An Old Dog Learns New Tricks

[This article is also posted on Plastics Today.]

In our last episode, we learned that after deciding to search for a supplier to provide polypropylene at the new resins pricing, Poly Wise switched from defense to offense on profits, telling their employees:

“Profits keep us in business and you employed, so we all need to work together to secure and improve profits. We are attempting to change the pricing structure of our polypropylene supply to give us control over our biggest cost, but we also want your ideas. In return for your ideas and their successful implementation, you will share equitably and handsomely in the profits.”

Poly Wise follows up with specifics on its profit sharing program:

“We have two reward levels under our profit-sharing program: 1) Everyone Shares and 2) Key Contributors. Our objective is to meet or beat our budgeted 10% gross profit margin. The more we beat it, the more money we all make. Key contributors (employees whose ideas we adopt that lead to higher profits) will make even more.”

Poly Wise is overwhelmed with the positive response of its employees and the mood lifts. [Profit sharing is far more effective at improving employees' moods than cookies, absurdly recommended in this otherwise insightful WSJ article on improving morale in the work place.]

CFO Steps In

In moving from defense to offense on profit margins, Poly Wise takes the additional step of putting its CFO in charge of the Purchasing and Sales Departments. The aggressive but fair CFO calls in Ralph, the Purchasing Manager: “Ralph, you have been tasked with finding a long-term polypropylene supply for us at WTI futures plus 30 ¢/lb. We want to be able to control our polypropylene costs against our product prices so we can increase margins and sales while helping our customers control their costs. We’re tired of resins prices and the market controlling our profitability. You have a crucial role in this effort, but I’m concerned about this email you wrote to me a few months back:

In today’s world of such volatile resin prices (cost swings like we’ve never seen before), hedging is too risky. Public companies can make up excuses to shareholders as to why the “hedging strategy” did not work, leading to under-budgeted margin results or (most likely) losses. In plastics processing, no company can afford NOT to pass along resin cost increases immediately to customers. The real issue is communication between our Sales Department and customers’ Purchasing Departments. Our customers need to understand any type of price protection or the unwillingness to accept a justifiable increase not only puts our health/existence at risk, but theirs, too.

“That approach doesn’t cut it anymore, Ralph. We can’t just pass along higher resins costs to our customers when we want to, and that’s not our Sales Department’s fault. We’re losing customers despite not passing higher resins costs along to them. Worse, our profit margins are weak. We need to change. You need to change.

Carrot and Stick

“I’ve teed this up for you, Ralph. Learn about the new resins pricing paradigm and find us a polypropylene supplier at WTI plus 30 ¢/lb so we can all benefit – you, in particular, as a potential key contributor. But I want results, Ralph, and if you can’t do this, I’ll find someone who can. Given our new profit-sharing program, that won’t be too difficult.”

Ralph Steps Up

Ralph is an “old dog” but he’s not dumb. After 28 years in the plastics industry, he actually enjoys the challenge by his new boss, the CFO, and is determined to learn this “new pricing paradigm” stuff. He reads previous articles on Price Wise while the CFO provides backup for Poly Wise’s WTI + 30 ¢/lb bid to polypropylene suppliers:

 

 

 

 

 

 

 

 

 

 

Poly Bon Steps Up

Ralph contacts many polypropylene suppliers, including Big Oil Chemical Companies for whom Ralph thinks a polypropylene price at a differential to crude oil makes the most sense – Exxon, Chevron, Conoco, BP, and others. Ralph is somewhat surprised when his first response is from Matt, the Marketing Manager at Poly Bon.

To be continued …

Profit Sharing for Profit Making

[This article is also posted on Plastics Today.]

Last time, we learned that Poly Wise is attempting to structure a deal with a polypropylene supplier utilizing the new resins pricing paradigm. They offer to buy polypropylene on a long-term contract at WTI futures plus 30 ¢/lb. If successful, Poly Wise will easily be able to control its polypropylene costs against its product prices for many future months, opening the door to higher margins and sales while helping its customers control their costs.

