Today, companies are facing price shocks that they can’t easily absorb.
And it feels like costs are out of control. After a decade of stable prices, coping with price volatility is an unfamiliar experience. But as we noted in the first article of this series (When the Price is Wrong), there are a number of ways to reduce your cost uncertainty.
This report looks at price indexing, a contractual tool that many suppliers use to prevent their margins from being eaten up by unexpected price spikes. Indexing is a game with two sides. If you’re a buyer, your supplier wants to offload as much risk as possible on you while you want to pay no more than what you have paid before.
While they can be very useful, index agreements can also be dangerous for the buyer and must be negotiated carefully. You want the agreement to be good enough to keep your suppliers healthy but not so good that they profit at your expense. And details are easy to overlook. All it takes to lose margin is an improper calculation of the material’s value in a larger component or a drop in the commodity’s price that the supplier neglects to inform you about.