Category Archives: In The Press

Rolls-Royce accused of ‘buying the business’

The Financial Times newspaper reports that a former executive of the Brazilian state owned oil company Petrobras has accused British engineering company Rolls-Royce of bribery. 

Rolls-Royce accused of bribery according to The Financial Times

The newspaper claims (with supporting court documents) that Rolls-Royce paid bribes in excess of $200,000 USD to the former Petrobras employee in order to secure lucrative engineering contracts for gas turbines used on the company’s oil rigs. The contract had an alleged value of more than $100m USD.

Rolls-Royce has released the following statement via email:

“We have not received details of the allegations made in recent press reports, nor have we been approached by the authorities in Brazil”.

The allegation levelled at Rolls-Royce falls under a larger inquiry into Petrobras. The company is currently engulfed in controversy pertaining to wide spread corruption throughout its procurement practices. It has been alleged that Petrobras has received billions of dollars in bribes from suppliers eager to secure contracts.

Rolls-Royce is also currently under investigation by Britain’s Serious Fraud Office. The investigation that began in 2013 centres on corruption and bribery claims present within the company’s operations in China and Indonesia. Such claims included the ‘gifting’ of 20 million dollars and a blue Rolls-Royce car to Tommy Suharto (son of Indonesia’s former president, General Suharto) – in a bid to persuade the national airline to use Rolls-Royce engines for its fleet.

The CIPS Risk Index Explained

Following on from our review of the Purchasing Managers Index (or PMI) last week, Procurious continues its look into procurement performance indicators. This week we are focusing on the CIPS Risk Index. 

CIPS Risk Index

The CIPS Risk Index is a tool developed by CIPS and powered by Dun and Bradstreet (D&B). It has been designed to give procurement and supply chain professionals a country-by-country understanding of the risks that exist within their supply chain.

The index is generated through a number of unique assessments that are undertaken by D&B’s economics team and provides an individual country-based score for 132 countries. CIPS suggests that these country-based scores can be aggregated to indicate overall supply chain risk.

For procurement professionals that want to understand the details behind the high level risks pointed out by risk index, CIPS provides monthly Country RiskLine reports and more detailed quarterly Country Insight reports. These reports provide a more in-depth look into the political, economic and social risks present in countries and how these impact purchasing activities.

When calculating the index, D&B takes into account the following categories:

  • Short-term economic outlook.
  • Long-term potential
  • Market potential
  • FX risk
  • Transfer risk
  • Business environment quality
  • Business continuity
  • Insecurity/civil disorder risk
  • Expropriation/nationalisation risk.

To find out more about the CIPS Risk Index click here.

Are we going to run out of chocolate?

Cacao crisis - are we running out of chocolate?

Last week I warned that the increases in value of the Swiss franc could spell troubled times for chocolate lovers. Unfortunately, this week I have more troubling news about our favourite sweet treat…

In its 2015 report, the Earth Security Group (a company that provides intelligence on managing global resource risks) points out that we are headed for global shortages in cocoa (the key ingredient in chocolate) as soon as 2020.

Where is the chocolate going?

A number of factors are thought to be contributing to the dwindling supply of cocoa. These include; increased demand from emerging markets (Indonesia’s chocolate consumption is growing at 20 per cent a year) and fears around what might happen if Ebola crossed the border from neighbouring Liberia and Guinea into the Ivory Coast. The Ivory Coast is the world’s largest producer of Cacao – boasting 38.7 per cent of global production.

However from a procurement perspective – it is the fact that cocoa farmers are shifting their efforts to other crops that I find the most interesting.

In order to understand the reasons why cocoa growers are shifting production to palm oil and rubber, we need to look at the intriguing nature of the cocoa supply market.

An agricultural oddity

The cocoa growing industry is an anomaly of sorts in modern agriculture – in that it is still dominated by small landholders rather than corporate enterprises. These small landowners produce over 85 per cent of the world’s cocoa supply.

