ARE YOU OPTIMIZING YOUR FUTURE OR YOUR PAST?
With the increasing pressure on margin and prices, Purchasing and Formulation are more than ever the rule of the game in the Animal Feed industry. Every USD cent saved through a ‘smart’ purchase deal or formulation adjustment would represent millions USD at the end of the year and give significant competitive advantages.
Every material price variation on the market is an opportunity for aggressive players to gain advantages. The more often we adjust material prices into formulation software and the more savings we can realize.
The common sense would be to insert into our software the purchasing prices of the material we currently have in our warehouse. We would optimize formulas based on decision that we took in the past but this does not help us to take better decision in the future. Actually, formulation software is a tool that should help purchasers to capture market opportunities. To do so, we need to enter into our software not the past prices (for the raw material currently in our warehouse) but the prices that we could get for future purchases. With this information, the formulation department will be able to adjust formulas and calculate the nature and quantities of the materials to buy. Such proactive approach of purchase will enable companies to take earlier and better position than their competitors. Let us go together through 2 simulations varying price of Canola meal
SIMULATION 1 – High price in our warehouse / low price on the market If we keep in our formulation software the historical prices, we will limit the use of Canola meal in our formula and it will take long time before we use all our stock and make a new purchase. Meanwhile, competitors may have bought high volume of Canola meal at advantageous price, which would give them a cost edge.
If we update our software with current or future market prices, we will increase the use of Canola meal and make repurchase earlier to capture this opportunity.
Formulation department's role is to inform production what are the materials to use in excess (whatever prices we bought them) in order to reduce their stock and trigger a repurchase at a preferential price.
SIMULATION 2 – Low price in our warehouse / High price on the market If we keep in our formulation software the historical prices, we will maintain a high usage of Canola meal in our formula and ask to our purchasing department to repurchase expensive Canola meal. We will realize that it was a mistake only once the expensive material will be in our warehouse and therefore in our system. We will then come back to simulation 1. If we update our software with future market prices, the increase of prices in our software will reduce the usage of Canola meal and will therefore do not generate purchase needs for expensive materials. At the opposite, the software will trigger new purchase requirement for other materials whose future market prices are low (cf simulation 1) Such approach could help your organization to make significant savings but it is a major cultural change when we have been used to formulate with historical prices. We need to organize the change and get support from colleagues from purchasing and financial department.
The newest formulation software on the market are equipped to handle such simulation by enabling you to enter as many price list as you want to simulate.
We can even project the prices of several ingredients together to be sure that the requirement that you are sending to your purchase department takes into account the evolution of all ingredients and not only one. Very few software can enable you to make these simulations based on several ingredients at that same time.
There is a lot of savings to gain by working on future prices but it requires to be equipped with the proper software with the proper functions.
MONITOR MATERIALS EXPIRY When we formulate on today or future prices, software may remove from our formulas materials with high future prices. In such case, we will end up with materials sitting in our warehouse. To avoid such situation, we need to manage materials with low rotation and ensure their use by forcing a minimum usage in the formula (called FORCED formulas). These ‘FORCED’ formulas will be used only for production but should not be given to purchasing department to calculate requirement. Otherwise, we will keep on buying forced materials that we want to get rid of.
We therefore need to manage 2 sets of formulas; the FORCED formulas for production and the FUTURE formulas for purchase.
ADJUST PERFORMANCE MATRIX We are measuring company performance monthly through the income statement. Purchasing and Formulation aims at reducing the cost of materials of the month.
But when we start working on future prices formulation, such model would change. The mission of formulators is not to minimise the material cost of the month but rather to take the best medium term position for the company. Some decision may actually result in increasing the material cost of the month with the aim of capturing a purchase opportunity. Therefore, to measure the performance of the formulation process, we will need to look at the FPI technic that I introduced in our December 2014 nutricle. If you want me to send you that article, please let me know. DEVELOP EXPERTISE ON FUTURE PRICES Given the methodology proposed, it is becoming strategic for all feed manufacturers to develop their intelligence on raw materials price projections. This expertise can be developed in partnership with your raw materials suppliers but it should be proprietary as it has to become a competitive advantage. The company who will forecast the best, will take earlier position and gain significant profitability gain.
Should we use spot price, 1-month, 3-month or 6-month future prices? Actually it depends on your purchasing practices. If you are used to buy the spot price, you should use that spot price for your simulation. If your purchasing department is equipped to buy at 3 or 6-month term, you should then use those.
Future price formulation is a critical step in an organization and it must well planned and clearly explained transversally to all departments before being implemented. If you need some help in implementing such approach, Nutrispices experts are available to help you through the process.