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Effective Procurement Programs Create a Competitive Edge

NAFFS Staff Report

Every purchase of a natural product involves thoughtful risk assessment, even if that consideration is done subconsciously, Richard Pisano, Jr., president of Citrus & Allied Essences, told attendees of the 103rd NAFFS Annual Convention. 

Gathering information as to the availability and price of products you’re buying is the first step, Pisano said, noting procurement of aroma chemicals can be more difficult than a typical procurement program because this process is not always subject to measurable calculations, but more instincts and personal judgment. 

“Judgment, like wisdom, comes with experience,” said Pisano. “A good procurement program can hedge your company against a shortage, which is the ultimate objective.” A plan based on strategy is needed to buy with confidence, he added. Since Pisano specializes in both selling and buying essential oils, he’s been on both sides of the procurement equation. He’s well-aware of the universal distaste for increased prices and dramatic price fluctuation which he said was much more prevalent for essential oils than with aroma chemicals. 

In addition to gut-level judgments, there are technological calculations that happen, he said. Software programs can calculate a company’s requirement for a particular chemical. Past actual volumes for both the business won and lost can be used for a current forecast, he added.

If a chemical is derived from petroleum, (as many aroma chemicals are) and the price is either high or low, Pisano says a reasonable assumption about the pricing for the downstream chemical can be made. If it’s made with crude sulfate turpentine, the procurement might take the form of contacting a supplier and requesting prices for a contract or for price protection in exchange for the purchase of a specific quantity, he said.

Having more than one approved source can help manage some of the risk, Pisano advised. It allows a company to split the purchase, thereby averting a problem if one supplier can’t meet demand.   

Pisano, a student of world history, told attendees the world’s basic economic structure has stayed the same since the end of World War II. “The ability to ship products from anywhere in the world with complete confidence is to our great advantage,” he said. “This is because the United States has been the guarantor of freedom of the seas everywhere based on our ability to project naval power.” Pisano surmised. “We enjoy an open market on every conceivable product and that has allowed other countries to also rebuild their economies as well.” 

Pisano said since World War II, flavorists and perfumers have worked with many of the same natural products. Basic citrus, mint, spice and floral ingredients continue to be important. 

In the 1980s, he said, productivity for both the natural and artificial products soared due to improvements in technology and inflation coming under control. Prices leveled off as consolidation of flavor and fragrance industries also reduced the number of suppliers. For example, essential oils went from production in 10 countries to only three. Since those countries were the ones where botanicals thrived, prices were kept low. Other factors in the countries with good climate proved to add challenges in production – weather, currency, lack of competition affected the supply. As for demand, Pisano said it’s increased in the last decade due to the popularity of aromatherapy. Western products such as toothpaste, shampoo and candy require flavors and essential oils, so the demand has increased for that reason as well, he added.

“So planning is paramount,” he said. “A solid plan to purchase natural products" must include:

• Lowest possible price.
• Sufficient quality to assure customer satisfaction.
• More than one source of supply.
• Sufficient coverage in case of shortage (3-6 months).
• Extended payment terms.Prompt delivery.
• Access to regulatory information.
• Access to new and innovative ingredients.

He said information for this plan can be found in an industry market reports, at industry events or old-fashioned research. He stressed the importance – and advantage – of creating strong relationships with suppliers, noting it creates the chance for suppliers to know which factors are most important to their buyers. “These people have the judgment and instincts on the natural product market from years and even generations in the business,” he said.

Offering a quick overview of natural products, Pisano said essential oils, natural chemicals, oleoresins (such as black pepper) and botanical extracts (such as vanilla extract) are produced with polar solvents such as ethyl alcohol. “Typically, they’re recovered by steam distillation or mechanical expression,” he said. Many of these produced at the source need to be further refined, eg; the need to concentrate orange oil or the need to redistill peppermint oil.

