Back in the good old days, raw materials' prices typically only moved in one direction—up—and a manager was tasked with guessing the rate of increase and timing his orders to get ahead of the price hikes. That was then; now, prices for key raw materials fluctuate up and down, often dramatically, and it can be a company-ending mistake to take delivery just before prices fall.  

How are managers dealing with this fluctuation? Finding the answer to that question was the reason behind a recent poll of more than 250 European managers from the chemical, construction, and base-material industries. The poll's questions were designed to reveal how these managers address higher costs, inflation, and collapsing margins. Although not all of the respondents are plastics processors, their problems and responses are familiar to processors.

The survey, titled "Fluctuating Raw Material Prices," was organized by Simon-Kucher & Partners, a global strategy and marketing consultancy. Most (60%) of the respondents agreed that current variations in raw-material prices are primarily driven by supply and demand. Although the consultancy believes speculation also plays an ever-increasing role, only 40% of the survey respondents believe that speculation is the cause of higher raw-material costs.

"Volatile raw material costs and ineffective price management pose an acute risk to a company's performance and long-term success," stated Desmond Sullivan, director at Simon-Kucher & Partners. If companies only delay or pass on a proportion of the increased costs, or if rising raw-material costs coincide with falling sales prices, a squeeze on margins is inevitable. For just one example, plastics and chemicals major Bayer expects a loss of approximately €500 million in 2010 due to higher raw-material costs

"Facing increasing volatility, companies must move away from rigid and fixed systems," states Sullivan. The survey respondents share his viewpoint with 70% of them confirming that annual contracts are no longer appropriate or up-to-date with the current volatility in raw material prices. Moreover, 80% predict the elimination of annual contracts will further exacerbate the price dynamics.

What does this mean for plastics processors? Shorter terms—quarterly and monthly prices instead of annual contracts—allow companies to quickly and accurately assess the price opportunities and adapt prices accordingly. As that happens, the gap between contract and spot prices will narrow.

More than 60% of the responding managers said their companies respond to higher raw-materials prices by raising the prices they charge to customers. Such "formula pricing" can create greater risks, according to Andrea Maessen, partner at Simon-Kucher & Partners, who opined, "Formula pricing in fact turns active price management into passive pricing-by-the-rules." Other solutions to include improved inventory management, which according to 78% of the respondents is seen as the most important means of dealing with raw-material cost fluctuations. Almost 70% also responded that active price leadership on the part of the market leader is another important solution.