capacity projects are mainly located in North America
and Australia. Mining is however becoming increasingly
difficult and costly. Ore is found and mines established
further away from demand, sometimes in deeper deposits, with lower ore grade, or in areas that lack proper
infrastructure or political stability.
160
USD/Tonne
PRICE
200
120
80
40
2010/2011:
Mixed governmental policies and
economic uncertainty make prices volatile
Future price indication:
Several mining & exploration projects are ongoing
2008/2009:
Global financial crisis, early
movers abandon annual contracts
Many such projects could close down if prices
fall below a certain limit (esp. projects in China)
2007:
China record GDP growth (11,7%)
It is believed that prices will stay comparatively high
in 2013, around USD 110-120
2004:
China’s steel demand booming
0
1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012
Figure 1: Iron ore – a key raw material to make steel
Key steel raw material: Iron ore
During the last decade, iron ore prices
have more than quadrupled compared to
prices in 2002. Mainly due to rapidly growing demand in China and the oligopolylike iron ore market domintated by BHP
Billiton, Vale, and Rio Tinto.
This type of reasoning is followed up in Triathlon’s and
ISEA’s quarterly raw material report – Raw Material Watch.
Source: IMF, 62% Fe fines China imports
NEWSLETTER
Increased raw material
Substitutes (low) Some suppliers have successfully
replaced steel parts with lower quality steel (e.g. from
scrap), or with other materials such as aluminium and
plastics. However, only to a limited extent.
New entrants (low/medium) Mining operations are
capital intensive and the market is highly regulated
by governments. Existing global firms are keen to get
stronger foothold.
To reap the full benefit of the high iron ore prices, suppliers have replaced annual benchmarking of iron ore
price with quarterly or even monthly price agreements.
Vale for example, determines the iron ore price based on
the spot price of 62% iron ore fines to China, then taking
quality into account, and adjusting the price with respect
to the current and the previous quarters’ price levels.
A simple 5-forces analysis gives an indication of how
the market will behave: the strong market position held
by large mining companies is expected to remain, as are
the volatile spot market price levels.
Expected market behavior
In the current market situation, iron ore (and therefore
steel) price levels are high and are expected to remain
high for the foreseeable future.
Internal competition (low) A few suppliers dominates
the market. Some high-quality iron ore producers exist
with very small output volumes (e.g. in Sweden).
1 Challenge old ways of working based on best
practice, to identify weak areas using internal
and external data
Customers (low/moderate) Demand is high, especially
in Asia, and outpaces supply.
2 Establish the raw material strategy and break
it down into sub-activities for each department
Supply (moderate/high) Iron ore is common in the
earth’s crust, but new capacity is increasingly hard and
difficult to exploit.
3 Develop time plans and deliverable plans, e.g.
to realize wanted cost savings and transparency
Consequences for steel buyers
To avoid uncontrolled raw material price increases,
now is the time to revise the raw material strategy.
A successful approach is to:
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Where to begin – spend
& sensitivity analysis
Case-study: Sensitivity analysis
Spend analysis has been the object of considerable management and media attention in
the past five years.
Existing product or spend databases normally
suffice to reap first benefits from increased
raw material insight.
Many firms have invested heavily in IT, ranging from simpler
tools to advanced ERP systems. Surprisingly, many companies still face considerable challenges to improve data granularity. Experience shows that many firms lack sufficient
transparency in product and spend data. The reason is that
purely automated analysis does not deliver complete insight
into spend unless accompanied by business process improvement, compliance control, and change management.
In a recent Triathlon assignment, the senior executive team
needed answers to the following set of questions:
Levels of spend analysis
1 Spend data is aggregated yearly, often on
supplier or high-level commodity basis, to
identify the most obvious opportunities
2 Spend data is aggregated for prioritized suppli ers/commodities, and often lacks insight into e.g. spend per site, division, suppliers, and buyers
3 Spend data is regularly collected and
classified on item level, to allow for detailed
and actionable anlaysis of spend data
Leading firms have successfully implemented standardization and classification of spend data at the source – e.g.
at the point of requisition or sourcing request.
geographical markets. Thus, the client understood the
contribution of raw material cost for each product, based
on different external circumstances.
A number of measures were implemented in purchasing and other departments, in order to decrease raw
material spend and increase profitability (see page 1).
NEWSLETTER
Best practice: Spend data analysis
Which raw materials have the highest impact on
product cost and profitability?
How will changes in annual product volumes affect the raw material spend?
How will fluctuations in raw material price affect
the profit of individual products and the company
as a whole?
Triathlon used the existing product BOMs to determine
the raw material content for each component. With
additional parameters added on component level such
as raw material price, annual purchased volume, and
geographical market, the client could link raw material
price to cost and profitability for each specific product.
Performing a sensitivity analysis and reaping first benefits will usually take 4-5 weeks, applying Triathlon tools.
The client could view each product’s component
sourcing cost side-by-side with the component’s raw
material cost. Thus, the client could compare and
benchmark different suppliers’ component prices with
raw material cost as a fixed reference.
The client was also able to analyze various scenarios of raw material price developments in different
Key success factors
Avoid the most common pitfalls
The foundation of any raw material strategy is a raw
material database. However, even with a blue-chip
IT-tool in place that allows for automatic data extraction, classification, and spend breakdown with graphical visualization, the most appropriate action is not
necessarily obvious. To understand how the information can be used to drive changed behaviour and to
sustain benefits over time, dedicated effort and hard
work through change management, compliance control, and process improvement are normally required.
Start small, scale fast
Triathlon recommends to start with an investigation of
business needs by realizing opportunities with a small
set of data. Then, it is recommended to move on to
higher grade of automation, IT investment, and process improvement. In any of these phases, Triathlon
believes that the quarterly updated Raw Material
Watch report can be of great benefit.
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NEWSLETTER
Triathlon Consulting Group
Triathlon is a growing management consultancy dedicated to strategy, operations
and finance with a prestigious track record. Our clients are large and medium-sized
companies within the manufacturing, high-tech and professional service industries.
Triathlon Consulting Group
Klippan 3B, SE-414 51 Göteborg Sweden
Phone: +46 (0) 31 704 12 90
Fax: +46 (0) 31 704 12 91
Box 21009
SE-100 31 Stockholm Sweden
Phone: +46 (0) 8 54 54 81 60
By combining innovation and best practice, we develop distinctive and substantial
value to our clients through long-term relationships and genuine understanding of
their business needs. In our assignments we preferably work in teams together with
client personnel so that we transfer our knowledge to the client organization.
Strategy
Operations
Finance
Developing strategies
and governance to
reach objectives
Improving operations
by combining innovation and best practice
Setting up business
structure and control
to support strategy
and operations
Need a success story of your own?
– Triathlon develops your business
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