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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 Q1 2013 1 – 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: Q1 2013 2 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. Q1 2013 3 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 Q1 2013 4