When will this booming economy slow down?
Time flies when the economy is recovering. In fact, it’s already been ten years since the last recession ended, marking the longest period of economic expansion in the United States. This long period of growth has everyone wondering when the next recession will hit. Businesses, jobseekers and investors alike are trying to predict just how long they have to ready themselves for the looming downturn. While no one can say for sure when the economy will turn, experts agree that decline is inevitable.
In fact, UCLA economist Edward Leamer says, "The effect of the 2019 first-quarter data is to 'increase the recession probabilities from near zero to 15% for the next year and to between 24% and 83% for the year after that. Don’t worry about the coming year; worry about the year after that.'"
How can procurement deal with economic downturns?
During recessionary periods, procurement professionals must work even harder to score deals and avoid unnecessary costs. At the same time, buyers must consider the financial health of their suppliers. While low bids may be enticing at a time when business is struggling, below-average bids may signal financial distress on the part of suppliers. Since recessions impact nearly every sector of the economy, procurement departments must consider the impact on supplier stability as they determine their ideal price points. Although long-term contracts are often helpful during periods of economic decline in that they help control price growth, buyers should consider how below-average rates can affect supplier longevity. After all, suppliers that are ill-prepared for the recession may not be able to deliver on long-term contracts.
Transportation and long-term contracts
Let’s take a look at one sector of the economy that often relies on long-term contracts to control volatile input costs. We’ll discuss how recessions put pressure on operators within the transportation sector and shape their negotiation techniques.
[Within the transportation sector, the trucking industry has been burdened by volatility in fuel prices, a major input cost that gets particularly unpredictable during periods of economic distress.]
Input costs and demand trends converge
These markets are heavily impacted by consumer spending, another trend to consider as the possibility of recession grows near. Recessions are characterized by plunging consumer spending. During the 2008 recession, carriers in these markets faced a sudden dip in demand for their services as budgets tightened for businesses and consumers alike, meaning less spending and fewer goods to be shipped. With business all but grinding to a halt, many carriers filed for bankruptcy.
Growth in oil prices
Another major indicator of an oncoming recession is growth in oil prices. Since operators in the transportation sector rely on fuel to power their vehicles, growing oil prices place a heavy burden on transportation companies. Fuel prices, which trend in line with crude oil prices, have a sizeable impact on providers in the local freight trucking and national trucking service markets, in particular.
On top of lower shipping volumes from the drop in consumer spending, these carriers faced higher fuel prices in 2008 due to spikes in Brent Crude Oil prices. Diesel fuel prices, which hit about $5.00 per gallon in 2008, are currently much lower, at about $3.15 per gallon in May 2019.
In comparison, Brent Crude Oil prices averaged $96.94 per barrel in 2008, hitting about $145 per barrel at the highest. Though this year’s prices are still below the 2008 average, at about $66.44 per barrel to date on average, the climb past $71.00 per barrel in April and May 2019 has some economists raising an eyebrow.
With many economists blaming heightened oil prices for the 2008 recession, the climb in prices this year is certainly something to watch when predicting the next recession. The combination of OPEC cuts, which have been tightening oil supply, and the possibility of weather-related events, worker strikes and further geopolitical stress could cause prices to double over the next several months.
Fuel-hedging during a recession
With fuel costs making up nearly 20.0% of the average trucking company’s cost structure, it’s clear that procurement professionals in the trucking industry are in a difficult position during recessionary periods. For procurement departments across the transportation sector, taking an aggressive approach to procuring fuel can help guard against dives in profit. In preparation for a looming downturn, several markets within the transportation sector are expected to secure long-term contracts with fuel suppliers or renegotiate their current supply contracts. While these contracts are difficult to establish, companies that put long-term fuel supply contracts in place have historically fared better during recessions than those without such contracts.
What to consider before locking into a long-term contract
Before establishing a multiyear fuel contract, however, operators in the transportation sector must consider their needs. While understanding fuel needs is a basic fundamental to negotiating fuel contracts in general, fuel needs are even more important to consider when preparing a contract on the edge of economic decline. While fuel needs may be high during periods of economic growth, lower shipping volumes during a recession may lead trucking companies to operate smaller fleets that take fewer trips. In establishing long-term contracts for fuel or renegotiating current contracts, buyers should consult historical data on trucking activity to determine how much fuel they should secure through the contract as overpromising fuel consumption will lead to wasted money in the long-run.
Up front work can help in the long run
While developing a fuel contract may be a daunting task, containing price growth and reducing fluctuations through fixed pricing can help keep carriers afloat during a recession. Buyers that have previously foregone fuel contracts due to their small size may need to reconsider in response to warnings of the next recession. Smaller buyers may be able to establish relationships with other buyers to engage in collective bargaining. As fuel prices climb in the face of tightened supply, discounts will become more difficult to attain. However, when buyers join forces, they are often able to secure more favorable prices in return for the additional business they offer fuel providers.
By: Kim Bucci, Business Research Analyst
Sign up to our newsletter
COVID-19: Pushing the Evolution of Procurement
As organizations have struggled to stay afloat amidst this tough economic environment, procurement professionals have worked hard to adapt and show up for their businesses in new ways. The work, however, is far from over.
Technologies Shaping the Future of Procurement
Heading into 2021, procurement professionals will need to embrace emerging technologies to overcome modern risks.
ProcurementIQ Launches New Supplier Information Collection
With 2020 bringing on unexpected supply chain disruptions, ProcurementIQ knows it’s more important than ever to shape and strengthen your sourcing strategies.