Natural chemicals, he said, are produced by chemical reactions and fermentation. They’re also produced by fractional distillation from natural sources, for example, natural citral. Factors such as weather and pests can create differences in quality from year to year, Pisano said. He likened fine natural products such as essential oils to fine wines. “Vineyards produce different qualities of wine in different years,” he said. “Similarly, sellers and processors of essential oils often keep inventories from several regions so they can blend and standardize the color and aldehyde or some other important attributes of the oil."

Pisano said the following factors should be part of every purchasing system.

Economic Factors: Citing current issues, Pisano said tariffs add cost and are focused on specific countries of origin. He said currency values/exchange rates also play a big role in the cost, since most deals are done in U.S. dollars.

Climate: Pisano said it’s important to note the important difference between “climate” and “weather.”  Climate is weather in a region over time, while weather is what’s experienced in real time. Weather needs to be built into a purchasing system, with contingencies in the event of a weather disaster, such as a hurricane. In that case, a supply of a natural product can go from oversupply to a shortage in one day. A common phrase heard at Citrus & Allied Essences, Pisano said, is “weather wins.” Climate though, is the factor that can control the quality of the natural products. For example, he said, Florida oranges grow in a humid sub-tropical climate but an orange tree growing in California or a Mediterranean climate (which is cooler at night) can produce a better Orange Valencia Oil.

Botanical Varieties: Natural products are not all produced from just one botanical variety, Pisano said. Lemon, for example, has many origins. The primary variety, said Pisano, is the Italian Fumenello. In Spain, Fino and in South America, Eureka and Lisboa. Each has its own, meaningful characteristics that can set them apart, he said.

Geography: Seasonality of products, said Pisano, is important because it’s winter in the northern hemisphere in January and winter in the southern hemisphere in July. Winter crop products may very well be available in different hemispheres at different times. This gives a buyer a chance to “play the seasons,” Pisano said, when it comes to requesting pricing. This advantage to buyers of natural products can mitigate shortages and dampen price increases. 

Factor X: This is something, Pisano said, one may never put his/her finger on. “Recently, it’s been coronavirus that basically closed production, transportation and commerce. In the past, it’s been war, as in the case of the shortage of coriander during the invasion of Crimea by Russia. It’s also been port strikes in California, Olympics in China, and disease,” he said.

Inventory: Inventory is the most important of all the factors, Pisano said. “Known as an asset, it can also be seen as a liability, particularly in many flavor and fragrance companies; something to keep low, or constantly reduce or avoid whenever possible,” he said.

If a natural product is subjected to any of the other factors, it could also carry a history of shortage, Pisano said. “I suggest reviewing all your natural products with your suppliers and highlight which ones had a history of problems and rank them in order of risk to determine which need to be handled in a special way,” he said.

Pisano said these factors are all known instantly in today’s world. Inventory, he said, plays an even more important role today because if there is a shortage in one region, the transparency means other regions are likely to immediately increase their prices. “The way to guard against this is to a) have the material in stock or b) have a contract with a supplier at a fixed price guaranteeing delivery,” he said.

Pisano recommends a seven-step strategy in seeking to manage risk when purchasing natural products:

Step 1 – Get a crop calendar for your natural products. “It’s always a good idea to know when the natural product is being harvested and produced at source,” he said.
Step 2 – Put together a list of the natural products your company buys and see if you can identify those that you know have experienced shortages or other problems in the past.
Step 3 – Decide how much inventory each product needs. 
Step 4 – Fight with the CFO about step 3. “It’s a tough discussion,” Pisano said. “But you have to be up for the big game!
Step 5 – Contact your supplier and see if they will hold material for your company in exchange for a contract or some other written arrangement. 
Step 6 – Continue to ask questions and learn as much as you can about the natural products you purchase. Make friends of your suppliers. 
Step 7 – “Have fun with this interesting industry. This career allows you to be an economist, a geo-politician, sometimes even a soothsayer. Ask the questions and learn; it doesn’t have to be crisis management. Developing a well-designed strategy will help avoid disaster and bring success for you and for your company,” he said.

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