How To Minimize The Impact Of Raw Material Prices On Your Margin (Part 1)

Anand Sundar

Obtaining the right grade of raw material at the right price and at the right time while complying with all safety and regulatory requirements is fundamental to the profitability of chemical companies. However, chemical companies have faced volatility in feedstock and raw material prices for decades.

Whether you are making commodity chemicals, intermediates, or specialty chemicals, raw material volatility has been directly impacting the margin for today’s chemical manufacturers. Industry shifts like the increase in demand due to the rising middle-class population in Asia, stranded oil and gas due to the shale phenomena, and increased investment in capacity have further complicated raw material distribution and pricing. The chart below shows the change in price of basic chemicals that are used as feedstock for intermediates and specialty.

Further, foreign exchange markets come into play as global commodities markets are typically US dollar-denominated. This creates significant cost impacts for countries that have seen their currencies weaken vis a vis the US dollar; an example is China, where the dollar is currently near highs vs. the RMB. Another example is Brexit, which weakened the British pound and created a disadvantage for companies in the UK.

As crude oil and petrochemicals are tightly linked, changes in crude prices have an impact on chemicals. This is because key building blocks for chemicals, like olefins and aromatics, are directly produced from oil or its derivatives and are used as feedstock for solvents, additives, and resins. Other raw materials and additives are likewise prone to price volatility due to supply and demand forces. The price for TiO2 (a common pigment), for example, has been adversely impacted recently due to strong growth in the coatings market.

Silos within chemical organizations also contribute to margin surprises. We are seeing an increase in demand for chemical companies trying to better integrate, both within the organization and throughout the value chain, to capture the impact of recent raw material price increases. This will allow companies to better analyze and determine just how much their margins will be impacted today, tomorrow, and in the future.

The immediate and rational response is to implement price increases and pass these higher costs onto their customers. Those companies that are planning to or have already implemented price increases often don’t have a solution to forecast and predict in real-time the impact this response will have on the bottom line.

Illustrated below is the first of three levers used by leading companies to manage the risk and impact of raw material price. The first lever is advanced supplier management, which is described below. The second and third levers, increasing visibility with digital technology and managing risk, are discussed in Part 2 of this two-part blog post.

Advanced supplier management

Chemical manufacturing is quite different from discrete manufacturing, as illustrated in the figure below. Based on a report by McKinsey, purchasing expenditures comprise 20-60% of revenue for specialty chemical companies and 50-80% of revenue for commodity chemical companies. Clearly, changes in raw material input costs can have quite a significant impact on profitability and cannot be ignored.

Most companies use commercial terms in supplier contract management to manage price. They are typically rigorous about renegotiating contracts when there is a decline in oil prices or other key indicators. However, cost impacts typically hit quickly, while chemical companies often struggle to pass along these cost changes efficiently.

Often, we find that the reasons are related to a lack of visibility into supplier costs, product quality and service level variability, and raw material transportation options. It is therefore critical for chemical companies to maintain a fact-based knowledge database to analyze each supplier in terms of their costs, quality, and service level attainment to efficiently pass along raw material cost increases. Some frequently used techniques include:

  • Clean sheet cost models: Using data from suppliers, it is possible to predict product costs (see an example in the graph below). This data-driven approach provides a record that cannot be ignored when negotiating contracts and using levers that will enable price adjustments.
  • Quality trending and correlations: Raw material quality variability can impact final product quality and processability and give rise to disputes with customers and their related costs. For example, variability in resin viscosity can give rise to quality issues for thin film applications, which could lead to product rework, rejection, and/or higher scrap rates.
  • Product form and transportation options: Raw materials are supplied in many forms and numerous grades. Minor changes in the characteristics of the batch could have a huge cost impact on transportation and processing. For example, shipping materials in a dry or concentrated state as opposed to in solution would reduce the weight and volume and reduce transportation costs. Another way to lower costs is to use lower expensive ingredients. Integration across the enterprise enables collaboration with R&D to innovate on changes to the recipe, spacing, and mixtures to use alternate lower cost raw materials.

This is the first of a two-part blog that illustrates how leading chemical companies manage the risk and impact of raw material price. The second part will discuss the next two levers: the importance of increasing visibility with digital technology and risk management strategies.

Learn more about using these levers to minimize the impact of raw material prices, supplier collaboration, compliance, visibility, and risk mitigation.

Anand Sundar

About Anand Sundar

Anand Sundar is an Executive Advisor of the SAP Chief Customer Office at SAP. He is passionate about using digital technology and business process excellence to extract value for customers. Anand previously worked for several years in various industries in supply chain operations and as a consultant and trusted advisor. He is a certified SCOR professional (SCOR-P) and part of the advisory board that developed the SCOR operations reference model and framework for standardization of supply chain processes.