COVID-19 is the economic Black Swan event of the year (if not the decade) that no one expected. But how the US government responds to it from a policy standpoint will have as great an impact on the health of domestic manufacturing as the responses businesses take. For both policy makers and executives, navigating these volatile and uncertain times may be a week-to-week challenge; or it could last months or quarters. No one knows yet.
In this month’s Publisher’s Page, we first share some of the highlights that NAM (National Association of Manufacturers) provided in a recent policy statement on COVID-19. Then we provide our own tips which we are advising our manufacturing clients on in terms of managing uncertainty and volatility in their own businesses.
NAM divides their policy and business recommendations into five groups. The first, Keeping Our Workforce Safe and Healthy, focuses on tax and workplace safety. Recommendations include providing “ a tax credit for employers who continue to pay workers during periods that a business is forced to close temporarily” and enhancing “tax deductions for employers who invest in safety equipment.” It also suggests enacting “legislation to ensure employers who implement practices to reduce the risk of COVID-19 in the workplace are protected against frivolous litigation.”
The second area, Protecting Our Communities, includes individual recommendations to encourage specific investment to support first responder, healthcare and national infrastructure constituents and groups. The third recommendation, Providing Economic Stability, includes recommendations around liability limitations and promoting market-driven investment in vaccines and treatment.. It also encourages regulators to “support leniency from financial institutions regarding the credit conditions of small and medium-sized businesses facing short-term challenges.” The fourth and fifth recommendations, Encouraging Resilient Growth in the United States and Encouraging Long-Term Job Growth, include broad-based recommendations around tax credit and other policies to create a sustainable industry recovery.
Manufacturers can also take matters into their own hands. Undoubtedly, in periods of market turmoil when macro-economic indicators appear all out of sync (oil prices tumbling, the USD falling, bond yields down to zero, stock markets sliding, the VIX – volatility index rising) businesses need to prepare for the price volatility for the raw materials, components, parts and assemblies that make up their inbound supply chains. There are a number of strategies we have seen our own clients deploy to mitigate price risk. Here we cover three such strategies.
The first relates to a steel-buying scenario. In times of high price volatility, it makes greater sense to use some sort of market price index that has the least amount of volatility. In this case, a scrap cap/collar contract would minimize volatility better than a market adjusting price index such as the CRU. Since scrap trades for half the cost of a ton of steel, implementing a scrap cap/collar contract in which the price of finished steel will cost more only if the scrap price moves above/below the cap/collar means the buying organization will see less price fluctuation than if they used a market price index that goes up and down based on the cost of a ton of finished steel. (e.g. $300 scrap +/- is less than $600/st +/-)
The second strategy involves what we call “lock and load”. Most manufacturers buy materials that contain an element of “commodity price or a fluctuating price” and then some sort of conversion/value-add component, plus logistics, packaging etc. Companies that can identify those items would do well by putting those up for bid and contracting with the supplier to adjust the finished price for the item with only the piece that actually floats against the market and holding “fixed and firm” the conversion or value-added, logistics and packaging elements. The contract should reflect “fixed and firm” prices for these additional elements.
Last but not least, just as private wealth advisors suggest to investors that they maintain a portfolio approach to managing wealth, manufacturing organizations are well advised to deploy a range of strategies to mitigate price risk within one category. Not all companies can take advantage of this strategy based on their volume, but in cases where a company has a multi-million dollar spend, a best practice sourcing strategy entails taking a product portfolio strategy whereby some of the items are purchased under a fixed price long-term contract (where possible), some purchased on the spot market, some purchased globally, some purchased from near-shore suppliers etc. This way, when markets move, the company can flexibly move volumes to spot or move to contract where/when necessary.