Achieving Procurement Excellence in the Chemical Industry
The global chemical industry is one of the world’s largest industry employing millions of people and generating billions of dollars in revenue. The chemical industry is critical to the operation of automotive, pharmaceutical, agriculture, and construction industry as they procure the primary inputs from the chemical industry. Changes in price, production, and quality from the […]
The global chemical industry is one of the world’s largest industry employing millions of people and generating billions of dollars in revenue. The chemical industry is critical to the operation of automotive, pharmaceutical, agriculture, and construction industry as they procure the primary inputs from the chemical industry. Changes in price, production, and quality from the chemical industry will highly impact such connected industries. As a result, it is important that the chemical industry achieve procurement excellence by obtaining the right raw materials at the right price, with the correct specification, quantity and quality. Purchasing expenditures amounts for a significant part of sales revenue for the chemical companies. For instance, purchasing costs account for about 58% of the total cost in the global benzene market. (SpendEdge Procurement Market Intelligence Report – Global Benzene Market) Additionally, achieving excellence in the procurement of raw materials for the chemical industry is critical to their success as CPOs can realize substantial cost savings due to high volatility of input materials. For instance, crude oil is a significant cost driver in the petrochemical industry as it is the building block for chemicals such as ethylene, propylene, and aromatics. The sharp oil price dip in 2014 came as a major shock for the chemical industry.
Achieving procurement excellence in the chemical industry won’t be an easy task. Procurement in the chemical industry is complicated by numerous factors, and CPOs have to address a wide variety of factors to make strategic decisions. For a start, chemical companies will have hundreds of products and specifications ranging from polymers, petrochemicals, intermediaries, derivatives, and inorganic chemicals which is sold to thousands of customers. Specialty chemicals is a different beast when it comes to complexity, as it is highly diversified that serve multiple end-use industries such as construction, oil and gas, cosmetics, textiles, and food. And if that was not enough then multiple grades of chemicals are available from suppliers spread across vast geographies. With quality being of utmost importance, CPOs often face the dilemma to source the right chemical grade for the right price as a slight variation in quality will hugely impact the finished product.
Additionally, going by the 80-20 rule, 80% of the raw materials used in the production of chemicals account for only 20% of the cost. That’s a lot of work for the purchasing manager that affect such small part of the cost base. For instance, manufacturing certain specialty chemicals may use thousands of additives, some of which may be used only in a small quantity, but largely influence the quality of the final product. If you thought that was all, chemical suppliers still have to package and supply these products in different packages, in various quantities and quality, to different customers. Analyzing all these factors in order to achieve procurement excellence can be a big headache for purchasing
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- Changes in government policy, ethics and quality control regulations
- Changes in foreign policy regarding regions and territories that financial, logistics, and compliance issues
- Supply chain disruption in cases of political collapse, revolt, and disjoint
- Added cost of putting up measures to control chemical spills, gas release, and chemical waste
- Innovations in processes which deals minimal to no damage to the environment, but such innovations come at a cost
- Globalization and rapid expansion of population is increasing the global demand for chemical products
- Labor rate differences is a crucial factor in selecting destinations to source raw materials from
- Technological advancement can drastically reduce product lifecycles and enable mass customization
- Purchasing managers must make decisions if adopting new technology will reap benefit as opposed to traditional means
- Toxic Substances Control Act (TSCA) have adversely affected the development of new chemicals
- Clean Air Act, Clean Water Act, Occupational Safety and Health Act, Product Safety Act, and numerous other regulations affect purchasing in the chemical industry
- Currency fluctuations can impact cost of materials as payments have to made in foreign currency for global suppliers
- Changes in oil and commodity prices largely impact the price of the final product
- Interest rate, lending rate, and inflation
Achieving Procurement Excellence in the Chemical Industry
Chemical companies can enhance their savings by following procurement best practices and giving purchasing a strategic level importance. A proper segmentation of spend data can give in-depth insights for a purchasing manager on areas of improvement. Spend analysis can also identify hidden materials that are of strategic importance to the firm alongside other low-cost critical materials and tail spends. Generally, critical materials account for a small number of commodities but take up a large part of the cost-base. Also, they are strategically important for the firms as supply chain disruptions and price volatility will primarily affect the entire cost structure.
The Commercial and Economic Levers
The most obvious way to increase procurement efficiency in the chemical industry is through contracts and supplier management. However, in order to achieve procurement excellence, companies should consider other elements as well. As the raw material prices hugely depend upon commodities and oil market, price volatility can negatively affect them. So, companies insert a clause in the contract or renegotiate the contract to offset such changes. Chemical manufacturers should always try to stay ahead of the game by understanding suppliers true cost base so as to provide strong leverage while renegotiating contracts.
