The price rise for some commodities will likely continue, predicts David MacLennan, CFO of agribusiness giant Cargill, which buys and sells a wide range of commodities. “Higher agricultural prices in the short term are probably here to stay, notwithstanding some type of shock to the system,” he says.
Last month the privately held company reported earning $2.37 billion in the first half of fiscal year 2011, double the amount for the same period a year ago. Cargill is able to predict and adjust to pricing changes mostly due to the diversity of the work it does; it operates agricultural, steel, shipping, energy, and risk-management businesses across some 65 countries. “A big part of our strategy is keeping different parts of the company connected in terms of information flow, because you never know how something happening in one market in one part of the world is going to impact something in another part of the world,” says MacLennan.
Some companies may need to revisit their business models if they’re unable to work around the unpredictable costs, which could mean divestments of business units deemed more risky because of price increases, according to Oliver Wyman’s Drzik.
CFOs whose businesses rely heavily on commodities say they pay attention to prices on a daily basis and read all they can about geopolitical events that could have an impact. Still, “you can do all of that, but it doesn’t necessarily give you a perfect answer of where things are going,” says Peter Ingram, CFO of Hawaiian Holdings, parent company of Hawaiian Airlines.
Indeed, the price jumps have made it challenging for CFOs across industries to stay ahead of the changes, feel confident in their forecasts, and maintain their gross margins. “Having this kind of volatility has a significant impact on margins, which means organizations will have challenges in accurately forecasting results,” says Gary Lynch, who leads the global supply-chain risk-management practice at Marsh. It’s also a time when companies could lose their market share if their competitors have a better strategy for mitigating the risk of high prices, he adds.
To work around the price pressure, companies have found ways to redirect consumers’ interests to less-expensive products. For example, Darden Restaurants, which operates the Olive Garden, Red Lobster, and Capital Grille chains, makes quick changes to its advertising when certain foods are suffering from sudden price hikes. “We can influence what consumers are craving and their reason for coming into the restaurant,” says Darden CFO Brad Richmond.
Darden predicts that 80% of its cost increases in the next 18 months will come from beef and seafood. But Richmond is wary of transferring any immediate costs to customers. “We don’t overreact to short-term market movements,” he says. The company has instead locked in prices through supplier contracts, such as for wheat, and has reduced energy costs.
Other industries have less control over their customers’ behavior. Hawaiian Airlines, for example, is at the mercy of its “leisure-oriented” consumers, says Ingram. “What we are able to charge has very little to do with the cost to produce our product,” he says, and much more with ticket demand and seat availability.
In fact, Ingram doesn’t mind the high price of oil. What’s been bothering him, he says, is the uncertainty: “Volatility to me is even more of a problem than the high level of cost.”