How to Manage Commodity Price Volatility and Control Business Costs

Commodity prices are a constant concern for business owners and leaders, procurement professionals, and supply chain managers. Whether it’s steel spiking unexpectedly or pulp prices fluctuating, these shifts can erode profits fast. The good news? You can take control with a structured approach.

While we can’t control commodity prices themselves, we can take strategic actions to mitigate their impact on costs. Here’s a step-by-step guide to managing the effect of commodity price fluctuations on your bottom line.

Identify Commodities Driving Business Costs

Start by pinpointing which commodities have the most significant influence on your purchase prices. This insight helps prioritize where to focus your efforts and resources. For example, if steel makes up a considerable percentage of your product cost, this is where you start.

Select the Right Commodity Index for Price Tracking

Most commodities have an index that tracks their market value. For example, Pulp & Paper Week publishes several indices that track commodity prices. They are based on the type of material and buying location, such as the US, Europe, and Asia.

Select the index that best correlates with the price fluctuations you’re experiencing. Accurate index selection is critical, as this becomes the benchmark for monitoring price changes and negotiating with suppliers.

Select the index, but then be sure to check the index's correlation to the purchase price. Don't assume that the index tracks the purchase price; this should be verified. For example, a mid-sized manufacturer we worked with assumed a global steel index reflected their local supplier’s prices. After analyzing six months of data, they discovered a regional index correlated 30% better, saving them tens of thousands of dollars annually.

Build Supplier Pricing Agreements with Index Tracking

Work with your supplier to include the chosen index in your pricing mechanism. This ensures transparency and a fair alignment between market trends and pricing changes. This article can help you avoid pitfalls with supplier pricing agreements.

Set a Starting Price

Establish a baseline price for your commodity anchored to the current market value. This will serve as the reference point for all future price adjustments. This step is crucial for managing commodity price volatility effectively

Define a Price Fluctuation Band

To prevent constant price changes, define a small range or band around the index starting price within which no adjustments to the purchase price occur. This minimizes administrative burdens and provides more price stability.

Adjust Pricing for Larger Fluctuations

For price changes outside the agreed band, determine how much the purchase price will adjust relative to the commodity’s movement. For instance, a $10 per ton rise in the index might trigger a proportional increase in your costs and vice versa.

Set Adjustment Frequency

Decide how often to review and adjust prices based on the index. A quarterly or semi-annual schedule balances responsiveness to market changes while not becoming overly burdensome to manage.

Sign and Implement the Agreement

Finalize the supplier pricing agreement, sign it, and integrate the new pricing mechanism into your procurement process.

Develop a process for commodity index tracking. If the commodity price changes, and increases or decreases more than the band, then adjust prices as defined in the pricing agreement.

This approach creates a structured way to deal with commodity volatility. It helps you to control business costs. Purchase prices will not rise more than defined when commodity prices increase. Likewise, your purchase price and business costs will decline when the commodity price goes down.

Use Financial Hedging for Commodity Price Risk Management

If you’re managing a particularly volatile commodity, consider placing financial hedges against the index. Hedging can help stabilize costs and provide an extra layer of protection against market unpredictability.

Think of hedging like insurance: it locks in prices to protect against sudden spikes. Work with a financial advisor to explore options like futures contracts tied to your index. Read our article on commodity hedges to learn more.

Why This Works

This method leverages market-based mechanisms to manage cost uncertainty while fostering better supplier relationships. Suppliers appreciate the transparency and shared risk while you gain more predictability and control over your costs.

By implementing this strategy, you transform commodity price volatility from a threat into a manageable aspect of your procurement process.

Flambeau Consulting can help you implement a supplier pricing agreement at your company. Learn more about our services or contact us for a custom solution for your business.

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