While awaiting responses from suppliers, Poly Wise communicates its determination to secure the company’s future to its employees, and wants to ensure employees are as focused on profit margins as management. Poly Wise constructs a two-part survey and emails the survey (anonymously) to employees who can significantly affect costs and revenues — mold designers, engineers, sales staff, etc. The survey and results are as follows:

1. Why are you in the plastics processing business?
   
   1. To make good stuff 28%
   2. Pay the bills 43%
   3. Nothing better to do 16%
   4. Help make a profit 13%
2. If your employer had a profit-sharing program, how would you answer that question?
   
   1. To make good stuff 11%
   2. Pay the bills 19%
   3. Nothing better to do 7%
   4. Help make a profit 63%

Poly Wise expected to see a shift in responses between questions 1 and 2, but they didn’t expect the shift to be that big. After gathering their composure, management decides to capitalize on the results of the survey with this message:

Shifting the Profit Paradigm

“Dear Employees –

We are shifting our modus operandi on profit margins from defense to offense. Our profit margins have mostly just fallen out of our day-to-day operations and decisions. We’ve done a decent job managing margins in an environment of obscure and volatile polypropylene prices and hard-hit customers. However, times are tough and getting tougher. Our competitors are breathing down our necks and customer loyalty is more dependent on price than ever before. Profits keep us in business and you employed, so we all need to work together to secure and improve profits while helping our customers. We are attempting to change the pricing structure of our polypropylene supply to give us control over our biggest cost, but we also want your ideas. In return for your ideas and their successful implementation, you will share equitably and handsomely in the profits. Our primary objective is to meet or beat our budget projection of a 10% gross profit margin. The more we beat our budget projection, the greater your share of the profits. We will provide more details in upcoming messages.”

Defense to Offense Pays

Poly Wise is overwhelmed with the positive response of its employees to its paradigm shift on profit margins. The mood lifts appreciably and ideas start to roll in from mold designers and others. Poly Wise is reducing its risk of employee dissatisfaction and sub-optimal performance while shifting from defense to offense on polypropylene costs. Management and employees smile, customers take notice, and competitors wince. Poly Wise is wise indeed.

New Pricing Paradigm for Higher Margins and a Secure Future

[This article is also posted on Plastics Today.]

A recent study (Plastics Today, 27-June-11) indicates plastics manufacturers are happy with an 8% return on sales (gross profit margin) because the historical average is 5% to 7%. If you’re happy with 8% and you expect the market to give you that, then there’s no reason to change your approach with respect to profit margins. You are content with the status quo and comfortable with the future. Read no more.

If, however, you don’t think the market owes you a profit and you’re uncertain about the future, keep reading. This is a first in a series on a proactive and proven approach for processors to manage profit margins – including the small to medium-sized guys. With this approach, utilizing the new resins pricing paradigm, you can:

• Capture higher profit margins – consistently, and months ahead
  
• Secure customers and your future
  
• Beat your competition, handily
  

For all processors –

1. Gross Profit Margin (GPM) = Sales – Total Operating Cost

   Total Operating Cost, TOC = (Resins +Manufacturing) Cost

Assuming resins are 50% of TOC, TOC = 2 x Resins Cost

1. GPM ($/lb) = Product price per pound – (2 x Resins price)
2. 1 + (% GPM ÷ 100) = Product price per pound / (2 x Resins price)

For a 20% GPM –

1. 1.2 = Product price per pound / (2 x Resins price)

For Poly Wise, a polypropylene processor who wants higher margins and a secure future:

1 + (% GPM ÷ 100) = Product price per pound / (2 x Polypropylene price)

For a 20% GPM –

1.2 = Product price per pound / (2 x Polypropylene price)

If polypropylene is $0.83/lb, 1.2 = Product price / (2 x 0.83)

àProduct price for 20% GPM = $2 per lb

Feeling the heat –

Poly Wise works closely with its customers and knows they’re under a lot of competitive and margin pressure. 2012 looks grim and customers tell Poly Wise their budgets leave no room for price increases in Poly Wise’s products. They ask Poly Wise (and Poly Wise’s competitors) for help in meeting or beating their budgets so they can be profitable and stay in business next year. Poly Wise’s production is already less than 40% capacity and they feel the heat.

