Pricing and Purchasing Case Studies

Case Study: Building Materials Manufacturer Saves on Aluminum

A building materials manufacturer saved at least 10-15% on aluminum purchases by delaying a contract based on IHS Global Insight's forecasts. Our expert, John Mothersole, accurately predicted a significant unwinding of aluminum prices in 2009. The client, armed with that forecast, floated aluminum purchases on the spot market for a few months, before locking in a contract price at a 10-15% lower level.

A building materials manufacturer in Europe saved 10-15% on Aluminum purchases in 2009!

Case Study: Steel Cost Savings

Prices for hot-rolled sheet peaked in the third quarter of 2008. In IHS Global Insight's first-quarter 2008 forecast, we predicted a third-quarter peak, and forecasted fourth-quarter prices at $637/short ton. Our smallest clients buying from mills would typically procure at least 48,000 tons per year. A buyer choosing to float the price on a 48,000-ton contract delivered over the following four quarters would have saved $24.7 million* over a client who locked in a contract price at the peak-or half the contract value.

* Based on locking in the price in July 2008 at $1,032 for delivery at 12,000 tons per quarter over the next four quarters.

A typical steel buying company could have saved $24.7 million on a year's worth of steel if they had the service.

Case Study: Time-Sensitive Polyethylene Buy Decision

This case study comes from a leading shipping company and involved a major buy decision for polyethylene (PE). The client wanted a consultation in the fall of 2003 regarding the latest trends in PE availability and pricing. He was trying to estimate the cost of PE for several potential projects that would require buying 10,000,000 pounds of PE during 2004. More importantly, the client wanted to time his purchases to take advantage of the lowest pricing point projected by IHS Global Insight for the next 12 months. After discussing the issue with the client, Frantz Price, IHS Global Insight's petrochemical analyst, advised him to make the entire purchase right away in order to lock in current market prices. Price anticipated that PE prices would surge virtually non-stop in 2004 based on strengthening demand, tight supply, and soaring energy input costs. The client followed his advice. PE prices skyrocketed throughout 2004, and the client saved his organization nearly $1 million.

The client saved $1 million on their polyethylene buy!

Case Study: Motor Price Negotiation

The client manufactures recreational boats and other water sport equipment. They buy engines from automobile manufacturers, using the engines as power plants for inboard and inboard/outboard motors.

IHS Global Insight provided data showing that the price of motors, as measured by PPI3714201NS, had been declining fairly continuously since 1992. Further, we forecasted the decline to continue for the next several years. The client confronted its supplier with this information, along with our forecast of flat or declining prices for engine components, to document a lack of underlying cost pressure. The bottom line: the client won a [grudging] break in its contract price for engines, resulting in a $2.2-million savings.

The client saved $2.2 million on one equipment contract negotiation!

Case Study: Cost Benchmarking

As part of a company-wide cost-containment initiative, the Pricing and Purchasing (P&P) Service staff was asked by a global electronics company to assist its purchasing department in developing a formal cost-benchmarking model. The project involved assembling a model that tracked and forecasted material cost inflation by commodity, equipment component, or service.

In the first stage of the project, our staff and the company's purchasing department analyzed the company's material purchases. Over 300 separate "buys" were identified for which procurement data was maintained internally. Each buy was assigned an escalation measure-either an actual market price or a price or cost index. The second stage of the project involved developing forecasting models for each assigned price measure.

The final model yielded escalation measures-both historical and forecast-against which the company's own data was compared. This exercise provided an objective third-party benchmark of the purchasing department's performance in managing cost inflation. After an initial period of evaluation, the model is now used as a strategic tool to establish performance targets for the company's purchasing managers.

The net result is that, as part of a broader Best Cost Producer strategy, the benchmarking model has helped achieve substantial cost savings in materials procurement. In 1997 alone, the client estimated $60 million in cost savings!

The client saved $60 million using the service for cost benchmarking!

Case Study: Custom Audit

IHS Global Insight has a long history supporting the aerospace and defense industry. Price forecasts are employed in long-term contracting between the U.S. government and private parties via economic price adjustment (EPA) clauses. These projected costs are adjusted every year based on the actual data reported by the U.S. Bureau of Labor Statistics (BLS). One series heavily relied upon by the U.S. government and aircraft manufacturers is the employment cost index (ECI) for total compensation in aircraft manufacturing. This series is utilized in countless contracts, and in the mid-2000s, volatility in the series wreaked havoc on EPA calculations.

