Promise seen in response to oil collapse

by Morton Sosland
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Being aware of the companies in many different industries that are threatened by the history-making collapse in commodity prices during the past year cannot help but prompt a search for solutions even for an industry like food manufacturing. Perhaps the most telling impact of the commodity declines on this industry has been the pressure put on dollar sales, where drops in the cost of ingredients turned from being a highly welcome change to cause increased competition and a lowering in reported revenues. All too often these setbacks are interpreted as reflecting negatively on how a corporation is doing without regard for the effect of dramatic price falls in food ingredients.

As weakness in commodity markets — just as evident in metals, energy and other products that have no direct relationship to food — persists and projections are made that this will continue for at least another year, companies in food manufacturing need to explore whether the effect is as benign as first thought. One telling impact relates to figuring operating profits as a percentage of sales, a ratio difficult to maintain, much less increase, when sales are under downward pressure.

At the other extreme, any enjoyment of lower ingredient costs in an industry like food manufacturing needs to be tempered by realizing the effect this price weakness is having on ultimate ingredient suppliers — the crop growers. Farmers producing crops like wheat, corn and soybeans have experienced drastic reductions in incomes that, according to most calculations, have fallen below the cost of production. Just how these financial difficulties will determine what crops are grown and how much is planted is still to play out. Obviously, though, reason exists for concern not just about supply adequacy but also regarding choices that might mean surprises that could make the present situation appear favorable.

Watching once large and highly regarded commodity trading businesses suffer with these markets, due in large part to heavy debt loads and price moves that have proved treacherous has prompted a few radical approaches. These include sale of once important assets to raise funds to pay down debt. Another is to search desperately for new partners willing to provide funds for restoring the lost balance in the business. Most important, for businesses like food manufacturing, is to recognize how very different these markets have become, not only from the pressure of overwhelming supplies having to face reduced demand but from the remains of commodity funds that offered huge returns when the markets, especially oil, were soaring and now are doing just the opposite.

If it’s any relief, the case could be made that the problems faced by companies on account of commodity price weakness are nothing compared with what faces those nations that had their economies totally dependent on oil revenues. A striking example is Saudi Arabia, where rising oil prices for a decade into 2013 meant unimaginable prosperity. Present oil prices mean that the Saudis no longer rely on oil revenues to maintain, much less grow, the economy. Dealing with this is especially important because a demographic transition means a significant increase in the country’s working age population. This is where the McKinsey Global Institute examined the situation and pointed out that typical approaches would lead to rapid deterioration in both household income and the fiscal position of the government.

It is no surprise that McKinsey concludes the answer to this dilemma lies in an accelerated shift from the current government-led economy to a more market-based approach. ”Faster productivity growth requires better business regulation and more openness to competition, trade and investment,” McKinsey says. Pointing out how difficult this transition will be, McKinsey says success could promote economic growth more sustainable than the oil booms of the past. Those attitudes are great for a country. They also signal the best course that industries like food manufacturing should follow in avoiding the pitfalls now evident from the commodity market collapse.

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