How Do Procurement Managers Define the Right Mix of Spot and Long-Term Contracts?

Raw material procurement is not only important but also complex. Challenges range from ensuring security of supply, buying at better terms than the competition, adhering to process compliance requirements and supporting the company’s sustainability goals. The expectations for raw material buyers are very high.

Therefore, a robust raw material procurement strategy is paramount to ensure operational efficiency, mitigate risks, and achieve strong commercial outcomes.

At the heart of procurement strategy lies the term structure design of the contract portfolio. This fundamental choice between spot and long-term contracts (LTCs) with various maturities holds profound implications for the company’s performance.

A raw material spot contract is an agreement between a buyer and a supplier for immediate delivery at current market prices. An LTC, on the other hand, is an agreement over an extended period of time at a fixed price or variable, formula-based pricing mechanism.

While an efficient spot market should, in theory, suffice to match supply and demand, LTCs are required and used by more than 95% of companies as an instrument to navigate the complexities and challenges of raw material markets (PwC & DERA, 2022).

Determining the right mix of spot and LTCs is no easy task. First, buyers must consider the benefits and risks of the two.

Second, buyers must assess and weigh these factors considering numerous contractual terms, such as volume options, price clauses, duration, quotational periods and more. These contractual elements significantly impact the benefit and risk profile of either option.

Third, buyers must also look to the market and thoroughly assess current and forecasted developments of numerous factors including:

• Demand requirements: How full is my order book and how is it structured?
• Security of supply: Is supply for the raw material guaranteed in the future?
• Market liquidity: How easy is it to buy volume in the spot market?
• Market timing: Are we currently in an oversupplied, undersupplied, or balanced market and what are expectations for the future?
• Price volatility & trend: How volatile has been the price for the raw material and what future trend is expected?
• Hedging options: Can I hedge my exposure against unfavourable price fluctuations?
• Market position: How strong is my company’s negotiation position?
• Market signalling: How will the market react to my contract choices?
• Financing: How do my financing options line up to meet the raw material demand?
• Re-allocation: Do I have re-allocation options for any potential oversupply?

Fourth, buyers must also look internally and assess the company’s risk strategy, administrative capacities as well as negotiation power. Particularly the interpretation of risk may at times falsely drive decision making and risk averse buyers end up locking in LTCs despite potentially favourable future spot market conditions.

Across these four steps, an unbiased decision-making process based on reliable forecasts is key when determining the spot to LTC mix. Here, companies are increasingly using industry-tailored raw material procurement software solutions, like Metalshub, to support with robust analytics around historical contract data, market trends, and supplier performance.

Learn more about how the Metalshub Procurement Solution can help you determine the right mix of spot and LTCs here.

Learn more about how to effectively manage LTCs on Metalshub by downloading our white paper on LTC digitalisation here.

PwC & DERA (2022, March): Securing raw material supply: Benchmarking of measures of foreign manufacturing companies and recommendations for action. Retrieved: April 25th 2024.