Boeing made pension contributions of $8.0 billion between 2002 and 2005 and reported these to the BLS. The pension cost Boeing incurred during the time under CAS accounting standards was only $1.1 billion, however. Therefore, $6.9 billion of the pension funding reported was a pre-payment credit, and not a change to compensation of employees. The BLS, however, counted the $8.0 billion in contributions in their estimations of the cost to employers of having employees, rather than the $1.1 billion. Therefore, the ECI for "Compensation, Aircraft Manufacturing" registered wild spikes periodically from 2003 to 2006. These spikes were not, in fact, a reflection of changes in compensation for workers, but changes in the funding of pension trusts. Therefore, the ECI was not reflective of compensation at this time. Because the series was utilized in so many contracts, the U.S. government found itself beholden to major payouts based on the change-in many cases, to Boeing itself.

With the assistance of IHS Global Insight, the U.S. Department of Defense Inspector General's (DoD IG) office was able to estimate what the true changes to compensation were in 2005 and 2006, excluding the pre-payment pension credits reported by Boeing. IHS Global Insight provided new projections of compensation changes going forward based on these estimations. The DoD IG's office then recalculated contract adjustments with Boeing for the Air Force C-17, the Navy F/A 18 E/F, and the Army Apache Longbow using the estimated series. As a result, the U.S. government avoided significant costs that would have been incurred based on the ECI as reported by BLS. In the wake of the adjustment, Claude Kicklighter, of the DoD IG's office offered his sincere thanks to IHS Global Insight, saying, "[b]ecause of your support, we were able to calculate price adjustments on the multiyear contracts that were significantly less than those based on the improperly inflated aircraft manufacturing index and we were able to avoid a cost of $520.6 million for DoD and the taxpayers."

IHS Global Insight played a vital role in ensuring proper contract adjustments and enormous cost savings for the U.S. Department of Defense.

With IHS Global Insight's help, the U.S. Department of Defense and U.S. taxpayers saved $520.6 million!

Case Study: Correctly Specifying a Contract Escalator Clause

The client, a truck manufacturer, used the Cost Analyzer to help negotiate a long-term contract with a supplier valued at $2.5 million. The key point of negotiation was the long-term escalator clause. The supplier wished to use an index that posted a 2.5% long-term escalation rate. Using the Analyzer, the client identified a commodity index that matched the material buy but showed a long-term escalation rate of just 1.4%. When confronted with this [more appropriate] escalator, the supplier conceded the lower escalation rate, saving the truck manufacturer an estimated $2.2 million over the life of the contract. The savings realized were garnered over three separate delivery dates, with the savings estimated for each phase of the contract being $1,057,000, $436,000, and $741,000.

The client saved over $2 million by identifying the right series for their escalator clause!

Case Study: Margin Analysis

The purchasing manager of a mid-Atlantic ready-mix concrete maker asked our Pricing and Purchasing (P&P) staff if we could provide insights into recent, aggressive price moves by cement makers. By way of background, Portland cement prices had risen some 38% from 1993 to 1998. The manager was fully aware of the industry's recent history, but needed harder documentation in a report to senior management.

The P&P price forecasting model for hydraulic (Portland) cement, like all of our price forecasting equations, attempts to break down price escalation into its constituent elements. Price escalation is a function of many factors, but broadly speaking, it can be divided into two principal factors: input costs and end-market activity.

In assisting the purchasing manager, our staff analyzed the cement industry in the context of our price forecasting model's structure. Most importantly, recorded escalation in measured input costs was contrasted with cement price escalation from 1980 to the present. This revealed that during the 1980s, prices grew only 14% while underlying input costs jumped over 40%. Although the industry did enjoy [average] productivity growth over this span, this differential in cost and price escalation implied significant erosion in cement maker's margins. Earnings data for the industry help to confirm this analysis.

Placed in this context, the cement price growth observed since 1990 has in large part been an attempt by cement makers, enjoying healthy shipment growth, to restore margins. This was again confirmed by the P&P price model, which noted a cumulative price increase of 38% since 1993, compared to production cost increases of 15%. Summarized in a brief report, this information was forwarded to senior management.

Case Study: Electrical Equipment Negotiation

The client, an electrical equipment manufacturer, needed to purchase small electrical engines to power the machinery it sells. We forecasted that prices for such motors would barely increase during the client's fiscal year. The internal buyer was upset by this projection, and during a conference call with his manager said [our forecast] was an unfair standard to hold him to. He had accepted a 5% increase in the previous year's contract, and felt the increase of less than 1% implied by the IHS Global Insight forecast in the current contract period was impossible.

The Pricing and Purchasing analyst showed that in the coming year there was little increase expected in prices for steel, copper, aluminum, and brushings, the major inputs in motor production. The analyst then provided data showing that in the prior year, the nationwide producer price index for small motors had actually declined slightly. The client's buyer, when confronted with this information, challenged his supplier's requested price increase. The supplier, over the course of subsequent negotiations, conceded to the client's position, and no price increase was paid.

