Governance

When financial experts speak of commodity markets they often discuss futures markets. But for a layperson like me, I didn’t really understand how “futures” work or how they influence commodity markets. I would like to share a bit of the basics that I have learned with you. 

Cotton’s Revolution held a Strategic Thinking Session on April 25^th to discuss cotton’s recent price volatility and how the industry can strengthen existing mechanisms and promote policies to address harmful price volatility. I was not in attendance but found the CCI’s summary of observations and Mr. Arvind Singhal’s presentation on Managing Impact of Cotton Supply Chain Volatility very interesting and important to share with others in the wider cotton community – and beyond.

The cotton industry is vast and involves a wide variety of actors – from small-scale farmers and weavers to spinners to global brands. It is influenced by entity outside of the supply chain such as hedge funds and speculators and faces competition from other fibers and crops. Some key observations from the Bangkok Session include the imbalance of power and lack of risk management mechanisms along the entire supply chain as highlighted in the following points raised by the thinking session’s participants:

• There is a need to develop mechanisms to enforce contract sanctity and to continue to foster communication along the entire supply chain.
• Speculators, hedge funds and pension plans can create artificial and higher levels of volatility, creating a higher level of risk for more vulnerable members of the supply chain.
• The lack of export from China and India, two of the largest producing countries, places the US, the largest exporter, in a strong negotiating position.
• A handful of large retailers have a disproportionate negotiating power. At the same time mechanisms do not currently exist to manage risk associated with their actions that hurt the entire supply chain such as defaulting on contracts and incentivizing bad buying behavior. Additional challenges that the retailers pose include their lack of knowledge about fiber characteristics and continuous change in sourcing personnel.
• E-commerce will open up communication connections between different supply chain actors. This could allow new segments of the supply chain to communicate to consumers without having to go through retailers.
• The consumer is an important stakeholder and the industry has not yet created a “sexy” or positive message about cotton.

In addition to these thoughtful discussion points, I also found Mr. Singhal’s presentation very interesting with some more detailed insight into contributors to cotton price volatility and examples of steps food companies are taking to manage risks in their supply chains. Some of the factors behind cotton price volatility that Mr. Singhal presented include shifts in production due to climate change, government interventions (e.g. India bans), currency movements and entry of large commodity speculators. He also shows how cotton has lost market share to other fibers as a result of higher prices. He also points out that retailers have changed sourcing patterns by increasing the number of seasons, reducing lead times (which helps control raw material costs) and many have outsourced to a sourcing management firm (e.g. Li & Fung).

Mr. Singhal provides us with four case studies on food companies’ strategies to manage the volatility of raw materials:

• Nestle has a four-point strategy to: 1) enhance connections with farmers and suppliers, 2) improve understanding of price movement trends and sensitizing customers accordingly, 3) innovate to replace expensive ingredients, and 4) reduce waste and improve efficiencies.
• McDonald’s approach involves establishing long-term contracts with suppliers and vendors, buying in bulk to take advantage of the economies of scale, using “no frills” logistics, and improving ability to forecast input costs.
• Barilla, a leading pasta company, takes a central role in deciding raw material procurement – even for its suppliers, stays abreast of raw materials demand-supply equation on price trends, and provides sourcing intelligence to suppliers to help them source better.
• Starbucks has a diversified procurement model and sources from multiple regions. It is important to note that Starbucks had to increase prices of its products when the purchased for an entire year in 2011 when prices were high.

These case studies indicate that large global brands are engaging more deeply in their supply chain, possibly creating new business relationships. If done correctly, these models could help manage risk along the supply chain. However, it could pose more risk to vulnerable members of the supply chain if the brands use an approach that increases their negotiating power.  Regardless, more direct engagement with retailers and brands appears to be inevitable.

 Mr. Singhal closes his presentation with some suggestions:

• Volatility will likely remain and brands and retailers can dampen its effects on the other members of the supply chain.
• Producers and traders should work more directly with retailers.
• Affected actors or cotton institutions should strategically address harmful, short-term government interventions.

This session was clearly a timely and covered issues that must be addressed to ensure a healthy and more stable cotton industry. We now must come together to develop effective and sustainable solutions to address the issues of most concern.

Questions to consider

What is the most pressing issue that the industry should address?

How can we engage the least involved members of our wider community - consumers, retailers, hedge funds and speculators?