Supply Excellence — Dow Price Hike: A lesson for buyers

Dow Price Hike: A lesson for buyers

June 6th, 2008 · by Bob Zieger · No Comments · oil/energy, sourcing, supply management, supply market dynamics

Dow Chemical made a lot of headlines last week when they very publicly announced price hikes of up to 20% on their products. Most of Dow’s customers were left scratching their heads as to why this made any news. After all, it’s not as though buyers aren’t used to Dow and other suppliers raising prices, particularly at a time of soaring commodity prices. But, I think that largely misses the point of this “news” story, which was actually aimed at Washington and Wall Street more than their customer base.

Dow has been very outspoken about the lack of a cohesive US energy policy, which most experts agree has helped exacerbate inflation in the energy markets. And since the Fed’s core inflation rate doesn’t fully capture the increasing price at the pump and grocery store (arguably the consumers’ “inflation index”), Dow’s move sends a message - loud and clear - that spiking energy prices are fast becoming a critical economic concern.

Announcing a price hike also sends a clear signal to investors that Dow is attempting to maintain their margin percentages by passing the costs onto their customers. The issue is that simply keeping pace with their raw material cost increases actually lowers profit margin percentages on products, since most of their base raw material increases are passed along to them on an absolute basis ($0.05/lb, let’s say). Even if raw material costs and selling prices rise the same amount (keeping margin $ flat), margin percentage goes down since costs are relatively higher. Alternatively, if price moves were executed on a percentage basis, then margin percentage wouldn’t change. But base energy costs to run manufacturing plants can typically only be re-captured this way, which is part of what prompted Dow’s announcement.

When price hikes are primarily the result of market signaling, it provides a sliver of opportunity for prepared buyers to mitigate them, IF they are prepared.

First and foremost, you need to have a good understanding of the cost drivers for your inputs. It’s an obvious component of being an informed buyer, but you would be amazed how many sourcing and procurement organizations don’t fully grasp the materials their suppliers use. If you don’t know the important commodities involved, current price of those commodities and what drivers are pushing prices up, you simply won’t know your options. And that leads us to my second point…

You need to have options. Let’s say through your knowledge of cost drivers, you deduce that your supplier’s price increase - which they attribute to rising crude oil prices - may be overstated. Even with a well-informed case, if you don’t have any approved alternatives, your leverage to mitigate the unwarranted portion of the increases is limited. By having multiple sources, you have additional market information, which generates and sustains competitive threats. Faced with legitimate threats, most suppliers will cave to maintain their percentage share of a customer’s business rather than try to eke out a bit more profit margin for investors. Ultimately, this is the best way to ensure that you are not competitively disadvantaged by opportunistic supplier price movements.

Bob Zieger is a Category Manager for Plastics and Raw Materials in Ariba’s Global Sourcing Organization. Bob holds a MBA from Katz Graduate School of Business at the University of Pittsburgh and spent 11 years in the plastics industry in engineering and sourcing roles. He is also a Certified Purchasing Manager (C.P.M.) as recognized by the Institute for Supply Management.

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