The manufacturing sector in the US has witnessed modest revenue growth in the last five years. While the industry’s revenue is estimated to reach $7.0 trillion in 2024, its upward trajectory is relatively slow. Rising costs of raw materials, transport, and compliance are the biggest reasons for this slow growth.
The profitability of a manufacturing business boils down to several factors, with raw material procurement being a primary one. A key component in manufacturing supply chains, smart raw material inventory management drives production efficiency. Additionally, it ensures optimal product quality and overall profitability of the firm.
As a manufacturer, you can understand the significance of optimizing the commodity procurement process. After all, depending on the vertical in which you operate, these costs may amount to around half of your operating expenses. Effective purchasing decisions can impact the company’s financial performance in the long run.
Timing and strategy become essential considerations for manufacturing businesses. In this guide, we will highlight some strategic approaches for timing the raw material purchases for your firm.
Buying Raw Materials: A Few Different Approaches
Raw material purchase is critical for manufacturing enterprises, regardless of their product category. For example, the food and non-fossil fuel segment has witnessed a huge surge in raw material use. According to the Center for Sustainable Systems, raw material usage in these sectors is 3.17 times faster than the population growth from 1910 to 2020.
Therefore, it becomes essential to have a plan for optimizing your procurement processes. Here are a few approaches you can consider for your business.
Just-in-Time (JIT) Purchasing
With the Just-in-Time (JIT) purchasing approach, you order and receive raw materials only as they are required in the production process. By doing so, you can cut the inventory holding costs and limit the risk of obsolescence. It also enables manufacturers to optimize cash flow and storage space.
While this approach does come with risks of late delivery and dependence on market fluctuations, losses incurred may or may not be offset by storage savings.
The concept was introduced by the Japanese in the early 1970s, with the Toyota Manufacturing plants taking the lead. Eventually, many US companies, such as Hewlett-Packard, adopted the “zero inventory” approach as well.
In the AI era, JIT purchasing has become much easier, with tools such as thouSense making it simple to implement. This tool brings demand forecasting to your fingertips, helping to effectively plan and optimize the raw material procurement process.
Hedging with Commodity Contracts
Another strategic approach to optimize the raw material inventory is hedging with commodity contracts. This method involves the use of financial instruments like futures and price protection contracts to lock the raw material prices at a specific time, either based on the price at the moment the contract is signed or based on mutually agreed price projections for future procurement windows.
This approach helps manufacturers to avoid risks associated with price volatility. According to EuroFinance, consumer goods giants used this strategy to prepare for the inflation driven by the Ukraine-Russia conflict in 2023. PepsiCo, Kraft Heinz, Hershey, Mondelez, and Conagra are some brands that used this strategy to protect their margins.
While managing hedging contracts may seem complex to mid-sized manufacturers, the Hedgify platform makes it easier to ensure stability against market fluctuations. This solution offers AI-based insights regarding specific commodity markets and helps with decision-making to lock in price protection contracts using three different models.
With “rolling protections,” prices are automatically renewed at predefined intervals, running on an automated basis. With “layered protections,” a dynamic, algorithm-based price is afforded as informed by market condition trend data. And with “continuous protection,” today’s prices are honored for an extended period, and Hedgify pays manufacturers the difference via a defined cadence.
Bulk Purchases Based on Market Trends
Taking dynamic demand considerations out of the center of the decision-making process, purchasing in bulk is perhaps the simplest way to optimize the raw material procurement process.
Consider buying during periods or when prices are favorable to unlock significant cost savings and profits for your business.
Utilizing tools such as Attest can help manufacturing companies with insightful market analysis. They can make informed decisions about when to buy raw materials according to current trends and forecasts.
Conversely, this model may not be suitable for all businesses, specifically the ones dealing in perishable products like food and beverages.
Economic Order Quantity (EOQ)
With the Economic Order Quantity (EOQ) model, you calculate the optimal order size that limits total inventory costs, including shortage costs, holding costs, and ordering costs. This model ensures that a firm orders the right amount of inventory per batch.
With this approach, you need not order too frequently, which reduces reordering costs. At the same time, you do not have an excess of inventory sitting on hand, limiting your storage and holding expenses.
While EOQ can be extremely helpful for looking at the big picture of your organization’s procurement needs over the course of a year, it doesn’t take day-to-day market fluctuations into account.
Software tools like Zoho’s EOQ Calculator can help with the implementation of this inventory model, helping procurement decision makers to determine the exact amount of inventory in a few clicks. Zoho’s suite of tools also provides analytics modules and inventory management modules to further guide procurement strategies.
Best Practices to Determine the Right Time for Purchase
While choosing the right raw material buying model can give you a head start, you need to do more to ensure the right decisions every time. Here are a few best practices that can help.
Stay on Top of Market Conditions and Pricing Trends
Continuous monitoring of market conditions is a wise move to make informed purchasing decisions. Manufacturers must understand price trends and seasonal fluctuations to time their purchases effectively. The Boston Consulting Group notes that companies can use historical insights related to volatility to compile the risk indicators for their critical raw materials.
Align Purchases with Production Schedules
Integrating procurement planning with production schedules is another good move. It ensures that raw materials are available when required, optimizing resource allocation and minimizing delays. This way, you can avoid getting overly stressed-out about potential bottlenecks, because they are far less likely to ever happen.
Understand Your Company’s Cash Flow
Like any business, a manufacturing company’s finance and procurement managers should understand its cash flow thoroughly. This becomes even more crucial in the context of raw buying commodities, because a hefty sum goes into it. A good understanding of your cash flow will help you determine how much capital you can allocate to raw material purchases at various times of year without risking operational liquidity.
Don’t Ignore Macroeconomic Factors
Macroeconomic indicators such as currency fluctuations, inflation rates, and geopolitical events can significantly affect the prices of raw materials. The pandemic and the Ukraine-Russia war are examples of the kind of impact these factors may have. Firms should bear these factors in mind when planning their procurement strategies.
Key Takeaways
Effective raw material procurement is not just about purchasing raw materials. It also requires market analysis, strategic planning, and risk management. Manufacturers can cover all these fronts by comparing and choosing the right approach. Moreover, they must utilize the right tools to implement the chosen model.
With the right model and practices in place, manufacturing firms can remain agile and profitable in a dynamic market. They can maintain quality and cost-effectiveness as well.
