Now that steel prices are rising, automotive suppliers may be tempted to use a hedging strategy to generate some windfall profits.
The idea is to lock in the current -- and presumably low -- price with your steel supplier. As spot prices subsequently rise, your customer pays you the prevailing rate for steel and -- voila! -- you pocket a tidy profit.
But consultant Steve Wybo has some blunt advice: Don't do it.
Wybo, a senior managing director for the consulting firm Conway MacKenzie in Detroit, says some Tier 2 and Tier 3 suppliers have gotten burned doing this when prices suddenly reversed course.
"It's a gamble," Wybo says. "Our clients are good at making parts, but they shouldn't gamble on things they can't control."
Big Tier 1 companies typically protect themselves by negotiating raw material price indexes with their customers or by purchasing their key raw materials from the customer.
Smaller suppliers should opt for an indexing program with their customers rather than try to outguess the market with a hedging strategy, he recommends.
The fluctuating market for scrap steel also has tempted some suppliers to bet on price swings. Instead of selling scrap at the going rate, a stamper might hold it for a few months until prices float higher, Wybo says.
But again, the problem is that scrap steel prices can fall as well as rise.
"The scrap market is very volatile," Wybo points out. "Over the past 18 months, it's gone from $433 a ton to $150, then back up to $280. We've seen some massive swings. I wouldn't play in that market either."
Instead of betting on raw material prices -- or scrap, for that matter -- it makes more sense to secure indexing agreements with customers.
Suppliers can survive a bad bet on raw materials when North American vehicle production is running at record highs. But if the market enters a downswing, a bad bet could prove fatal.
"Suppliers have thin margins to begin with," Wybo observes. "It's hard enough to make a profit on car parts. A guess in the wrong direction could put a little guy out of business."