The highly fragmented supply market for cocoa means that farmers hold little bargaining power when it comes to negotiating with the large buyers like Nestle and Barry Callebaut*.

As a result of this buyer dominated market, the price of cocoa halved between 2009 and 2011. In 2012 the Ivorian government introduced a fixed pricing scheme designed to keep its cocoa industry intact and prices started to recover.

Combine falling prices with the fact that cocoa growers are very poorly remunerated for their efforts, and the motivations for shifting production begins to become apparent.

Makechocolatefair.org suggests most cocoa farmers earn less than $1.25 USD a day, meaning they living in ‘absolute poverty’ as defined by the UN. The paltry sum they receive from large buying organisations means cocoa farmers have a high propensity to shift production to more profitable crops. It just might be what pulls them out of poverty.

Furthermore, farmers in these communities remain largely unconnected to the global information sources and the outside world. This is resulting in two worrying occurrences. The first is that sustainable farming practices and infrastructure have not been implemented in cocoa farming regions causing widespread land degradation. The second is that these small holders have no concept about the increases in the global demand for their product and the implications it could have for the price they charge.

“You can’t sustain a booming chocolate industry worth billions while the producers are living in poverty” – Alejandro Litovsky founder and chief executive Earth Security Group.

Cocoa is an old mans game

The combination of tough customers, poverty, low prices and changing climatic patterns is severely hampering the motivation of young farmers to move into producing cocoa. It is estimated that the area of world’s surface dedicated to cocoa plantations has decreased by 40 per cent in the past four decades.

Perhaps more concerning is that the Fairtrade organisation estimates the average age of a cocoa farmer is 50! If that’s not a telling sign for the future of the industry, tell me what is.

The Earth Security Group report highlights the challenge that chocolate producers face, and the need to change the dynamics of this supply market. Companies should look to spread the benefits of what is a lucrative industry downstream and back into the supply chain. Failure to do so will mean facing the future supply crisis, knowing that they hold at least some of the responsibility for the shortages.

* Never heard of Barry Callebaut? That’s where Cadburys, Hershey’s, Ben and Jerry’s and Magnum get their cocoa. The company purchases about 40 per cent of cocoa available to the open market.

What is a Purchasing Managers Index? PMI explained

You may have heard of the Purchasing Managers Index (PMI) in the media recently and questioned what it was. The index was used on Monday to show a slowing in China’s manufacturing sector and again on Wednesday when discussing the strength of the Canadian economy.

What is the Purchasing Managers Index

Here is a brief run down on exactly what the PMI is:

PMI is essentially a means for economists to understand economic activity in a particular area based on the outputs of its procurement departments.

The index is generated monthly by surveying purchasing managers activity across five key indicators. These being: new orders, inventory levels, production levels, supplier deliveries and employment environment.

Once the results have been collated, a PMI score is produced. A PMI of above 50 represents an expansion in economic activity over the previous month. Anything below 50 represents a contraction.

The PMI indicator is used extensively by economists because it is thought to be one of the most accurate leading (or predictive indicators) for the future health of the economy.

PwC on business intelligence systems and organisational change

50 per cent of the costs of public sector administration and service delivery are incurred through procurement. Contracts are getting more complex. More is expected of them. BiP Solutions know this and as a result have enjoyed considerable success with their Procurex Live brand. 

Procurex Live has announced Southern and Northern dates for 2015

The 2015 dates for these procurement exhibition, conference and training events have recently been announced, use our Events listings to RSVP and secure your place below:

Procurex South Live 2015
Procurex North Live 2015

Both events have been designed to support commissioners and procurement practitioners to meet the ever-increasing expectations of politicians and the general public. They will also offer guidance to SME’s in winning public sector contracts through a range of training and networking opportunities.

Henry Needler – PricewaterhouseCoopers (PwC) Senior Consultant, is set to appear across both dates. In the North, audiences can hear his take on business intelligence systems:

“Generally with business intelligence, we’re trying to understand what the business is doing but also understand where the market is going and anticipate that and forecast it so that they can get the best possible deal in the marketplace. In terms of the alpha aspect, that’s focused on what local SMEs can do for big organisations going out and buying services so that money is invested back into the local economy.”

