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.

 

Critical raw materials are essential for the economy and a wide range of technologies necessary for strategic sectors such as renewable energy, digital technology, space and defense. The EU’s Critical Raw Materials Act (CRM Act) has been created to ensure the bloc’s access to a secure and sustainable supply of critical raw materials and enable Europe to meet its 2030 climate and digital targets.

Get to grips with strategic raw material procurement now

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.

// Which external factors currently have a significant influence on your business results? (multiple answers possible)

Raw material prices
78%
Energy prices
70%
Uncertainty regarding economic & geopolitical developments
68%
Declining sales volumes
43%
Personnel shortage
38%
Political framework conditions (e.g. legislation)
35%
Reduced availability of raw materials
28%
Increased competition
18%
Exchange rate fluctuations
15%
Bureaucratic hurdles for imports and exports
8%

The price pendulum continues to swing

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.

// Which pricing model has your company mainly been able to implement in agreements with its suppliers in the last 12 months? (multiple answers possible)

78

Price agreements with price escalation clause for raw material costs with suppliers (e.g. index-linked)

54

Longer-term fixed price agreements (incl. raw material costs)

25

No fixed price agreement; daily prices/spot market

32

Price agreements with predefined material surcharges for raw material costs with suppliers

15

Tranche agreements

2

Countertrade

 

Security of supply remains the task of the company

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.

 

Friendshoring or “allied shoring” originates from the United States and is a concept for increasing the resilience of supply chains. Moving the production and procurement of raw materials as  well as products to friendly countries is intended to minimize supply disruptions due to geopolitical risks, such as China’s recent zero Covid policy or the Russian invasion of Ukraine.

The switch to sustainable business practices brings with it an interesting aspect that could lead to cost reductions: Recycling.

Sustainability is essential

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.

  • Does recycling lead to a drop in quality?
  • Can recycling processes be used to develop substitutes that make up for the scarcity of raw materials?

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.

Do not disregard the internal processes

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.

 

CONCLUSION

Strategic raw material management must be on the executive board’s agenda. After all, the procurement team cannot make the necessary adjustments on its own. With the appropriate backing, it can act consistently both internally and externally and develop new, effective solutions for the procurement of raw materials.

Given that markets are still volatile and the geopolitical situation remains tense, companies that take this step will gain a competitive advantage. The current situation provides the ideal opportunity to secure stock and prepare for the next crisis.

Authors

Justus Brinkmann

Principal

is a Principal at Inverto in Cologne and is an expert in raw materials within Industrial Goods and has been and has been in charge of our annual study for several years. Brinkmann mainly supports clients from the chemical and metal processing industries.

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Theresa Schwämmlein

Project Manager

is Project Manager at Inverto’s Munich office. The mechanical engineer mainly works with companies in the mechanical and plant engineering sector. She is responsible for Climate and Sustainability within Industrial Goods.

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