The challenge and the problem –

Poly Wise asks customers what 2012 prices they would like from Poly Wise. The company learns that $1.70/lb would enable most customers to beat their budgets and secure business in 2012. Unfortunately, at $0.83/lb for polypropylene and a product price of $1.70/lb, Poly Wise’s GPM is less than 3%. Polypropylene would need to decrease to $0.77/lb for Poly Wise to have a 10% GPM. Further complicating matters, Poly Wise has neither the capital nor storage needed for a long-term, fixed price purchase of polypropylene — assuming they could even find a willing supplier at a reasonable price, let alone a price below the short-term $0.83/lb. Suppliers are feeling the heat as much as processors. Poly Wise searches for a solution and finds …

A way out and up –

After reading about the new resins pricing paradigm on Plastics Today, Poly Wise sees a way to help their customers and themselves. A supply of polypropylene at a price spread to crude oil will position Poly Wise to make their customers happy and increase profit margins while enabling suppliers to do the same. Poly Wise contacts polypropylene suppliers, hoping to find one as ‘wise’ as they are.

To be continued …

Resins Prices: A New Paradigm

[This article is also posted on Plastics Today.]

Earlier, I recommended CME replace its moribund resins futures contracts with spread contracts against crude oil futures. Crude oil prices drive resins prices (see discussion on my website, and here and here in Price Wise). Crude oil futures are transparent, fair, liquid, option-able, and executable months and years ahead. Converting resins prices to spreads against crude oil makes them transparent, fair, liquid, option-able, and controllable years ahead – everything they aren’t now. For purchase managers, that means no more wondering or concerns about price ‘fairness’ for spot purchases and, similarly, no more vulnerability to an index price for contract purchases.

Regardless of what CME does with its resins futures contracts, a spread price to crude oil opens a wide avenue for processors (and suppliers) to effectively and economically manage resins prices vis-à-vis product sales prices and, therefore, protect and improve profit margins.

In the case of polypropylene –

Converting the WTI price to ¢/lb and taking the difference yields a price spread curve –

 

 

 

 

 

 

 

 

 

Using historical polypropylene prices from Plastics News, in the ‘good old days’ of cheap oil (below $50/bbl), the spread averaged 25 ¢/lb. When crude oil leaped to trading in or near three digits (the ‘new normal’), the average spread blew out to 50 ¢/lb. In 2010, the ‘new abnormal’ appeared and will remain until the pipeline-constrained supply glut of WTI at Cushing, OK is relieved. (See discussion here.) When that occurs – hopefully, within the next few months – expect a return to the ‘new normal’.

Price spread for any resin

Using historical data, a fair price spread may be determined for any resin, not just for high-volume resins like polypropylene. In fact, when and if polypropylene trades as a price spread against crude oil, other resins prices may be established as price spreads against polypropylene, which then makes them transparent, fair, etc.

Price spread is key

The price spread becomes the traded and negotiated variable between processors and suppliers, rather than the absolute (or outright) price, which is much more difficult to agree on. When this occurs, market information providers need only switch from outright price surveys and intelligence gathering to price spreads – instantly making their numbers less time sensitive and more actionable.

Up to the CFOs

Shifting the resins pricing paradigm from its current problematic, absolute form to a fair, relative form (crude oil spreads) will require the involvement of CFOs or higher in respective processor’s and supplier’s organizations. Once the shift is made, however, purchase and sales managers’ jobs will advance to capturing fair price spreads for their companies and managing the absolute price via the abundance of risk management tools available in crude oil. Then, finally, businesses in the plastics industry can effectively manage their bottom line like energy, agricultural, metals, and other commodity-price sensitive businesses do.

Resins Futures – A Better Idea

[This article is also posted on Plastics Today.]

Last time, I reported on the death of CME‘s resins futures contracts. After several months, the contracts have zero trading volume and open interest, rendering them illiquid and useless for effective risk management, let alone trading. They may not completely disappear soon, but their illiquidity is a tombstone.

Resins are not the first futures contracts to flop. For similar reasons (lack of experience and incentives, fear of failure, unclear directives, no risk management policy, etc. among industry participants, and a ‘build it and they will come’ approach by the exchange), nearly forty electricity futures contracts are also moribund. Yet, happily for electricity buyers and sellers, electricity futures aren’t required to manage medium to long-term price risk. Electricity market participants have, in natural gas, a highly correlated alternative. Natural gas is the incremental fuel for electricity generation across the U.S. and, therefore, sets forward market prices for electricity. Natural gas futures, highly liquid and option-able, made the death of electricity futures academic for buyers and sellers who want to manage risk.

