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Price Wise: On Stingy Customers & Profit Margins

'Stingy customers' are everywhere, even for medical device manufacturers. Device Talk and this article in the Economist discuss how Medtronic is dealing with them. Some excerpts -

Scandals, recalls, stingy customers, anxious regulators - America's industry for medical devices is suffering from all of them... the pressure on prices is growing more intense. Hospitals, squeezed by lower government payments, are squeezing companies in turn, refusing to pay more for a new product that is only slightly better than the old version ... To appeal to stingy customers, [CEO Omar Ishrak] wants to change the way Medtronic's products are sold, gathering data on cost-effectiveness so that the firm can 'project offerings in economic terms'.

Plastics processors have their fair share of stingy customers. 'Stingy' means a need to control costs as much as processors, and an unwillingness to accept cost increases for whatever reason - including higher resins costs. So processors, to retain customers and hold on to already low utilization rates, must absorb higher resins costs and risks and withstand lower profit margins in the hope that customers stop being stingy and business returns to 'normal' someday, right? Wrong, but that's what the majority of processors are doing - evidenced by the death of resins futures.

 

Resins Futures are Dead

The five CME resins futures contracts in polypropylene and polyethylene (listed here) are, by daily trading volume and open interest, dead. Why? Are the contracts poorly designed by CME? No. The CME knows what it's doing when it designs futures contracts. Then why are the resins contracts dead? For the same reasons other futures contracts (e.g. electricity) are dead, such as:

  • The industry participants for whom the contracts are designed are inexperienced and fearful of futures.
  • Participants see more downside risk to their jobs by using futures than upside reward. (Futures transactions are visible. Physical transactions are part of the business and purchases that are "above market" by the time the commodity is consumed can be buried or written off as a 'cost of doing business'.)
  • A simple risk management policy with approved hedging strategies and tools isn't established.
  • Participants are unfamiliar with and don't take the time to learn about options and their many advantages.
  • Purchasing and Sales departments don't work as a team.

Those are just a few reasons. Sound familiar? Others are more subjective. Yet, despite the death of resins futures, processors are emphatic about wanting to control their resins costs against sales prices that are fixed by 'stingy customers'. They should be. Margins are weak and at risk of being weaker, and weak margins kill businesses and put people out of work; unless, perhaps, your business is government-subsidized - though not even massive government subsidies saved Solyndra.

If you're a manufacturer who isn't processing resins 'just for the fun of it' and you want to protect and improve margins, while making stingy customers happy and you want to know how to do that despite the death of resins futures, tune in starting next week. Some topics I'll be discussing --

  • Margin protection and improvement strategies in a 'stingy customer' environment
  • Resuscitating resins futures and making them liquid, optionable, and fairly priced
  • Writing a risk management policy and answering the tough questions
  • Old dogs and new tricks

 

About the author: Tom Langan is a risk management consultant who operates WTL Trading. He provides Tier 1 and Tier 2 services for large and small processors to control costs, secure and improve margins, and increase sales.

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