At the Southern event he will explain how procurement professionals can use and analyse data to make better decisions and optimise value for money for their organisations.

As a senior consultant at PwC, Henry’s role is to help clients implement procurement-led transformation within their organisations. Here he explains:

“It’s about how you can engage local markets best. It’s a case of understanding what that market can provide or what the suppliers can provide and about making sure you do whatever you can to engage a company and ultimately help them survive.”

Henry believes that Procurex Live is a good platform for businesses to learn about the procurement marketplace and how it is set to change:

“I think that it should help them understand where the market is going because consumer retail (you and I) is far more real time now. We can find a product and within a few seconds we can immediately compare prices, identify similar products and get some information so that, without a lot of effort, we can go into a traditional shop already very well informed.

Going forward, client organisations, councils, central government or manufacturers are going to be dealing with somebody in procurement who can immediately compare those prices so they end up in a more dynamic and fast-moving marketplace than the traditional local authority procurement that takes forever and has long-term monolithic deals.

The way forward is going to be smaller, shorter-term deals which are looking to exploit the innovation which the market is generating. That’s exciting for the SMEs as they can see what buyers want and what the customer wants and the larger organisations should also be in a good position to meet those demands.”

For details of Procurex Live and other professional events view our full listings

In logistics? Take the ‘joined-up’ approach

Maritime places Fargo at the heart of its approach to doing business

Thanks to Maritime Transport and Fargo Systems for providing Procurious with this case study.

The decision to implement Fargo Systems’ TOPS system back in 2004 was a turning point in the way the UK’s largest container transport company, Maritime Transport, approached its IT business model.  Fast forward ten years and Fargo Systems’ technology yields benefits across almost all aspects of Maritime’s business.

Tim Goddard, IT director at Maritime Transport takes up the story: “I was initially brought in by Maritime to oversee the introduction of TOPS.  The decision to invest in this new ‘off the shelf’ technology was made to replace an outdated and inflexible system currently in operation and to equip the business for growth.

 “From the outset, what was appealing about working with Fargo Systems was the team’s understanding of our business; a result of their logistics background, and their commitment to work with us and further develop their systems to meet our evolving needs.”

Managing over 10,000 shipments a week, an impressive 90 per cent of Maritime’s work is now received via EDI directly into TOPS from customers, forwarders and shipping lines’ systems.  TOPS helps to efficiently meet customers’ reporting requirements by sending automated job acknowledgements, status updates and PODs back to the originating systems, and where required can also provide electronic invoice transactions via EDI, which speeds up the process of issuing invoices and of invoices being approved.

The importance of real-time reporting

Interfaces to Maritime’s telematics system, assists the traffic planners by sending job details direct to the drivers in the cabs, who receive automated job updates, which are processed in real time into TOPS and by retrieving vehicle positioning data for use on the traffic sheet.  This data is also of huge benefit to the fleet department.  Creating an electronic process for defect reporting is vital for a fleet of over 3,400 truck/trailer assets.   Defects captured by the telematics are processed into TOPS, where fleet appointments can be scheduled and purchase orders raised.

The partnership between the two companies has strengthened over the last decade and today Fargo Systems works closely with Maritime Transport to develop systems which link together administrative IT functions across the business. Integration is the key to the successful use of technology and TOPS is integrated into Maritime’s accounting system, with plans to use data in other areas such as purchase order processing as well as the payroll and HR systems.

Tim continues: “The size of our operation today, which includes over 350 desktop users, 17 depots, 1,400 vehicles and 2,000 plus trailers, means it is vital that our IT systems maximise every piece of data.” 

MTL head office

Optimise systems for maximum potential

As pioneers of ‘joined up’ IT systems in the logistics industry, Maritime will be taking its integrated IT approach one stage further, when it launches a fleet vendor web portal shortly.