What about resins? Is there an alternative, highly correlated commodity to manage long-term resins prices? Yes. As discussed earlier in Price Wise and on my website, resins are petrochemicals and their prices are tied to crude oil. Price correlations are over 90%, which is close enough to control most resins costs, protect profit margins, and retain those ‘stingy customers’. However, is ‘close enough’ good enough?

For experienced risk managers, close enough is good enough when it comes with high liquidity and options like crude oil futures do. For most neophyte risk managers (plastics processors, for sure), close enough isn’t good enough. Managing crude oil positions warrants familiarity with the crude oil market and neophytes crumble at the first tough question from a curious owner or CFO. Is there another solution? My suggestion –

Crude Oil Spread Contracts

Replace the moribund resins futures contracts with spread contracts against crude oil. (I would also change the contract size from the awkward 47,000 pounds to 10,000.) Crude oil spread contracts exist in abundance (gasoline, heating oil, and other energy commodities) and they offer plenty of liquidity. Resins spread contracts would be easy for the CME to create. The spread sets the relative price of the resin to crude oil and contains (implicitly) the cost of production of the resin plus a profit margin plus or minus supply/demand factors. The spread becomes the traded and negotiated variable rather than the outright price, which is more difficult to peg in any commodity market, let alone the resins market. A spread contract may be created for any resin, not just for the high-volume resins like polypropylene. Further, a spread has a lot less potential buyer’s or seller’s remorse built into it than an outright, and – best of all in a stingy economy — requires a lot less capital.

What do you think? If you’d like a spread contract for your resins prices, you don’t have to wait for the CME to create one. If you’re a processor, ask your supplier for one. If you’re a supplier, ask your customer if he’d like one. You can both benefit from the highly liquid and fair-priced market you create — and maybe even resuscitate resins futures while you’re at it and benefit everyone.

Stingy Customers & Profit Margins

[This article is also posted on Plastics Today.]

‘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

Options Give You Options

Learn and apply this powerful tool for controlling costs, increasing sales, and improving margins — and outperform and outlast your competitors. Really

[This article is also posted on Plastics Today.]

Options give you ‘options’ (choices) – lots of them. They open up a wide range of transactions to match your market expectations, purchase and sale requirements and concerns, and risk tolerance. Without options, transactions are limited to buy or sell, now or later – stark choices. Such stark choices are ‘gut checks’ for suppliers, processors, and customers that – given the economic environment, and fear and loathing of potential buyer’s or seller’s remorse (i.e. making a ‘mistake’) among buyers and sellers – significantly contribute to the preponderance of as-needed, short-term only transactions in resins. It doesn’t have to be that way and options are key to changing things for the better.

Most successful traders and hedgers understand and utilize options. Some nearly exclusively. The table below shows why, comparing transaction choices — consistent with a given market opinion (or concern) — with and without options.

* This list is far from exhaustive, as CME options guides (available for download here) demonstrate.

Advantages

Beyond transaction choices and flexibility, options also provide buyers and sellers volume leverage with little capital and risk. For example, the purchase of a near-the-money resin call or put option requires far less capital than an equivalent outright purchase of resins. Equally important, the premium paid for the option is the only capital at risk by the buyer. On the flip side, options sellers have little to no counter-party credit risk because buyers must pay options premiums up-front. Buyers cannot renege on options transactions, and unless the option is in-the-money at expiration, sellers have collected (in the premium) all the money they are due in the transaction.

Resins Options

Currently, options are not available alongside the existing CME resins futures contracts . (Futures options become available once sufficient open interest and trading volume are established in a futures contract.) Options in resins must be transacted in the over-the-counter (OTC) market. Alternatively, depending on the objective, options in highly correlated commodities like crude oil futures may provide the same benefits as options in particular resins.

Since resins options are OTC-only, premiums must be calculated. Fair valuations may be obtained with historical pricing data and a good options valuation program, available at Hoadley Trading and Investment Tools .

Pricing Choices

Several posts have discussed offering pricing choices to customers to increase margins and sales. Two powerful choices are the fixed price with a floor and the capped price. The ‘floor’ is the strike price of a put option. The ‘cap’ is the strike price of a call option. You must know options to offer these pricing choices to your customers.

