Weaker second-quarter performance from a bevy of businesses suggests that the corporate profit train may finally be running out of steam. The main culprit: rising energy and materials prices.

A new National Association for Business Economics study of 170 U.S. businesses uncovered narrowing margins in all major industry sectors during the second business quarter. Goods-producing sectors, such as manufacturing and construction, were particularly hard hit, with most responding companies in these segments reporting shrinking margins. Only 27% of all businesses participating in the survey said they were able to raise prices in the second quarter. However, nearly two-thirds of respondents said material costs rose.

Prices for copper, aluminum, and palladium soared as much as 77% this year. Prices for petroleum-based products are also up, with manufacturers reporting that plastics resins prices this July were up as much as 35% above year-ago prices. Unfortunately, market watchers don’t foresee relief anytime soon. In fact, economists now warn that oil prices could top $80 per barrel. And, with hurricane season now in full swing, analysts fear that another weather-related disruption in the fuel supply could send fuel prices even higher.

Even supply management visionaries are feeling the pinch. Case in point: Honda Motor Company this week blamed higher raw material prices for lower than expected profits. The automaker warned that increases in metals prices will exceed planned supply cost reductions this year. Honda expects to incur an extra $157 million in costs due to material price increases this year.

Upshot: while much cost and inefficiency remains to be removed from most supply chains, supply managers must be prepared to deal with increasing inflationary and supply constraint issues. Here are some tips for weathering the storm:

• Do your homework: Cool hand Luke once said, “I never make a bet I know I can’t win.” Supply managers would be wise to apply this knowledge by performing additional diligence in tightening supply markets, including price benchmarks. Faced with wild price volatility in food markets, sourcing managers at Compass, the world’s largest food services company, benchmark market pricing and dynamics before initiating a sourcing project.
• (Re)set expectations: Use pricing benchmarks to set realistic expectations for sourcing and auction goals. When benchmarks portend a price increase, Compass resets expectations, using e-sourcing to negotiate below-market increases. Says one Compass sourcing executive: “While no one likes a price increase, it helps to prepare [stakeholders] for what to expect from each sourcing event.”
• Don’t be afraid of commitment: Savvy supply management execs are constantly assessing future pricing and supply market implications and using those to determine when to engage in long-term supplier agreements in order to assure supply and lock in preferred pricing. Southwest Airlines is now legendary for its decision to use supply market forecasts and a hedging (i.e., “early buying”) strategy to lock in 85% of its fuel purchases for 2005 based on prices for when oil was at $26 per barrel. In light of the current oil crunch, it is estimated that the move has saved Southwest more than $200 million in fuel costs – at a time when most other airlines are under financial duress.
• Share with your suppliers: Leading supply management organizations are ensuring supply and reducing costs across their supply chain by training suppliers on sourcing and supply management best practices and engaging in collaborative multi-tier sourcing, co-sourcing, and contract sharing. For example, Ford Motor Company has used its commodity expertise and buying clout to negotiate favored trading terms with material and part suppliers. The automaker “shares” its preferred pricing and availability with contract manufacturers and other supply partners to lower costs and ensure supply availability across the supply chain.
• Hedge your bets: Once limited to industrial sectors buying energy and materials, such as steel, hedging practices are proving to be an antidote to global supply market uncertainty. For example, food giant Sara Lee has hired former pork traders onto its supply management squad in order to monitor and hedge pricing and supply for pork products, which are a key input for many Sara Lee products.
• Think green: Higher material prices have revitalized efforts to recycle and reuse raw materials, particularly precious metals, such as copper, aluminum, and gold. As reported here, all major PC manufacturers have recently stepped up initiatives to recover end of life products in order to reclaim such materials. Hewlett-Packard is leading the charge. By the end of next year, HP will have recycled 1 billion pounds of electronic waste. The company now gets 60% more of the precious metals it uses in its products from its recycling program than from mining.

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