As soon as the economy picks up again, demand will also increase again and commodity prices will rise significantly.
Raw Materials
AN ADVANCED STRATEGY GAME
Supply chain bottlenecks and geopolitical crises have shown just how important raw material procurement is to companies. A growing number of decision-makers are realizing that it represents a key element of any corporate strategy.
CATAN is one of the most successful board games of all time. It is popular not only in Europe but worldwide, with over 30 million games sold to date. The game taught people across different countries one thing above all: large cities and armies of knights may secure victory, but without the corresponding supply of raw materials – such as wood, ore, or grain – there is neither one nor the other.
It is no different in the business world. Steel, oil, chemicals: the wheels of industry would soon grind to a halt without sufficient raw materials. In the latest edition of the Inverto Raw Materials Study, 55% of the companies surveyed in the UK and the DACH region stated that raw materials account for 30% or more of their procurement volume. For decades, however, this has not led to any special appreciation of raw material management and procurement. Due to globalization, there were cheap enough supply sources, and the raw material buyers’ main task was to keep costs stable.
Tempi passati: Geopolitical conflicts are turning the job of securing supplies of raw materials into a challenge. The war in Ukraine suddenly caused gas supplies from Russia to dry up, while the COVID-19 pandemic paralyzed global supply chains at a stroke. And in view of Chinese restrictions, the question is increasingly being raised as to how secure the supply of rare earth elements really is, since they mainly come from there. No less than 98% of these raw materials come from China, as do 97% of lithium and 93% of magnesium.
Politicians have been addressing the issue for some time. By passing the Critical Raw Materials Act (CRM Act), the European Union wants to ensure that there is a “secure and sustainable supply of critical raw materials.” The German government is spending billions to build liquefied natural gas terminals on Germany’s coasts. It is now a C-level issue at many companies; the secure supply of raw materials at prices still deemed acceptable has become part of the corporate strategy. With modern tools, smart warehousing, and the efficient use of technology, there are a whole host of ways to hedge against risks.
The opportunity to set the appropriate strategic course is currently better than it has been for some time. That’s because price pressure has eased somewhat. Admittedly, high raw material and energy prices continue to take their toll on business results, as stated by 78% and 70% of the companies surveyed in the Inverto Raw Materials Study, respectively. Almost half still expect prices to rise, but only 7% believe that any increase will be significant. Last year, 49% of respondents shared this concern.
The measures taken in recent years are starting to take effect. Having optimized the supplier base and warehousing operations, just 28% of companies still refer to acute raw material shortages. Most are optimistic, at least for the next few months. This is also due to the fact that sales volumes are declining significantly as a result of the weakening economy. But demand will rise again as soon as the economy picks up, and raw material prices will increase considerably. The people in charge of such matters should therefore take appropriate precautions now.
Advising companies to pay closer attention to the procurement of raw materials during a period when the situation has eased may sound somewhat contradictory. Yet it is precisely when those in charge are not busy trying to deal with short-term shortages and absorb price increases that the strategic course should be set.
That’s because prices are currently very volatile and remain at historically high levels. The price of oil, for example, has fallen by a good 10% over the past year. However, it has still risen significantly over the past three years. Those who wish to take a strategic approach to tackling the price problem firstly need to switch from defense to attack mode. In other words, it isn’t enough simply to react to rising prices. Instead, companies should plan proactively to compensate for large price fluctuations. There are many tools at their disposal to do this.
Firstly, it is clear that procurement via the spot market is becoming less important. Results over recent years also support this: from one year to the next, the number of companies stating that they will continue to rely on the spot market in the coming year is declining. Currently, 25% of companies are still planning to do so, an all-time low. Instead, long-term fixed price agreements with suppliers are gaining importance, with the survey showing a clear and steady rise over the past three years. As things stand, 54% of companies want to use this instrument.
