Commodity Management and ERP

COMMODITY MANAGEMENT AND ERP

WHITE PAPER

© Commodity Technology Advisory LLC, 2014

Introduction Over the last several years, the phenomenal growth and expansion of wholesale commodity trading has begun to have a significant impact on both business practices and strategic thinking across commodity supply chains. Producers and processors of raw materials (commodities) and sellers of finished goods that rely heavily on commodity feed stocks have had to come to terms with a business environment of generally increasing and significantly more volatile prices for their raw materials. Despite some weakening in commodity prices on the back of a stronger dollar and increased supply recently, volatilities remain problematic and in the longer-term, prices will continue to increase as the global popula-tion continues to grow and as more of that population become consumers of goods.

Recently, many of the larger banks have begun to exit com-modities trading under fire from various regulators and a set of new regulations. Their position has arguably been taken up by large commodity trading firms, with companies such as Glencore, Mercuria, and others expanding their operations and filling much of the liquidity vacuum left by the exit of the banks. These large commodity traders have also experienced much thinner trading margins and have increasingly sought to secure physical commodity supply by purchas-ing producers and their assets in order to de-risk a portion of their supply chain. In the future, the boundary between producer and trader may be increasingly blurred.


A ComTech Advisory WhitepaperCommodity Management and ERP

As a consequence of these trends, many commodity pro-ducers, processors, merchants and even sellers of finished goods have been forced to re-examine their supply chains, looking for both cost reduction and potential optimizations in inventory planning, warehousing, and logistics helping to reduce their feedstock costs. However, these process improve-ments do little to reduce the exposure to commodity price volatility. As a result, many companies have also started to hedge that price exposure using a variety of readily available financial instruments for commodities. However, with increased hedging via financial trading, these firms now find themselves exposed to increased regulatory risk as new and bolstered regulations such as Dodd-Frank, EMIR and MiFiD2 demand more active and increased regulatory vigilance and reporting. In summary, current trends in commodities markets means that many firms have seen the complexity of their businesses increase dramatically.

Traditionally, commodity risk management has been a highly specialized function, used primarily by wholesale and retail commodity trading firms; with the requisite technology solu-tions provided by specialist commodity trading and risk man-agement (CTRM) applications. A CTRM system provides the ability to quickly and easily capture deals or trades in the various physical and financial instruments that are used as hedges. They also allow close to real-time valuation and position reporting with easy to use analytical, reporting and drill-down capabilities. This sort of functionality and capability has not been previously considered to be a part of an ERP solution.



ENTERPRISE RESOURCE PLANNING

COMMODITY MANAGEMENT – THE NEXT STEP

As a mature class of software, ERP solutions are well equipped to capture complicated or large data structures such as commodity contracts, and agreements, in industries where the materials pric-ing is dependent upon a number of quality criteria. Furthermore, the ERP solution is able to manage a wide variety of other common problems facing phys-ical commodity producers and processors, includ-ing sophisticated document management around shipping and logistics, tracking inventory in multi-ple locations, producing interim and final invoices once final pricing is available, and ensuring proper accounting treatment of such activities. In fact, the twenty-year or more history of the ERP software

Commodity pricing adds an entirely new dimension to pricing raw materials, as it requires referencing a quoted price for a standard financial instrument where that price may not actually be available or fi-nalized until some point in the future. Furthermore,

Given the complexity of their operations, many producers and processors of raw materials have invested at some time in the past in Enterprise Resource Planning (ERP) solutions to better monitor and manage their business pro-cesses. An ERP system integrates multiple business functions such as planning, inventory/materials management, engineering, order processing, manufacturing, purchasing, accounting and finance, human resources, and more, providing a number of tangible and considerable benefits. However, in order to realize these benefits, the ERP system must be fully integrated and highly configurable, providing its users insights into operational and financial performance that would otherwise be unavailable.

