Philips identified a significant exposure to raw material price risk which was resulting in high levels of EBITA volatility. A state of the art tool has been developed in order to give Philips full transparency and visibility on their commodity market price risk. Raw material prices can’t be predicted, but knowing your exposures and being able to react appropriately gives Philips a real competitive edge.

Philips put commodity price risk management on CFO’s agenda

The challenge

Within Philips, commodity price risk management was not receiving the full attention needed to create a value-adding and well-prepared approach to fluctuating and uncertain commodity prices. At the time this concern was raised, there was neither visibility on the exposure and how this was impacting the profit margin, nor a holistic process in place to mitigate risk.

Together with Philips Internal Audit, Philips Procurement Risk department identified a potential Gross Value at Risk from volatility of raw material prices. This required a ‘best in class’ approach to commodity risk management.

Project objectives

The overall project objective was to protect margins, reduce risk and increase transparency. As Thomas Frijns, Procurement Risk Manager points out: “Our ultimate goal was to implement a proactive strategy and approach to manage commodity price risk across Philips”.

The solution

The project started in early 2015. By the end of 2016, all three project phases (see phases) were fully completed. This resulted in a state-of-the-art commodity risk management solution that was embedded in the global organisation, supported by procurement, treasury and business functions. The solution included a tool and process set capable of aligning gross risks between procurement, finance and risk management.

The key benefits of the CPRM tool: visibility, transparency and improved information quality.

Significant improvement was made on exposure visibility. This was achieved by having a centralised repository of raw material exposures underlying in procurement spend. With visibility, the solution creates transparency on potential impacts (positive and negative) from material price developments.

Existing market intelligence information taken to the next level is leading to improved information quality. Philips now has early warnings on the impact of raw-material market-price change on procurement prices, and an improved ability to manage gross margin for future periods. The solution also enables the simulation and anticipation of the most appropriate contingency actions between procurement, sales, and engineering, helping to define the most appropriate mitigation plans.

Best practice and innovation

Rather than treasury trying to cover every risk using financial derivatives, a series of optimal mitigating actions and processes have been defined. The unique Philips approach, starting with procurement, has seen the business function define a new model for managing commodity risk, where the use of financial derivatives is now the last resort.

Philips’ commodity exposures (mostly in semi-and finished goods) is highly complex. An approach was needed where procurement could leverage existing treasury policies to gain a centralised and full view of economic exposures. It now has a holistic approach for managing commodity risk, based on close cooperation between procurement, treasury and business functions.

The company’s achievement, together with the support of Zanders, is outstanding. Within a relatively short timeframe, and with limited resources, the team has put commodity risk management on the CFO’s agenda, advancing a process that was individually managed by commodity buyers to one of group-wide importance. “Raw material prices can’t be predicted, but knowing your exposures and being able to react appropriately, gives a great competitive edge,” concludes Frijns.