Due to the volatile raw material prices, procurement should focus on contracts with price escalation clauses. With these agreements, supplier prices are linked to an index so that rising or falling prices are taken into account. This allows companies to profit from falling prices, while providing some degree of protection for suppliers. Among the companies surveyed, 78% use such escalation clauses, making them currently the most popular instrument. This is also due to the fact that suppliers are often not prepared to sign long-term fixed price agreements.
However, the raw material procurement strategy should continue to include a flexible share. Depending on the company’s situation, short-term spot purchases can be a good idea, not least because the sales position also influences its procurement policy. In order to find the right strategy, buyers must strive for maximum transparency. This means conducting a thorough review of existing contracts, taking into account the central question of where adjustments may be necessary. The use of appropriate forecasting models is also essential.
Corresponding tools are now highly developed. While they may not be able to anticipate every geopolitical crisis, they do provide a good sense of where the pendulum will swing in the foreseeable future.
As soon as the economy picks up again, demand will also increase again and commodity prices will rise significantly.
Price agreements with price escalation clause for raw material costs with suppliers (e.g. index-linked)
Longer-term fixed price agreements (incl. raw material costs)
No fixed price agreement; daily prices/spot market
Price agreements with predefined material surcharges for raw material costs with suppliers
Tranche agreements
Countertrade
When the supplier can no longer deliver due to changed conditions, a purely cost-based raw material strategy no longer helps. This is on the radar of companies, especially for certain materials whose supply situation will remain under strain this year. These continue to include oil and gas (albeit for fewer companies than in 2022), electricity, and the rare earth elements and lithium mainly sourced from China.
Respondents expect the EU’s raw material plans to do little to help. For instance, 61% do not expect the situation to improve as a result of the CRMA – either due to a lack of relevance, insufficient effectiveness for specific raw materials, or a lack of feasibility. Resistance to such projects is considerable in European countries. Due to strict environmental regulations, mining in Europe is also relatively expensive, which raises the question of the viability of these projects. The whole thing could ultimately only succeed with high subsidies. And even if these plans are pursued with the necessary urgency, it is likely to be years, if not decades, before they have an effect.
Accordingly, companies have to help themselves first. The easiest way to do this is to build up a diverse network of suppliers. For critical raw materials in particular, companies should never be dependent on just one supplier if at all possible. Some companies procure materials solely from one source and like to refer to it as a “strategic partnership.” They should rethink their strategy in cases where this is possible and where there isn’t just one or a handful of suppliers available for a certain raw material. After all, if any bottlenecks and problems reoccur, it becomes much more difficult to find a second supplier at short notice. Moreover, multi-sourcing strategies have the advantage that competition between suppliers often leads to lower prices.
When choosing alternative suppliers, it is also important to consider different regions. Near- and friendshoring options are a way of hedging geopolitical risks – in other words, procuring goods from countries that either maintain good relations with the home country or are at least geographically close. The respondents to the Raw Materials Study are essentially in favor of these strategies, with 43% stating that nearshoring has the potential to solve or mitigate problems. When it comes to friendshoring, the figure is as high as 51%. However, there are concerns about the actual feasibility of nearshoring in particular. Among the companies surveyed, 38% either do not see any corresponding alternatives for the relevant raw materials or they consider them too expensive. Friendshoring, which is also possible in non-European regions with lower cost structures, appears to be more attractive. All aspects must be considered from every angle when making such decisions, not least because nearshoring significantly reduces the transport risk and is usually associated with better monitoring of labor standards and production conditions.
The complexity of these decisions shows that the procurement team cannot approach the solution in isolation. Security of supply concerns the production and development departments as well as the sales managers. For this reason, the procurement team should weigh everything up in close conjunction with the various departments. Recognizing the strategic importance of raw material management also means integrating the matter into the overall corporate strategy.
At the latest when the supplier can no longer deliver due to changed framework conditions, a purely cost-based raw material strategy is no longer helpful.
Let’s not forget that sustainability is also of considerable relevance when procuring raw materials. Particularly critical materials such as rare earth elements, cobalt, and lithium are often mined under dubious conditions, and not always in compliance with human rights and environmental standards. At the same time, a particularly large amount of carbon dioxide is emitted here, which is why companies must pay special attention to the sources of raw materials on their way to becoming climate friendly.