Tim continues: “It’s important that we don’t treat any aspect of our business in isolation. Our fleet and our employees are assets and it’s vital that all are achieving their maximum potential.  An example of the integration the new system will bring is when a driver reports a tyre blow out, the repair company will be notified immediately and will then receive instant approval to attend the breakdown and undertake the repair.  The system will pre-advise the driver of the ETA of the repair van and simultaneously raise a purchase order for the repair company to invoice against.”

Ten years on… the next ten… and the next

Looking ahead to the next ten years, Tim believes Fargo Systems’ CYMAN (Container Yard Management) will play an increasingly important role in the company’s IT portfolio. “Our acquisition of Roadways in August this year has provided us with the impetus to investigate how best to utilise CYMAN in our rail operations at Tamworth, but also within our other Intermodal facilities.  Again, it’s all about joined up thinking – this time with our train and planning functionality.”

When asked about the longevity of the relationship between the two companies, Tim is quick to respond: “Fargo Systems’ understanding of our industry has always played a crucial role in the success of our relationship.  I also believe there are instances when working with the ‘not such big guys’ brings real benefit.  Although both far bigger operations than back in 2004, I believe Fargo Systems’ size is still a key strength as they are able to deliver what we require whilst maintaining the personal touch, something that the larger enterprises miss. And finally, they’re agile, listening to our needs and delivering innovative solutions expediently and to our timeframes.  Fargo Systems definitely has a role to play in the future development of our IT strategies.”

Does bad weather have the power to impact procurement?

It’s too cold… I can’t work in here… my hands don’t work anymore.

So uttered my girlfriend last night. Despite frantically working towards completing her PhD, the current freeze enveloping Granada had halted progress.

As millions of people in the US Northeast braced for blizzard conditions accompanying Winter Storm Juno, Europe is freezing through another winter with record snowfalls posted last week.

Could Storm Juno affect supply chains?

The impact of weather on output

The effect the cold weather had on my girlfriend’s ability to work reminded me of a chart I recently stumbled across online. Produced by the Bank of America; it details the monetary impact that severe weather events had on the global economy in 2014.

The chart shows everything from a major drought sweeping across the Californian agriculture belt, to a snowstorm in Tokyo last February that grounded 9,500 airline passengers

More than anything though, this chart highlights our utter vulnerability to weather events. Events that, at least for now, are completely beyond our control.

Severe weather has the ability to stop the transportation of goods, close down production plants and leave office workers stranded at home (or worse still, stranded in the office).

The Bank of America chart was produced in order to stimulate climate change debate at the Davos World Economic Forum (an excellent run down of the event can be found here).

Climate change’s impact on supply chains

Despite some ongoing rumblings to the contrary, the scientific community is in agreement that climate change is indeed ‘a thing’, that it is already happening and that humans are largely to blame.

All of this got me thinking. Procurement is perhaps more vulnerable than any other business function to the impact of severe weather and climate change.

I believe climate change has the potential to impact procurement operations in two main ways:

  1. Impact on the availability of raw materials. Most businesses rely on raw materials either directly or indirectly. Changing weather patterns will likely alter the ability of firms to secure a reliable, ongoing supply of these commodities. As the supply of raw materials becomes scarcer (even if only in the short term), prices are destined to climb.
  2. Impact on transportation links. We are seeing an increase in both the frequency and intensity of storms and severe weather across the world. These weather systems have a direct impact on companies’ ability to move goods across their increasingly globalised supply networks. Our drive for efficiency and appetite for lower inventory levels has left us all the more vulnerable to these delays.

So what exactly are we doing about climate change?

In 2013 a report was released that highlighted just how little some companies were doing to ensure their supply chains were prepared for the impact of climate change. The report showed that while 86 per cent of the 350 UK companies surveyed understood the risks climate change posed, only 14 per cent were taking a long-term approach to managing the phenomenon.

It doesn’t matter what industry you are in, climate change will impact your business.