Case Study: Truck Windshield Quotation Analysis

The client, a truck manufacturer, put out to bid a windshield glass buy and received three quotes from suppliers. Two quotes came in with an 8.0% increase, and the third with a 3.5% increase. One of the suppliers cited labor costs as the reason behind the price increase. The client felt all three quotes were high and asked IHS Global Insight to help validate the proposed increases.

Our Pricing and Purchasing (P&P) staff analyzed recent price movements in a wide range of glass products, from raw flat glass down to laminated and tempered glass for automotive uses. In no instance were we able to document a price increase greater than 4.0% over the previous year. For most of the products reviewed, in fact, prices had remained flat or had actually fallen during the previous three years.

Given the discrepancy between our analysis and the conditions cited by our client's suppliers, we also examined raw material costs for the glass industry. Again, measured price change in three key areas showed either flat of declining prices during the previous year and a half.

Finally, because labor costs represent roughly 40% of glass production costs, and because labor cost increases were referenced specifically by one supplier as the reason for the requested price increase, P&P looked at labor market conditions in the industry. We were able to document wage pressures that had produced annual wage increases in the 4.0-8.0% range over the previous year. On closer examination, we discovered that overtime payments were responsible for much of the recent rise in wages, and believed the high overtime levels were not sustainable.

Our client was able to use this information to challenge the requested price increase. The net result was that the manufacturer and its suppliers initiated a program as part of a broader supply chain management initiative. The manufacturer is working to share information with its suppliers as part of a long-term relationship, the ultimate goal of which is controlling cost increases.

Case Study: Poorly Specified Contract Clause Contract Clause

A diversified equipment manufacturer, acting as the general manager in a power project, negotiated the purchase of copper tube bundles for the plant's heat exchanger. The tube supplier insisted on using the consumer price index (CPI) in the contract escalation clause determining the forward delivery price.

Since the CPI measures the market basket of goods and services purchased by a typical consumer, and not conditions in the volatile copper market, both parties exposed themselves to significant price risk in the escalator clause.

While the tube bundles were being manufactured, copper prices rose dramatically. With the CPI as the adjustment mechanism in the contract allowing for only a fraction of the copper price increase to be passed through, the tube maker realized a significant loss on delivery. Worse, the unfavorable terms of the contract provided no incentive for the tube maker to deliver the tube bundles in a timely fashion. Delivery was delayed, causing the entire project to fall behind schedule.

Ironically, the tube bundles were found to be damaged on delivery (the fault of the shipper) and had to be disposed of as scrap by the buyer. The only saving grace in this episode was that scrap prices had followed primary copper prices, and also risen dramatically. The final realized price for the damaged tube bundles still allowed the client to dispose of the damaged bundles at a profit, although the project fell even further behind the original schedule.

Case Study: Time-Sensitive Steel Buy Decision

This case study came from one of the largest steel producers. This company wanted a long-term outlook for steel prospects in Central Europe that would guide their investment decisions in the region. The study was to examine both supply and demand for steel produced in the Czech Republic, Hungary, Poland, and Slovakia.

The study approached the company's needs from each direction. On the supply side, detailed outlooks were prepared for prices and availability of materials to make steel, including coal, ore, scrap, and natural gas. Special attention was paid to disparities that would affect the selected region compared to the rest of the world.

The demand outlook examined internal demand from the four countries, as well as other Central European nations. Economic growth, the health of manufacturing, and the need for new construction were factored in. Furthermore, the potential for export to Western Europe, Asia, and North America was explored, along with competition from Ukraine, Russia, and other low-cost competitors from the former Soviet Union.

The report allowed the client to have an independent voice when formulating its business plan. IHS Global Insight's conclusions were compared with the company's internal outlook, and differences were discussed in depth at a meeting between company management and analysts from IHS Global Insight. The study was an integral part of developing the steel company's long-range business plan. The reconciliation of this study with the company's own internal outlook led to a series of favorable investment decisions by the company in Central Europe.

Case Study: IHS Global Insight's client-specific outlook helped avoid excess inventories, saving millions!

Our steel service director presented to a steelmaker's production group in September 2008 as they were setting their 2009 fiscal year budgets. After a great 2008, the group was very upbeat and anticipated continued high output and profits for the subsequent year. In our analysis, we examined each major end-market the company served and IHS Global Insight's projections for the coming year. We then translated the outlook into ramifications for steel by product type (construction on rebar, heavy machinery on plate, etc). Our uniformly gloomy outlooks (even before Lehman Brothers collapsed) signaled the company would need to curtail production amidst falling prices.

Following our presentation, the audience was dead silent. When asked if the presentation was of any assistance, the chief operating officer answered, "It was extremely valuable, but you just kicked the bottom out of all our plans for the coming year."

In mid-2009, we reconvened with some members of the same planning team. They said that while our outlook was tough to hear, it forced them to rethink their plans and helped avoid excess inventories, saving millions!

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