Procurement Intelligence Unit

During a week of uncertainty surrounding European sovereign debt and doubts over the future of the euro, the new business environment looks highly challenging. The PIU will be launching new research on managing procurement in a state of market volatility. As a part of this, we will be developing a guide for buyers on how to develop a resilient supply chain during a state of uncertainty.

Procurement concerns have been crowded out by two major risks: increased economic uncertainty and the persistent threat of commodity inflation.

With regard to the first of these, the world economic system teeters on the brink as the eurozone struggles to cope with contagion and spiralling debt crises. This week has seen further emergencies as the Greek government announced that its debt to this year and 2012 will be higher than expected. EU finance ministers now regularly suffer lectures from US and Chinese policy-makers for potentially dragging the world into another global recession.

The likeliest outcome is that Greece will default to some degree. Jean-Claude Trichet, head of the European Central Bank (ECB), is still strongly arguing against this, principally as a means to stave off potential contagion in Italy and Spain. However, Trichet will stand down at the end of October, to be replaced by Italy's Mario Draghi, who may take a harder line on the fiscally profligate south.

Whatever the proposed solution, the European financial markets certainly face another phase of difficulty. Already it seems as though Dexia - the jointly owned French and Belgian bank - is heading towards the abyss as its exposure to Greek debt drags it under.

The knock-on effect for the supply base in PIGS will be significant. PIU research has already found that supplier insolvency is the leading risk-related concern for procurement. This risk can only grow as access to credit in the Mediterranean dries up. Given the highly interconnected nature of global capital, the likelihood of contagion to other European economies (and beyond) remains high.

To stress test the resilience of the supply chain, procurement may consider a deep financial review of all key and high-risk suppliers. Not only should the backward-looking credit agencies and historic data be looked at, but buyers also need to engage in more future gazing. The viability of vendors and their business plans must be thoroughly reviewed to ensure that they are capable of withstanding a period of financial volatility. A cross-functional approach would do well here, with active participation from finance and other functions providing a rounded picture of the future market.

Added to this, the fate of the euro still seems uncertain. To many, this seems like the ultimate 'black swan'. Tim Geithner, US Treasury Secretary, has called it a 'catastrophic risk'. The implications of such an event are hard to compute. There is only so much that procurement can do to mitigate against such a risk.

On the supplier side, buyers may wish to consider updating contracts in case the euro disintegrates. If a transaction is conveyed in the middle of the currency collapsing, it is better to agree upon a process between purchaser and supplier prior to this, as opposed to managing a crisis in a situation of wider economic alarm. On the customer side, it may be prudent to commence the integration of currency collapse into disaster-recovery plans. Questions such as which currency systems to label goods or contracts under, which exchange rates to use, and how best to establish alternative payment means should all be considered.

Added to this economic malaise is the continual threat of commodity inflation. Almost all major input commodities have seen significant increases over recent years. This is partly attributable to high oil prices (brought about by Middle Eastern political unrest), which feeds into the transportation and extraction methods for these goods. The appetite of emerging markets for ever-greater quantities of materials to fuel expanding industries will be a dominant feature of the next decade.

Many procurement departments have already deployed sophisticated hedging positions in order to limit the potential impact of further shocks. Given that price rises will be the norm for the future economy, even companies with relatively modest exposure to commodity rises should consider forward-buying options in areas such as power, as fuel and gas prices will also experience price rises.

Although the potential crisis creates enormous uncertainty within the business environment, this does not render procurement impudent. By planning for adverse events in advance, shocks in the supply chain can be minimised and organisations can be protected from some of the most severe effects of market volatility.