Get to know options. Then try them. You and your company – supplier or processor – will benefit immensely, and lose less sleep.

Pricing Choices by Resins Suppliers

Profits, Sales, and Happy Processors

[This article is also posted on Plastics Today.]

“Your focus has been on processors. What about resins suppliers? Can we use hedging tools to offer pricing choices to our customers [processors]?” Anonymous Supplier

Response: Yes, the tools are the same. In fact, if you offer pricing choices, it will be easier for your customers to offer pricing choices to their customers — a potential win-win-win.

Pricing Formulas

Standard

The standard, or de facto, resin pricing formula is: Index + delta

where delta is a price-adder or subtracter depending on quality, location, and negotiating skills. The index reflects market transactions between suppliers and processors, but also sets the resin price paid by some processors after delivery. Such a standard has several potential problems for supplier and processor alike, not least being the price disparities between the indexes – a reflection of the lack of transparency and liquidity in the resins market, not flaws in market information gathering. More problematic from a resins cost control standpoint, the indexes are look-backs or current-day prices, not forward-looking. They don’t provide a means to gauge or manage forward prices and risks for either the supplier or processor. They simply measure where the market has been and currently is. Price uncertainty and the inability to control it makes securing and improving profit margins difficult for both buyers and sellers. That need not be the case.

Fair and Transparent

From the standpoints of price fairness and transparency alone, the following pricing formulas are superior to the standard. They also parallel formulas used to establish physical (cash) prices of commodities in other markets, particularly energy.

• Futures + basis
  
• WTI or Brent crude oil + differential

The basis reflects location and quality differences. The differential
reflects the cost of production for the particular resin plus a profit margin for the producer (oil or chemical company) plus a margin for the supplier.

In the energy markets, Formula 1 establishes the price of crude oil, gasoline, diesel fuel, natural gas, etc. in cash markets across the U.S. It provides complete price transparency and a means (futures transactions) to control prices — and, therefore, profits — for buyers and sellers alike. The basis is established at the front-end in supply contracts. There’s no haggling over the absolute price, or unnecessary angst over the accuracy or fairness of price indexes.

With regard to resins, the challenges with Formula 1 are the illiquidity in resins futures and the fact that resins futures contracts only exist for polypropylene and polyethylene. (See this list of resins futures contracts.)

Formula 2 meets all the requirements for price transparency, fairness, and profit management. The oil market is as transparent, liquid, and forward-looking as any. WTI and Brent futures contracts provide multiple means to control prices (futures, ETFs, and, most helpful of all, options and options combinations), and they make sense as price markers for all resins. Resins are petrochemicals – derived from oil refining and processing. The exceptions are ethylene and ethylene derivatives derived from natural gas.

Suppliers and Processors Benefit

In my opinion, resins suppliers who offer fair and transparent pricing formulas like 1 and 2 will leap ahead of their competitors, and should be rewarded by processors for their innovation and flexibility. Resins suppliers will profit, increase sales, and have happy customers. As for processors, with Formula 1 and particularly Formula 2 pricing, they may easily control their resins costs with a wide range of hedging strategies, and, in turn, offer pricing choices to their customers (as discussed in ‘Price Wise’ over the last few weeks) and increase sales and margins.

Recommendation

If you’re a processor, don’t wait for your resins supplier(s) to offer you pricing choices. Ask for them. Suppliers who don’t know how, may contact me at rarm@wtlinc.net for guidance. If you’re a supplier, leap ahead of your competitors while securing profits, increasing sales, and helping your customers.

High Margins and Even More Customers

Price Certainty and Price Protection for Customers

[This article is also posted on Plastics Today.]

Comments from Readers

“I believe resins are actually 70% or higher of most converters’ total costs. Hence, a big jump in resins prices can lead to disaster. Strong overseas competition has made this difficult situation worse. I also agree processors’ gross margins average less than 10%.” Member of Specialty Plastics Organization

Response: All the more reason to control resins costs and seize the opportunity to provide product price certainty to customers.

“20% gross margin? I’m ecstatic when the numbers fall out to 10%. How do I convince my customers to buy at 20%?” Anonymous Processor

Response: The idea is for margins to not just ‘fall out’. It’s for processors to use hedging tools to provide customers product price certainty while capturing higher margins – a proactive approach.