The price of chemicals can vary as per region due to fluctuations in quality and availability of raw materials, local demand, energy prices, labor costs, technologies, and production capacity of that area. For instance, MAP grade of Phosphate is costlier in North America one of the biggest consumers of phosphate with average prices ranging between $300-$332 per ton. On the other hand, the prices in the MEA region is about $248-$284 per ton. (SpendEdge Procurement Market Intelligence Report – Global Phosphate Market) The lower prices are because MEA accounts for about 80% of the global exports which can be attributed to the Arab spring, and availability of large amounts of scarce resources such as water and energy. At a glance, chemical companies might be tempted to partner with suppliers in the region where prices are low. But in order to achieve procurement excellence, purchasing managers should look at the global indicators and advancements in technologies to identify regions where the prices may fall in the near future. So, it makes sense to build a relationship with suppliers where the prices are expected to fall in the near future. For instance, the chemical industry requires a significant amount of energy to produce finished goods. The US is planning to increase its investment in low-cost energy sources which will drive down the cost of chemical commodities. CPOs can factor in differences in commodity and logistical cost to ascertain the final price of the commodity. Additionally, cost is not the only factor if one is looking for procurement excellence, total turnaround time, product quality, and payment terms also need to be considered before entering into a purchasing agreement.
Narrowing down to a specific geography, the prices and quality will vary among each individual supplier due to differences in their plant utilization capacities, technology, production volumes, business efficiency, and business strategy. Performing a cost breakdown analysis (CBA) is an effective means to understand suppliers cost base in order to gain the upper hand in the negotiation process. To efficiently perform CBA, all cost drivers in the chemical industry ranging from materials cost, labor costs, conversion costs, overheads, logistics costs, and supplier margins should be taken into consideration. The data to perform such analysis can be obtained from ERP systems, supplier invoices, spend analysis summaries, and procurement systems. However, negotiations should not be based solely on cost aspect. It is essential to analyze the strategic importance of supplier to the business to perform an effective negotiation. Today, more and more companies are looking at digital technologies such as electronic quotation, eRFQ, procure-to-pay, and e-sourcing to manage multiple suppliers and get the best deal to achieve procurement excellence.
The Technical Aspects
Apart from the economic factors, another way to cut costs is by focusing on technical aspects of the chemical production. Chemical companies can achieve substantial savings opportunity by altering the specification or grade of raw materials. However, such act is not as easy as it sounds, as adjusting such specification impacts the quality of the final product. One of the major cost incurred in the procurement of chemicals is the logistics cost. By understanding technical factors, companies can save on logistics cost by altering the state, form of quality of the material. For instance, suppliers ship liquid oxygen as it is less bulky and less costly than an equivalent capacity of the high-pressure gaseous state. For other chemicals, it makes more sense to procure it in dry or powdered form instead of a solution to reduce the overall weight and volume. For instance, caustic soda is available in various concentration such as 32% solution, 50% solution, and 60% solution. (Global Caustic Soda Procurement Market Intelligence Report) Instead of purchasing various concentration of solutions, buyers can purchase higher concentration solution and add water to the anhydrous form of caustic soda to form solutions of required strength. However, buyers should also be aware that higher concentration of caustic soda needs to be stored at temperatures of about 212F-230F to retain its liquid state. The purchasing departments will then have to decide by comparing logistics cost against storage costs to achieve procurement excellence.
Some suppliers choose to substitute expensive inputs with cheaper ones to bring down the overall cost. A careful analysis of such mixing ratio to achieve similar outputs can save chemical companies a ton of money. Additionally, choosing the form and transport mode also affects the cost of the chemical components. For instance, ocean shipping is about 75% cheaper than air transport. But some circumstances favor air routes as the delivery times are much faster, and it also contributes to the overall inventory turnover affecting profitability. Knowledge of chemistry gives a considerable advantage in terms of achieving procurement excellence, as certain costs can be avoided by pre-mixing and pre-processing chemicals at supplier’s facilities.
The Demand Lever
Procurement excellence can also be achieved through coordination amongst suppliers and business units to optimize product supply. For instance, instead of purchasing different containers for various SKUs, chemical companies can have standardized specifications of finished goods packaging at different sites. Additionally, opting for central warehousing can make the companies more adept at fulfilling the demand of each processing facility. Rationalizing the specifications for a component can sometimes reduce cost with minimal impact on the final product. Instead of stocking different chemical components to manufacture various end-product, chemical companies can opt to stock common components which can be used in the manufacturing of multiple end-products. It’s a smart way to gain procurement excellence as procurement managers have to deal with lesser complexity, reduce overall sourcing cost, and schedule production effectively.
Tracking Tail-Spend and Supplier Rationalization
It is evident that multiple low-cost materials make up for a large part of company’s purchasing portfolio. In order to achieve significant savings across categories, companies should carry out a tail spend analysis to figure out the tail end of the spends. They may also resort to strategies to use a single supplier for all such tail spends. Supplier rationalization can lead to procurement excellence as a manageable number of suppliers will fight for your business, and such suppliers can be of strategic importance to the company. Additionally, suppliers may also provide favorable pricing for high-volume purchases. Another alternative would be to eliminate the requirement of material altogether and substitute it with similar commodity if the end product is of little commercial value.
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