According to the industrial packaging website the market is expecting 3-12% price increases due to increases in the resin market. (And some other silly arguments). However as you can see from the analysis above, the resin prices are increasing significantly in some areas, though less in others.
So i decided to do an analysis for a friend to see if the demands of the packaging industry hold up overall, and what to do about it. Thankfully he allowed me to share the analysis on the condition of anonymity.
Here are the prices he has been charged for stand-up pouch pricing. These are the prices, on a single unit basis, he paid for the last 4 years. And below the is the analysis of the cost-driver argument for price increases
Task 1: Creating a cost-driver model for a stand-up pouch.
To set up cost-driver tracking for a stand-up pouch we had to estimate the cost structure of a stand-up pouch. This was our starting point and from here on we did more internet research and spoke to some experts we found on upwork.com and people who had some exposure to packaging costs.
From the analysis we broke down the cost-driver analysis of a stand-up pouch to almost 25 elements, of which we chose the top 11 cost drivers. These elements included the following cost drivers:
- Titanium Dioxide
We excluded conversion costs on the grounds that these are largely labour and depreciation, and are predominantly fixed cost. We also excluded contribution to overheads and profit as these are not variable cost of sales, and would generally be fixed, as a cost per unit, % of cost, or as a profit margin % expectation.
That creates an image of prices compared to critical cost drivers as follows:
After plotting the cost of the cost drivers against the cost of packaging, we came to the following overall comparison of the packaging cost and the trend of the cost-drivers.
In this analysis, the price of the stand up pouch is in red and the combined cost of the feedstocks in blue. Both trends are indexed to 1.00 on Jan 1, 2018 to make it visually more comparable. It is clear that there is a strong case for price increases as shown in the chart. In fact, it is a near certainty and it seems to be justified given that prices also went down over the last few months.
The cost curve shown for the period of February 2021 to April 2021 are not a forecast of prices themselves. They reflect that the prices of cost-drivers today will take between 1-3 months to impact the cost of packaging. So the current prices of cost drivers may be shown into the future when being bench-marked against the prices of stand-up pouches.
But there are other learning from the data about the cost and prices of packaging:
1) Prices of cost drivers are significantly below 2018
Here is a chart that shows the development in the prices of the critical cost drivers over the last 4 years. Sure it is a busy chart, but it has a simple conclusion: Prices of critical cost drivers are going up but they are not close to levels of late 2018.
Depending on the level of your price decreases, now may not be the right time to accept price increases. If the supplier did not pass on their lower cost these last 2 years, push back strongly on price increases.
If not, go back to market and start a process to create more competition of your business. This kind of analysis highlights point number 2 that i can make about these numbers:
2) Supplier are too slow to pass on price decreases
If you see the chart of the price of the packaging vs the price of the major cost drivers, you will see a standard phenomenon. Prices are fast to go up and slow to come down.
The challenge of the fast-up and slow-down is a classic issue in Procurement pricing where additional cost is incurred because suppliers are slow to pass on cost-decreases.
Having additional transparency on the critical cost drivers for the suppliers gives more urgency to the demand for price decreases that match the timing of price increases.
This brings us to the third observation on the cost development using ProcureAnalytiq.
3) The benchmark in ProcureAnalytiq will create alerts
Prices of cost-drivers will continue to fluctuate. Some of those changes will be within normal range, whereas other changes in cost driver prices will have a significant impact on the price of the packaging.
ProcureAnalytiq includes a tool to help identify which changes are beyond normal statistical variation and should lead to a change in price of the final product.
Once the bench-mark is set up, it will be automatically updated and once a month an alert is sent to the user (and anyone with whom the analysis is “Shared” in the system.
This analysis can fine-tuned and used as preparation for negotiation with the supplier. But the use of the analysis can also be extended beyond negotiation and used as input for the negotiation as part of a formula-pricing agreement. That brings me to the fourth benefit.
