22.10.2014
Commodity Price Volatility: What Should Distributors Do?
Bill Conery (titpi/www forbes, com/sites/billconerty) Contributor
Teonnect the dots berween the economy and business decisions.
STRATEGIES (STRATEGIES) &/372014 @ 1045AM | 1.52.vews
Commodity Price Volatility: What
Should Distributors Do?
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Dealers in commodities, or in parts that use a significant amount of a
commodity with large price fluctuations, have significant business challenges.
In previous articles I've written about the nature and impacts of commodity
price volatiit
Commodity Prices: Basies for Businesses That Buy, Sell or Use Basic
Materials
(http: //www.forbes.com/sites/billeonerly/2014/06/20/commodity-
prices-basics-for-businesses-that-buy-sell-or-use-basie-materials/’
Commodities Prices: Why Do They Shoot Up And Then Collapse?
(http://www. forbes,com/sites/billeonerly/2014/06/26/commodities-
prices-why-do-they-shoot-up-and-then-collapse/)
Commodity Price Volatility: What Should Producers Do About It?
(http://www. forbes,com/sites/billeonerly/2014/07/14/commodity-price
ty-what-should-producers-do-about-it
volati
‘This article will cover the two challenges of dealers: pricing and working
capital.
‘The owner of a gas station has the same pricing challenge as a copper and
brass distributor or a cocoa wholesaler: how to set selling prices when your
buying prices change frequently. To understand the right way to set prices, it's
easiest to understand the wrong way: pricing based on historic cost. Let's say
that the gas station owner marks up the price of gas by 50 cents, so when he
buys for $3.50, he sells for $4.00. Suppose a crisis in the Middle East pushes
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Commodity Price Volatility: What Should Distributors Do?
wholesale prices up to $3.75, but he still has gas in his storage tanks that cost
him $3.50. What happens if he leaves his retail price at $4.00? Customers buy
from him rather than from his competitors. He gets more sales, but at a thin
profit margin when measured against the cost of refilling his tanks
Be Zine Price
3000
2000
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1000
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‘What happens when wholesale prices fall? Our gas station owner keeps his
prices high until he runs out of gas in his tanks—which will be a while, because
customers will go to other gas stations that have already marked down retail
prices. In short, our gas station owner pricing on historic costs does a large
‘volume of sales when his profit margin is low, and a high small volume of sales
when his profit margin is large. This is a formula for failure. It's much better to
price based on replacement cost.
The second challenge that dealers face is changing working capital needs as
prices fluctuate. Let's say that you sell zinc to galvanizers across the country.
‘You have adequate working capital to buy zinc from producers and sel it to
galvanizers. Now the price of zinc doubles. You may still be moving as many
pounds of zinc as ever before, but you'll need twice as much working capital.
You'll tell your bank that your business has not really increased, at least not in
terms of volumes and profits, but you need a larger line of credit so that you
can buy at the higher wholesale prices.
Large price swings will trigger almost equally large swings in working capital
needs. This isn’t all bad, as it's a barrier to entry for new dealers trying to go
into competition with you. If you're not prepared for the increased working
capital—as well as for having idle funds when prices are low—then you cannot
run your business as you see best.
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