Further, customers only see your product price — with has no ‘cost adder’ strings attached – not your gross margin.

Rule to process by: “The market doesn’t owe you a profit. Be a profit-maker and taker, not a profit-hoper.”

Smart-Poly becomes Poly-Smart

As discussed previously, polypropylene processor Smart-Poly offers customers a fixed product price with no cost-adder for any contract term. They are able to do this using available hedging tools and strategies, and they increase margins and sales providing a service to customers who are not happy with higher resins costs being passed through to them by other processors. Many customers appreciate the price certainty as they look to control their costs and meet budget or other cost objectives.

Smart-Poly receives positive feedback on its new pricing program, but learns there are customers who are averse to long-term fixed-price contracts even without cost adders. Those customers are concerned about buyer’s remorse – locking in a product price and missing the opportunity of lower product prices over the contract term. Can Smart-Poly do business with those customers, still achieving higher margins? Yes!

After reading the Hedging Corner J, Smart-Poly learns about options – puts and calls – and their many advantages and applications. Smart-Poly uses them to offer customers two more pricing choices: the fixed price with a floor, and a capped price. Smart-Poly is so impressed with the results that the company changes its name to Poly-Smart.

Fixed Price with a Floor or a Capped Price

Poly-Smart’s version of the fixed price with a floor requires a customer to pay a premium equal to the cost of the floor. The premium is included in the fixed product price. The lower the floor, the lower the premium, but the customer chooses the floor price and Poly-Smart calculates the premium — not profiting on the premium, but passing the cost through. Whatever the floor costs Poly-Smart (i.e. the put option premium) is the premium paid by the customer. At product delivery, the customer pays the fixed price – however, if the market price of the product is below the floor price, the customer is reimbursed the difference between the fixed price and the floor.

As for the capped price, the customer specifies a ceiling price for the product and, as before, Poly-Smart calculates the premium and charges the customer the cost of the ceiling. The higher the ceiling, the lower the premium. The customer pays the premium up-front, but the product price isn’t known until delivery. At delivery, the customer pays the lower of the capped price or the market price.

Poly-Smart uses hedging tools and offers pricing choices that are standard in other markets. They’re capturing higher margins and increasing utilization; and they are better able to focus on product improvements and technology while competitors continue to struggle.

If you would like more information on how pricing choices will benefit you and your customers, email me at rarm@wtlinc.net. Be poly-smart.

20% Margin and Happy Customers

[This article is also posted on Plastics Today.]

20% Gross Margin for Processor, Price Certainty for Customer

According to a recent study, ‘earnings before interest, taxes, and owners’ compensation for 150 plastics processors averaged little more than 8%. For the last 15 years, the return was just 5% to 7%. Meanwhile, utilization of injection molding machinery averages less than 40%.’ Plastics processing is tough business, made tougher by offshore competition and weak companies who ‘routinely low-ball quotes to keep the presses running’. However, processing is a lot harder than it has to be. Fear or unwillingness among processors to understand and apply cost and sales pricing tools (futures, swaps, options, etc.) to benefit themselves and their customers make it so. Earn 20% and have happy customers at the same time. Here’s how –

 

 

 

 

 

 

 

 

 

 

Smart-Poly’s product prices are tied to the market price of polypropylene. With a target margin of 20%, the company offers products at fixed prices for whatever duration the customer requests. Customers obtain price certainty and are not exposed to cost adders for Smart-Poly’s resin costs. Smart-Poly leaves its competitors, stuck on the Standard pricing model, wondering how Smart-Poly stays in business. Smart-Poly laughs all the way to the bank.

Smart-Poly provides customers the first of the three pricing choices discussed below – the ‘fixed price with no cost-adder’ choice, common in energy and other markets. This choice is particularly attractive to customers who want to avoid cost-adders and meet or beat their budgets.

Footnotes:

1. 50% was chosen to simplify the math. The figure is closer to 45% according to Resin Pros
   
2. Fictitious name for a smart processor
   
3. Average delivered contract price for polypropylene per Plastics Exchange data on 18-July-2011
   

Next up: Smart-Poly gets smarter. They offer two more pricing choices — fixed prices with downside price protection, and price caps. Now their offshore competitors are feeling the heat.