Saturday, April 20, 2013

Is a Futures Hedging Specialist a must for your business?

The business environment has changed in just a couple of decades. While business success used to depend only on the skills of the early-eighties owner or manager, today businesses must attract and synergistically coordinate the efforts of many knowledge workers. Knowledge workers are those whose main job is to make sound decisions. Engineers, analysts and specialists, among others, carry the responsibility of making decisions beyond the ability of most, if not all, of the workers at the company. Often, these experts will demonstrate deeper subject knowledge than that of even company leaders.
Photo image of team of knowledge workers analyzing a problem on a whiteboard.
Knowledge Worker Performance - Peter Drucker
Thus, companies should develop guidelines for all decision making processes that are based on a sound risk/reward balance. The goal is to enter into situations where the balance is asymmetric; where the downside risk is low or limited while the upside reward potential is high or unlimited. This will result in the best deployment of all knowledge workers.
With this in mind, let's start by considering a topic of great importance for manufacturers: the cost of raw materials. The seemingly uncontrolled volatility of important materials like copper or oil turn business planning into a little more than a wild guess. Thankfully, there are ways to solve this problem. There are well established, liquid and transparent derivatives markets that can help a business hedge against raw material volatility. I am talking about Futures and Options markets. Both offer alternatives that can help insure against the kind of market gyrations that could put a company out of business. From these, the Futures market is the simplest to understand. Options are much more flexible. Unfortunately, such flexibility comes with a high price in complexity.
Like with other insurance policies, a business manager must understand that there is a cost associated with an insurance policy that protects profitability against large swings in cost of goods. The cost of such insurance is the limited downside. The fact that a business will not have to suffer the same fate as all other businesses in the same industry when raw materials go up is the great upside.
But chances are that the manager or owner has no idea on how to even start hedging through Futures contracts. It is therefore essential to employ a qualified knowledge worker who could help set up a basic insurance program for the company. As I mentioned above, there are many areas where specialists bring value to a company way beyond the leader's capability.
To help a manager get a beginning understanding of what Futures are, I found this great video from the UK's Money Week magazine.
Screenshot image of MoneyWekk's website where an important video explaining futures is hosted
While this video does not show how to hedge, it does describe how Futures operate. Hedging, should be individually addressed by a specialist in the field. Because all companies have different needs and due to the fact that improper hedging techniques could kill the company, I do not suggest for an old-fashioned manager to go it alone. Saving on the expert could prove to be very costly indeed.

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