A storm in Panama could double the cost of bananas in European supermarkets. If coastal settlements in the US Northeast continue to take battering’s from storm systems, insurance companies may be forced to rethink premiums. Oil producers need to understand the impact that storms and unsettled seas will have, not only on the production of offshore platforms, but also on the safety of their workers.

Does your business understand its exposure to severe weather and climate change? Is your supply chain at risk? Are you prepared for unforseen but inevitable events? Or are we about to see an increased prevalence of force majeure clause enactments?

Not your average product recall: improving retail safety

The safety expectations placed on suppliers in China are vastly different from those in the west. The growth of Internet giant, Alibaba has seen a new wave of  ‘made in China’ products reach the US, but are they safe?

Buckyballs craze - banned in the US

Buckyballs sweep the US

In 2009 a new toy stormed the US market. Buckyballs – tiny, highly magnetic spheres constructed of rare earth metals were a runaway success and registered $40 million dollars in sales over their first four years.

However, the same magnetic attraction that made the balls so much fun to play with, also made them incredibly dangerous if they wound up inside the human body. Despite only being marketed to adults, the small, candy like appearance of the product meant they had a habit of turning up in the digestive tracts of young children.

In his blog, Gastroenterologist Byran Vartabendian, gave the following horrifying rundown of what happens when the balls are accidentally swallowed.

“When two are ingested they have a way of finding one another. When they catch a loop of intestine, the pressure leads to loss of blood supply, tissue rot, perforation and potentially death.”

It was estimated that between 2009 and 2011, 1700 children passed through US emergency wards after having ingested the high-powered magnet.

In 2014 – the U.S. Consumer Product Safety Commission (CPSC), a US federal agency established to stop hazardous products entering US homes – recalled the product, claiming a ‘substantial risk of injury and death to children and teenagers’.

While this ruling signalled the end for Buckyballs (a then multi-million dollar product), its five years of success and profitability had inspired a number of competitors to emerge. Many of these competitors were selling the same dangerous product direct to US consumers through the Chinese online retail platform Alibaba.

Not your average product recall

This disparate, multinational supply chain presented a significant challenge for the CPSC.

In the past the agency would have simply issued a recall, shut down warehouses and monitored local stores to ensure no substitute products appeared.

Today however, the supply market for the high-powered magnets (as well as thousands of other toys) stretches well beyond US toy stores. The proliferation of online shopping has meant that controlling the purchase point of these products has become infinitely more difficult to manage. The CPSC’s chairman Elliot F. Kaye highlighted this recently when he said:

“Long gone are the days when we could pull stuff off of shelves,”

“We anticipate the next frontier will be outside of US borders.”

Working together for Product Safety

In response to this new challenge, the CPSC has announced a partnership with Alibaba. The agreement, the first of its kind between the CPSC and a foreign owned website, will see the two organisations collaborate to limit the movement of hazardous toys into the US.

The CPSC has given Alibaba a list of 15 Chinese produced products (including Buckyballs) that have been recalled from US shelves and requested that retailers on the e-commerce platform cease selling these goods directly to customers in the United States.

At the time of writing Alibaba was yet to detail how it planned to carry out the promises it has made to the CPSC, but a spokesman from the online retailer did state the company’s intention to:

“work (sic) collaboratively with the chairman and his team to do everything possible to protect consumers.” 

2014 was huge for Alibaba in the US

This commitment to product safety from Alibaba comes at a time when the firm is making significant headway into the US market and arguably represents the company’s dedication to ongoing success in western markets.

In 2014 the online platform became one of the world’s most valuable companies and its owner instantly garnered the title of China’s richest man – after it raised $25 billion USD in its US IPO.

In September of 2014 the company had an estimated market cap of $215 billion USD, a valuation outshone in the tech space only by Apple, Google and Microsoft.

As well as its success on the US stock exchange, Alibaba opened 11 Main – its first website dedicated to US consumers in July of 2014.