Hedging and price optimization for purchase and sales agreements requires integrated and real-time access to derivative and commodity prices across a variety of exchanges, giving users the ability to use these prices alone, or in combination using a formulaic structure, to price transactions.

category ensures that ERP platforms can handle a very wide variety of requirements across many industries including those dealing with physical commodities. Increasing price volatilities in commodity markets have, howev-er, changed the nature of the game for virtually all large-scale process-ing and manufacturing companies as both feedstock and energy costs move unpredictably. Producers and processors of both raw materials and finished goods increasingly find themselves trapped in the middle of volatile prices on one side and an inability to raise prices on the other. Margins are squeezed and profits become increasingly unpredictable. Fortunately, however, there are a number of solutions to this dilemma that include different approaches to production planning in addition to the use of improved hedging and risk management techniques.

the system must be able to process all of the different types of financial instruments in terms of execution, settlement, accounting and regulato-ry compliance needs. Active risk management further requires the ability to analyze positions in real-time via drill-down capabilities into that physical and/or



financial position data in order to identify and explain changes or trends in valuation or position. This capa-bility requires an intuitive user interface that overlays an application capable of accessing and processing complex data structures in real-time. Furthermore, the position and mark-to-market data needs to be available at multiple levels across multiple commod-ities. As exchanged-based trading in commodities is now global, price movements occur 24-hours per day, potentially requiring all of this information to be accessible via a hand held device like a tablet or mo-bile phone. Unfortunately, this level of performance and usability is an area in which many existing solu-tions fall sadly short. Enterprise risk management, of course, is not just concerned with price risk but also risks as-sociated with foreign exchange, counterparty credit and treasury management as well as various other operational exposures in the legal, compliance, contract management, logistics and other areas of the business. Being able to gain visibility into (and appropriately manage) all of these additional risks demands the use of a fully integrated solution in which the appropriate data is accessible and can be analyzed in multiple different dimensions as dictat-ed by the nature of the business. Such a capability requires that the risk management aspects of com-modity management be tightly integrated with all the other functions of an ERP solution.

Finally, commodity management solutions also need to help their users identify opportunities to improve profitability and continually optimize their businesses according to market dynamics. Opportunities to perform physical swaps, make sales of intermediate products, opti-mize recipes, eliminate poorly performing suppliers and logistics con-tractors, for example, may all help profitability but require an integrated real-time view of the business. Providing a commodity management solution for physical com-modity producers, processors and consumers demands a very high-lev-el of integration (both across business functions but as importantly, across a variety of different commodities), a scalable and powerful plat-form capable of handling large quantities of data often extracted from external systems and yet providing near real-time information about the business. Such a solution must have, at its core, a powerful and flexi-ble pricing engine that is capable of modeling and calculating purchase and/or sales prices based on a wide variety of factors including market data, differential rules, provisional and final pricing, fees, taxes and oth-er forms of charges (customs, broker fees etc.). It also must to be able to capture the range of financial commodity trades and instruments used in hedging, calculate position in a multitude of views for different purposes, provide analytical tools for drill-down and “what if” analysis, and ensure compliance with all regulations. Finally, it needs to do this while still providing all the complex functionality and business benefits associated with an ERP solution, including inventory management, lo-gistics, production planning, sales, manufacturing and of course finance and accounting often tracking and reporting on financials according to a number of complex accounting standards. It is a tall order.



SAP COMMODITY MANAGEMENT SOLUTION

At the request of its customers, SAP has created a strategic investment area within SAP Business Suite applications complete with a dedicated de-velopment and solutions team to collaborate with customers on commodity management. The SAP Commodity Management solution is able to lever-age SAP’s core strengths in logistics, finance and industry solutions as well as any and all work on plat-form, analytics and performance. SAP Commodity Management is already licensed by more than 70 SAP customers around the world.

The result is a solution that has addressed the three key areas needed in a commodi-ty management solution as follows,

COMMODITY PRICING – SAP’s pricing capabilities within a commodities or raw materials context were already very robust and configurable but SAP has added a special price calculation for commodities that are traded at exchanges. Com-modity pricing with SAP offers tremendous flexibil-ity in terms of building formulas and rules, building in other pricing criteria such as quality attributes for example, utilizing quoted market prices, calendars, currency exchange rates and much more. It is at the heart of the SAP Commodity Management solution and it supports the assessment of fees, taxes, dif-ferential pricing, fixed and floating pricing, derived forward curves and many of the other complexities

The leading provider of ERP software globally is SAP. With thousands of implementations across almost every in-dustry, SAP has conceivably seen almost every business need imaginable in terms of ERP requirements.

traditionally found in commodity transactions. Added to that function-ality is the ability to track the status of a price; as the final price cannot often be determined until some point in the future either due to fixation timing issues or a need to validate quality attributes, for example.

