The following article is a continuation of our Steel Buyers Basics series written by Mario Briccetti. Mario is Principal of Briccetti & Associates, a Supply Chain consulting firm, and can be reached at Mario@mbriccetti.com
I’ve been getting ready for my presentation in SMU’s May Steel 101 workshop and as part of that presentation updating the current effect of various types of steel pricing deals vs. spot pricing. At this moment, anyone buying on a long-term fixed price deal or even a lagging CRU index deal is doing poorly against a pure spot buyer of steel and probably will continue to do poorly for some time.
Companies selling steel (i.e. Steel Mills) like a rising market for obvious reasons. It’s also true that companies reselling steel (like Service Centers) like a rising market, perhaps even more than the mills. Service Centers can charge higher prices due to the market but their costs are still low since they typically have several months of lower cost inventory. Further, a buyer of steel (for a business reselling it) will also get a delay in the price increase if they have a long-term fixed price deal or even if they have a CRU index deal that lags the market. In short, resellers of steel get a DOUBLE BENEFIT when steel prices rise.
Unfortunately, steel resellers buying on a lagging index also get a DOUBLE PENALTY when the steel market falls. They have to sell high-cost inventory for a lower price and then they have to wait until they are able to buy at a lower price.
When the market moves up and down in small amounts these benefits and penalties average out. Even in periods of large market moves, these benefits and penalties will cancel out over the long run. However over the long run we are all dead. What can happen, and what is happening now, is that the market is moving down much more than average and for a longer period than average. Steel buyers on a lagging index price or a fixed price now face inventory that is high cost and the prospect of not being able to buy low-cost steel to replace it.
In this kind of situation buyers may be forced into breaking their deals for either their company’s survival or in order to keep their job. My experience tells me that long-term pricing deals for commodities, where no one really knows what may happen in the future, will sooner or later create a large winner pitted against a big loser and irresistible pressures on the loser to break their deal and relationship.
My experience also tells me that a buyer should always be suspicious of a mill willing to offer a long-term fixed price deal. The mill generally knows the market better than the buyer and any long-term deal is going to be in the mill’s interest and not the buyer’s. In short, a fixed price long-term deal is carries a lot of risk.
So enough of why long-term fixed prices are risky and how even indexed pricing can create trouble. I have some advice for steel buyers facing this situation today. First, don’t blame somebody else for your mistake – you made a judgment that was wrong, admit it and let your management know you will be a more experienced and better buyer in the future.
Second, you should be up-front with your supplier on the issues you face and ask for help. Be prepared to give something up. Having a solid long-term relationship with your supplier will help you overcome your current problem.
Third, you should have an alternative supplier that you can buy from in case you cannot reach a revised deal with your current supplier. (Any good buyer should always try to have back-up suppliers for reasons I’ve written about before.) Your current supplier will be much more receptive to modifying a deal favorable to them if they believe they may lose their business if they do not.
Fourth, breaking deals puts you in the wrong and may open your company up to litigation (although suppliers are loath to litigate against their customers). Even if you accomplish the change suppliers will not forget — and a good rule of thumb is that you have to do 10 good things to make up for one bad thing — so pay your bills on time, don’t make claims on material you can use and make sure the other side knows you appreciate their support and you will be a good customer in the future.
Finally, crises usually create opportunities to make positive changes. When times are good organizations have a great deal of inertia and tend to put off innovations or change suppliers. Don’t let a good crisis go to waste — now is the time to push your organization towards new engineering specs and suppliers in order to reduce cost of raw materials.
Mario BriccettiRead more from Mario Briccetti
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