If your business relies on raw materials of any kind to manufacture your product, you should ensure that you take measures to manage the risk of price fluctuations or shortages of that raw material. In other words, you should manage commodity risk. In this blog post, we explain the basics of commodity risk: what it is, what its causes are, and what you can do about it.
Does your company rely on a raw material – such as wood, grain, steel, etc. – to produce your product? Most companies that produce any kind of product rely on a raw material. This means automatically. Your company is threatened by raw material risks.
What are commodity risks?
Commodity risk is the risk of fluctuations in the price of a raw material. According to various studies, up to 70% of global companies cite raw material costs as the biggest supply chain threat. For example, the price of lithium, which is crucial for electric vehicle batteries, has increased tenfold in the last two years. However, prices for important base metals such as steel, aluminum and copper are trending downward. The reasons include increased supply and weaker global demand due to slower economic growth in major economies.
What causes commodity risks?
Price fluctuations for a raw material can have various causes, depending on what raw material it is and where the raw material comes from.
And risk events can occur simultaneously. The Russian invasion of Ukraine in 2022 continues to threaten grain and oilseed supplies. High fuel and energy prices reduce margins. At the same time, the COVID-19 pandemic had continued impacts on food production, labor needs and logistics. Extreme weather conditions are increasingly impacting crops and crop yields worldwide. All of these factors lead to strong fluctuations in market prices. In addition to price fluctuations, this also leads to bottlenecks. According to current forecasts, the semiconductor shortage is not expected to end until 2025.
How can I manage commodity risk?
Managing risk in commodity markets is not easy, but it is possible. The key is to understand where the raw material comes from and to keep an eye on the situation at all times. Diversifying supply sources plays an important role. In addition, risk scenarios must be developed so that if such a situation occurs, it is clearly regulated how to react. If you need support in setting up your raw material risk management, we have summarized the most important points here.
- Identification of key raw materials:
Identify the raw materials that are critical to your company or industry. These can be both primary raw materials used directly in your products and secondary raw materials processed in your supply chains. - Assessment of dependency:
Evaluate your company’s dependence on these raw materials. Which raw materials are irreplaceable, which can be replaced with great effort and which would be easy to switch to another raw material. Take into account both the quantity and the importance of the raw materials for your business processes and products. - Supply chain analysis:
Analyze your supply chains to understand the origin of raw materials and identify potential bottlenecks. Consider geopolitical risks, availability, price volatility and environmental impacts. - Diversification of supply sources:
Aim to diversify your supply sources to reduce the risk of supply shortages. Look for alternative suppliers and regions to reduce your reliance on single sources. - Monitoring market developments:
Keep up to date with market developments and trends related to raw materials. This includes price developments, technological innovations, political developments and environmental factors that may influence the availability of raw materials. - Development of risk scenarios:
Develop various risk scenarios for possible raw material shortages and their impact on your company. Consider different causes such as political instability, natural disasters, trade restrictions or technological changes. - Implement risk mitigation strategies:
Based on your risk analysis, you will develop strategies to mitigate the impact of raw material shortages. This can include storage of inventories, long-term supply contracts, hedging instruments, product innovations for reduction from dependence on raw materials and the development of recycling or circular economy solutions. - Continuous Monitoring and Adjustment:
Continuously monitor your risk management strategies and adapt them as necessary to changing market conditions and new risks. Flexible and adaptive risk management is crucial to being able to respond to changing conditions.
By following these steps and implementing comprehensive risk management around raw material shortages, you can improve your company’s resilience to raw material risks and ensure your long-term competitiveness.