Spot Pricing vs. Contracting

The Big QuestionJRW Birmingham, AL

Many raw materials, ingredients and commodities fluctuate in pricing throughout a calendar year. Some daily, some monthly, and others once or twice a year. For many of these items, buyers have the option to contract a product or ingredient for a finite period and set volume or purchase product at the current market price. These decisions add up and often contribute significantly to the overall ingredient spend of a company.

What is the best option?  How do I make the decision?

There are several important considerations when making a spot vs. contracting decision.

  1. Is this a product category that I or my team feel like we have equal or better familiarity with than my competition or the average buyer in this market?
  2. Is this a product category that is a big portion of my companies overall spend?
  3. Is this a product category that historically has shown volatility?
  4. Is this a product category that is in a variety of our finished goods?
  5. Does my end customer expect fixed pricing for the year or do they understand the fluctuation in pricing of raw materials?
  6. Do I have multiple sources for this product?
  7. Do I trust the opinions and research of my supplier?
  8. Is my team able to quickly respond and implement price changes?
  9. Does the ingredient contract period align with my customers contract period?

How to Decide

If your company is able to pass along price increases based on raw material fluctuations, spot pricing is generally an effective strategy. It allows you to support your customer to their satisfaction and capture some margin advantages if prices begin to increase.

If your company is expected to offer a fixed price for a year, contracting can mitigate the risk of margin fluctuations and lock in an acceptable price for both you and your customer.

There is no one size fits all approach, but if you communicate to your customers, define the options, and set expectations, your team will succeed.

Practical Examples

Tale of Success

  Recently the Red Pepper market experienced a price decrease. Organization A had locked in their price for the year while organization B decided to buy spot. Both organizations were able to keep their end customer happy even though they booked red pepper differently. Customer A’s end customer had a fixed price for the year and expectations were set on the front end that market pricing could go up or down, but their price would not change throughout the year. They were okay that the market price went down because of the communication and expectations set on the front end. Organization B passed along the price decrease to their customer ensuring loyalty and satisfaction.   

 

A Tale of Caution

The Garlic market experienced a price increase for a variety of reasons. One organization had contracted pricing for the year and experienced no price increase. They were able to keep their end customers happy.  Another organization decided to risk the spot market despite their end customers needing fixed pricing for a year. The second organization experienced margin loss and internal frustration because they were not able to pass along the increase to their end customer.  

 

 Contracting is a very tricky game, but if handled properly, can be profitable to your organization and advantageous for your customers.

Curious about what may work best for you and your company? We would love to talk to you about it! Click here to contact us or fill out the form below.

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