The requirements laid down by politicians, such as those covered by the European Supply Chain Act, are increasing the pressure. No company will be able to meet these requirements without a corresponding adjustment to the way in which raw materials are procured. It is essential to audit the suppliers and monitor them at local level.
However, the switch to sustainable business activities brings with it an interesting aspect that could cut costs: recycling. If raw materials can be used again and again in production, fewer of them have to be mined. Internally, it is important to ascertain the framework conditions from a technical perspective.
Buyers need to consult with other departments to secure the necessary knowledge so that a long-term transformation can be a success. Companies should also cooperate with suppliers. They themselves often have an interest in providing recycling solutions and they have the detailed knowledge needed to deal with the raw materials, which enables them to identify effective solutions.
For critical raw materials in particular, the first projects have already been launched, such as those involving the extraction of materials from removed electric car batteries. These are still reusable even after the official end of the battery life cycle – especially the scarce materials such as cobalt and lithium.
Especially in times of slowing demand, matters such as inventory optimization become more relevant. Professional warehousing can achieve the necessary flexibility and optimize working capital. Compared with last year’s survey, this is reflected in the latest raw materials study, with 73% of companies using the optimization of their inventories as a means of combating raw material shortages, an increase of 10 percentage points.
Strategic raw material management often goes hand in hand with increased personnel requirements, which is a challenge in times of skills shortage. Staff shortages in the field of procurement have increased since 2020, with 38% of companies citing this as a problem for their operating results (25 percentage points more than in 2020). Accordingly, the optimization of processes becomes just as relevant as agile working methods and prioritization in procurement in favor of critical raw materials. The increasing use of business intelligence tools and AI applications could make life easier for buyers because they can obtain faster and better-quality data when making their decisions, while standard processes for less critical needs can be automated.
Ordering raw materials when they are particularly cheap can save companies a lot of money. Yet, to manage forward buying efficiently, procurement departments need to know the market especially well – and be able to predict price developments. In this interview, Dominik Horsch, Senior Vice President of Global Procurement at access control specialist dormakaba, explains how his department approaches the task.
Mr. Horsch, when people board a plane or enter a modern office building, they often encounter dormakaba products without even realizing it. How has the market developed recently?
That is true – dormakaba is actually everywhere, although people don’t always notice our products. We are the market leader in the field of access control and security systems, and our market environment is currently undergoing rapid change. Right now, there is a major shift toward electromechanical and interconnected contactless access systems. Mobile, biometric authentication solutions are also playing a greater role. These can be found on scanners in the boarding area at airports, for example. They eliminate the need for a ticket because passengers are identified by their faces.
That sounds like ever more complex systems. What are the main raw materials you need to produce them?
The raw materials we use the most are similar to those used in classic locks: copper, steel, aluminum, and plastics. If the prices of these materials fluctuate, it has a considerable impact on us.
To mitigate this effect, you try to buy the materials at a particularly opportune time. How do you go about this?
We hold a cross-functional meeting once a month to decide whether we want to buy certain raw materials early. Our raw material buyers attend the meetings. Also present are the global category managers, who are responsible for a specific product group, along with the relevant production managers and me. The meetings help us to plan our warehouse utilization, especially from a working capital perspective. In addition, we use them to make sure that we order new raw materials at the right time. The final decision, however, must always be made by the CPO.
Which programs do you use for planning and decision-making?
We use various business and index intelligence tools, including Mintec as an index platform. This helps us to obtain historical data on the price developments of individual raw materials. We use it to monitor the prices over the past two years. To further validate this information and make sure we are using the right data points, we still have back-up tools, which enable us to track prices dating back 10 years. With the aid of these programs, we can then estimate how prices are likely to develop over the next 12 months. We collate the results in our hedging indicator, which makes a hedging recommendation for a single raw material. We make a distinction here between four phases: avoidance, planning, partial hedging, and full hedging.