4) The benchmark can be used in negotiation with the supplier
Once the critical cost drivers are agreed with a supplier, and the market indexes that most closely track the prices of cost-drivers, you can set up a simple price mechanism with the supplier based on the agreed parameters.
ProcureAnalytiq was designed to transition from an analysis tool, to a negotiation tool, to a formula pricing tool by allowing the user to set an index date, which is the date at which the critical cost drivers and the price of the packaging is agreed to be in line. The ProcureAnalytiq system will effectively “reset” itself as a bench-marking system if the users agree to do so.
I am not a fan of legally binding formula pricing, i think any commercial agreement should leave room for exceptional circumstances so neither party can suffer significant losses with no recourse, but i am a big fan of establishing documented cost-drivers to track in a transparent manner. The trick of course is to agree the right starting point….
And that brings me to the final 2 benefits of this analysis.
5) Stop!!! Prices will go up. What options do you have?
If you know that prices are going up, now is the time to ask:
- Do you have any leverage?
- Can you place orders before the prices go up?
- Do you have enough competition to offset the threatened price increases?
- Can you move volumes around to protect against price increases?
- Can you change specifications to offset price increases?
- Can you agree an increase in order size to offset price increases?
- Who in the business needs to know that prices are going up? Do you need to pre-condition your customers that price increases are coming?
Time to get Procurement, Purchasing and Planning together and plan how to minimize the damage
Finally the analysis can be used to update the stakeholders directly
6) The analysis can be used to update stakeholders
The benefit of understanding the impact of upstream price increases, and the ability to visualize them, will help internal stakeholders and customer understand the need to pass on price increases or decreases.
The conclusion is that even in the face of the strongest arguments for price increases, it is important to do the analysis.
At best, you can delay the threatened price increases, and at the very least you establish a clear basis for price decreases in future, as well as clear communication with your internal stakeholders
DELIVER DIRECT MATERIAL SAVINGS
ProcureAnalytiq is an online cloud-based software tool to track market developments and leading indicators related the direct material purchases for your business.
ProcureAnalytiq enables user to faster reaction to market changes, better negotiations, automated forecasting of material pricing, better internal and external communication, and ultimately reduces direct Raw Material prices.
Interested to explore more?
The summary above comes out of the ProcureAnalytiq system, based on generic market data and outline cost-driver models. In general, if we work with a client, we develop cost-driver models which are more accurate and relevant and which can be used in negotiations, price tracking, or even price mechanisms.
As market models are confidential, we can not work with competing companies in a single industry.
Here is a short summary of what ProcureAnalytiq is intended to do.
ProcureAnalytiq enables external benchmarking of your raw material pricing
ProcureAnalytiq was built to support tracking critical benchmark and cost-driver price development against your RM pricing.
Track your pricing against external benchmarks
Finding and tracking external benchmarks is a critical requirement in procurement. It requires advanced search for external benchmarks and system to ensure that the tracking is correctly done in terms of Indexing, FX, Unit of Measure,
Track your pricing against critical feed-stock pricing & disruption
Choosing the right data sources for the critical cost drivers and proving the correlation through a look at history. Many procurement managers already keep an eye on 1-2 critical cost drivers. But often they are searching for the right price trends and they may choosing the wrong source of cost-driver data leading them to reach the wrong conclusion.
Build price indexes which are an indicator for your business or SBU’s
ProcureAnalytiq enables you to set up benchmark indicators in minutes to establish overall market indicators for your industry.
Save time & effort in procurement
In addition, the search of data as well as model building in Excel takes times and effort by the procurement staff. This time is better spent on interpreting data and planning negotiations rather than fiddling around in Excel?
Sharing of results
ProcureAnalytiq helps users to share their analysis over time, so that only 1 junior person can maintain the data (based on reliable data sources) and the others can use the analysis for interpretation and communication. It also allows a team to share their input with the supervisor or with research or other business partners.
Interested to explore the topic futher?
If you are curious about the topic of price benchmarking, especially of critical cost-drivers, please feel free to reach out to me through the Explore ProcureAnalytiq page