ANALYTICS

COMMODITY PURCHASE PROCESS

COMMODITY SALESPROCESS

MANUFACTURING

TRANSPORTATION

COMMODITY RISK MANAGEMENT

ACCOUNTING

WAREHOUSING

QUALITY mgt.

1QUANTITYQUALITY MARKET DATA RULES

FRAMEWORK

Flexible Price Calculation

Figure 1 | SAP Business building blocks for Commodity Management

Figure 2 | Aspects of Commodity Pricing

ANALYTICS



The strength of SAP commodity pricing is that it is fully integrated with the SAP standard ERP pricing and therefore benefits from the increased flexibility and configurability that this brings. It also supports index-based and non-indexed based calculations as well as industry-specific pricing needs across all ar-eas of raw materials and commodities.

COMMODITY RISK MANAGEMENT – SAP Commodity Risk Management supports a complete range of derivative transactions including futures, listed options, forwards, swaps and OTC options which are used in real-time reporting and analytics. It offers real-time position reporting for physical commodity documents and derivative trans-actions and helps users with mark-to-market calcu-lations and reporting. It also supports the capture and execution of a number of commodity derivatives with full integration with SAP ERP allowing direct processing of postings and payments within one system. The SAP Commodity Risk Management offering is both highly configurable and adaptable in supporting multiple commodities, and other key attributes. Gaining visibility into key risk metrics is easy to achieve across a variety of views into the data by different selection criteria. As a result of the work SAP has done into the user interface, the results are available in readily consumable formats and dash-boards.

PERFORMANCE AND ANALYTICSSAP offers its Commodity Management solution on the SAP HANA in-memory platform to provide for scintillating performance and allowing real-time calculation of complex reports such as position and mark-to-market, for example. It can offer the com-plete solution in the Cloud via the SAP HANA En-terprise Cloud to enable rapid implementation and a compelling Total Cost of Ownership. Furthermore, users can select just the functionality that they re-quire.

SAP has also worked diligently on the user experience for analytics and reporting particularly leveraging the SAP Fiori user experience (UX) and working in design thinking co-innovation with customers to produce highly consumable and personalized dashboards and reports that can be accessed across a broad range of devices and provide drill-down capabilities. SAP Commodity Management can offer users supe-rior performance and flexibility as well as innovative reporting and user interfaces for enhanced productivity.

RULES FRAMEWORK

Figure 3 | SAP Commodity Management Analytics User Interface Example



SUMMARYSAP Commodity Management is a specific exten-sion of the SAP ERP solution thus incorporating decades of experience in building, delivering and supporting fully integrated solutions across all indus-tries including those that deal with commodities and raw materials. As a result of this pedigree, it offers some significant benefits to its users in terms of be-ing able to leverage the vast resources that SAP has to offer in terms of performance, scalability, User In-terface, functionality and much more. The focus of the solution supported by a strategic investment and an experienced SAP com-modities management team is on producers, pro-cessors and merchants of raw materials and sellers of finished goods. It is a true Commodity Manage-ment solution that delivers users an enhanced abil-

ity to manage their business by optimizing their purchasing and sales activities, helping them understand their exposures, manage positions and conduct hedging operations. Its’ focus is on de-risking the supply chain and helping customers face the unique challenges inherent in industries that are reliant on raw materials.Launching the SAP Commodity Management solution in 2011, SAP has been successful at building in commodity pricing, commodity risk management and other crucial aspects of functionality for this growing group of customers. It already boasts more than 70 customers for its commodity management solution across multiple industries, such as mining & metals, agribusiness and consumer products and others. When you add the ability to leverage performance-enhancing technology such as SAP HANA, sophisticated analytics and the work done by SAP into making highly usable user interfaces, it is clear that SAP has well and truly arrived in the commodity management arena and has built a platform that can only gain in strength with time.

ABOUT

Commodity Technology Advisory LLCCommodity Technology Advisory is the leading analyst organization covering the ETRM and CTRM markets. We provide the invaluable insights into the issues and trends affecting the users and providers of the technologies that are crucial for success in the constantly evolving global commodities markets.

Patrick Reames and Gary Vasey head our team, who’s combined 60-plus years in the energy and commodities markets, provides depth of understanding of the market and its issues that is unmatched and unrivaled by any analyst group.

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