What are the advantages of this approach?
Since introducing this method, we have seen a smaller increase in costs. Moreover, we have increased the security of our deliveries. We have thus been able to use this strategy to minimize the short-term risk of loss. We are more efficient because we don’t have to monitor how the market is developing on a daily basis, only then to make a hasty and potentially ill-considered decision. Another advantage, especially for us as a Swiss company, is the increased protection against unexpected currency fluctuations and interest rate rises. Overall, our approach allows us to plan costs and revenues more accurately.
Flender is one of the world’s leading companies in the field of drive technology, employing 9,000 people and generating a turnover of around €2 billion. In this interview, Andreas Weigelt, Head of Steel Procurement, talks about how the company is reducing carbon emissions, what role green steel will play in the future, and why a uniform industry standard has not yet been achieved.
Mr. Weigelt, Flender intends to be carbon-neutral by 2030. Is this a realistic prospect?
We have set ourselves this ambitious target because we want to be a partner for a sustainable future. We want to become carbon-neutral by 2030 in the areas covered by Scope 1 and Scope 2 emissions. These include both direct and indirect emissions generated during production – when using energy, for example. We are well on the way to achieving our target and have already been able to reduce our carbon dioxide equivalent emissions by 79%, which is a considerable success.
What measures have you taken?
We buy green energy and have increased our level of efficiency, while also storing energy and cutting greenhouse gas emissions. By investing in our locations, for example, we are making logistics processes more efficient. The shorter journeys are reducing carbon emissions.
However, since only 2% of our emissions are generated directly, it is essential that we include the supply chain in our consideration. If we look at our suppliers, steel production accounts for the largest share of emissions. I am therefore certain that green steel will play a key role if we wish to reduce greenhouse gas emissions in the economy.
What steps have you already taken to reduce Scope 3 emissions as well?
Firstly, we have established a cockpit to create transparency. This has enabled us to identify the 150 “hot spot” suppliers responsible for over 80% of Scope 3 emissions. We have been focusing on them ever since and asking, for example, how high their emissions are and where exactly they occur. In the long term, we want to be able to calculate the carbon emissions generated by each individual product from all the data available to us, which includes our own data, external databases, and those of our suppliers. It is about achieving full transparency, from the raw materials to the end product delivered to the customer. Only then will we be able to make a targeted effort to reduce emissions in the second step and work with our suppliers to make green steel possible.
In your opinion, what are the success factors in establishing green steel as the standard?
I think there are four important factors. Firstly, we need transparent data from all players involved in the supply chain, which of course requires a philosophy of openness from cradle to grave. Then we need global acceptance of a standard calculation in order to create a level playing field. In addition, of course, there needs to be a definition of what near-zero steel actually is. Based on all of this, we can then work out, for example, what form any support for a circular economy in the steel industry may take.
That won’t be easy. What have been the biggest challenges so far in trying to establish a global standard for green steel?
I think the biggest challenge, for a long time, was the lack of a standard definition for green steel. This changed in July 2023 following the publication of guidance from the Science Based Targets initiative (SBTi). It clarifies many aspects that were previously unclear, such as how to deal with intermediate products or alloys. This is extremely helpful.
What challenges remain?
Lead markets for green products are certainly still needed, along with carbon contracts for difference and green standards when awarding government and European contracts. Politics also plays an important role in this regard. We are trying to stay in touch with events and communicate as much as possible with the political institutions, with the aim of achieving planning and investment certainty so that the transformation to green steel can succeed.
So is more regulation needed rather than less?
Tighter regulation can help here. Yet it must be targeted and practicable. For example, we are currently implementing the new regulations laid down by the European Parliament. These include the Carbon Border Adjustment Mechanism, which has been in effect since October and requires us to report the quantity of carbon emissions we import into the EU, and the Corporate Sustainability Reporting Directive (CSRD), which of course affects many companies. Often, however, there is still a lack of exact specifications and reporting standards, even though these are vital to establishing green steel as a standard in the long run.