Is its size a hindrance to growth?

The greatest challenge for Alibaba’s plans to smoothly and safely transition into western markets is the sheer size of its vast online marketplace.

Alibaba is not only the world’s largest e-commerce marketplace, but it is also the fastest growing. The company has hundreds of millions of users, hosts, and merchants.

This immense size, combined with the fact that Alibaba doesn’t actually own any of the products being sold on its website, makes it nearly impossible to ensure product safety measures are anything but reactive.

A Sea of Counterfeits

This sort of criticism is not new for Alibaba. As recently as last year the company’s inability to effectively control the standards of its sellers came under fire. This time for the way counterfeit or ‘fake’ products sold by its merchants had been managed.

Haydn Simpson – a product director at counterfeit-tracker NetNames, claims his clients (mostly well known international brands), estimate that 20 per cent to 80 per cent of the products listed on Taobao (an Alibaba owned site) with their nametag are in-fact fakes.

In response to these claims, Alibaba last year spent more than $160 million USD attempting to remove fakes from its website. However even the briefest look on the platform shows that this initiative was entirely fruitless and counterfeit products can still easily be found on the website.

So how then is the CPSC – a US federal agency with a 2014-operating budget of $117 million USD, supposed to ensure product safety in this vast marketplace?

One thing is for sure, if they plan on tackling the problem15 products at a time, they’ve got a long road ahead of them.

How to use Big Data to inform your commodity strategies

Have you ever wondered what all the fuss about this thing call “Big Data” is all about?  Of course we all have access to spend data don’t we?  So why are people getting themselves in such a lather about the whole Big Data thing?

The importance of Big Data

WARNING: ONCE YOU’VE PLUNGED INTO YOUR BIG DATA YOU MIGHT NEVER COME UP FOR AIR!

Well first of all I need to share my guilty secret with you.  Big Data is addictive.  We’re lucky to have the national procurement information hub, which we lovingly call Spikes after it’s creator Spikes Cavell, to play with up here in Scottish public procurement.  Rather than being prickly and difficult to love, Spikes is cuddly and warm.

Plunging in can tell me about my spend, what category I spent it on, whether there was a contract for that spend, whether the suppliers were local, whether they were small, whether they were from the region… and on and on.  Knowing that you can find out all this stuff can leave you craving for the next Big Data hit.  Be careful, the addiction is frightening!

Next up is the fascination with the data.  Once you plunge in you can drill down and the fascination builds.  OK so we spend 5 per cent on a particular category like building supplies; who was that with, what type of products did we buy (we have classification codes on Spikes to help us there), how many invoices did we pay, which department was buying that?  Then off you go to find the line item detail from your purchasing system.  “I need to find out more… and more…and more” It can be as captivating as watching Professor Brian Cox explaining the Wonders of the Universe this plunging into Big Data thing.

Having all that Big Data also really helps on a practical level.  We use it to inform our commodity strategies.  We recently did some research to identify what we’d spent with suppliers of security systems.  Knowing what we’d bought helped us drill down into line item detail and then forecast what we needed to buy.  This was really powerful when it came to developing a strategy to secure a great contract going forward.  Forecasting based on our Big Data something we really need to do more of.

Big Data can ask us some difficult questions.  If 34 per cent of our spend is on construction then why are we focussing all our contract management effort on something else?  Why do we pay over 10,000 invoices a year to our catering suppliers?  Is there a better P2P process we could put in place to save both sides costs?

In this age of infographics and instant reporting Big Data is just what we need to help us present information to our senior management teams, operational managers, Boards or, in our case in public procurement, our elected councillors or Government Ministers.  It’s not good enough these days to say we don’t know the key procurement metrics for our organisation.

So all in all Big Data has the power to suck you in, pull you under and never let you go.  There’s so much potential, there’s so much we can find out.  The key is to make sure you have a plan to get out of Big Data and TAKE ACTION on what you find out today.

So come on, share with me the times when you’ve taken the plunge into Big Data!  Did you find your way out?  What tales can you tell of good savings and great outcomes?

Oil’s dropped, when will my flights get cheaper?

Oil is at $47 a barrel, shouldn’t we all be flying for less?

To answer this question I’d like to roll back the clock to 2012; a slimmer, less grey-haired version of me was working as a Procurement Specialist and had been tasked with renegotiating air travel, a category admittedly I knew little about…

Oil’s dropped, when will my flights get cheaper?

After perusing an article in the Economist magazine on the way to work detailing the falling price of oil and its impact on the economy, I foolishly assumed my upcoming contract negotiation would be a breeze.

I’d done my research. I knew that jet fuel accounted for between 30-50 per cent of an airline’s operating expenditure. So it stood to reason that if the price of this commodity fell, so too would airfares. I started doing some rudimentary savings calculations in my head and readied myself for a round of congratulatory high-fives.

Not so fast…

As it turns out, the link between oil prices and airfares is a little stickier than I first thought. The following points provide some background into why:

Airlines are now reluctant towards unchecked growth

In the past, airlines have seen lower fuel costs as an opportunity to increase their fleet, boost the number of routes they service and to reduce ticket prices.

While these knee jerk responses to low fuel costs made airlines money in the short term, as oil prices started to climb again, many firms were burnt (often to the point of no return) by the investments they made.

As one industry expert put it: “there are a lot of decisions that make sense at $80 a barrel that simply don’t add up at $100 a barrel.”

Having learnt from their past mistakes, airlines are now far more disciplined in their approach to capacity growth.

Jet fuel pricing is managed on a long-term basis

Whether it is locking in long term pricing agreements, or creating business strategies that are based on high oil prices, airline operating models are no longer designed to offer fare reductions every time the price of oil drops.

John Heimlich, the Vice President and Chief Economist of trade group Airlines for America, suggested in a recent conference call that the primary objective for airlines is to secure long term financial health and to implement measures that will help weather the next recession. He noted that spot discounting of fares would not aid in this endeavour.

In response to calls that the falling oil price should signal a period of discounted air travel John clever stated. 

“We don’t really hear people clamouring for lower prices of cheeseburgers when the price of beef comes down or lower prices of iPhones when the price of semiconductors go down.”

Not all costs are variable

Many consumers (and mainstream media outlets) assume that if oil prices fall by 50 per cent, so too should the cost of flying. This logic flies in the face of the most basic procurement theories, fixed vs. variable costs.

It’s true that fuel is, to some degree, a variable cost (see previous point). However, the majority of an airline’s operating expenditure is tied to costs that do not fluctuate with the price of fuel (wages, planes, airport taxes, food, etc.). This means that only a small percentage of a ticket’s price is subject to change based on oil price fluctuations.

Demand remains high

Airlines simply don’t need to reduce prices when demand levels are as high as they are.

An IATA (International Air Transport Association) press release published on January 8th indicated a 6 per cent growth in total passenger kilometres (a demand indicator used in the airline industry) for the month of November; similar figures have been recorded throughout 2014.

If flights are full at current prices, where is motivation for airlines discount fares?

The comments of American Airlines President, Scott Kirby, not only sum up this sentiment, but also make sound economic sense.

“Air travel remains a great bargain. We’ll continue to keep it a great bargain for customers. But in a strong demand environment, we don’t have plans to go off and just proactively cut fares.”

The airlines need to cash in

The airline industry has always been a tough place to make a buck. Warren Buffet articulated the cutthroat nature of the airlines when he famously stated:

“How do you become a millionaire? Make a billion dollars and then buy an airline.”

Airline bosses know that tough times will again befall the industry, so many are seeing the current boon in profitability as opportunity to prepare for the tough times that lie ahead. The following quote from B. Ben Baldanza, CEO, President, and Director of Spirit Airlines highlights this point.

“Lower fuel prices create a little bit of tailwind in the margin right now, which is good for us and probably good for the industry. But as long as demand stays strong, as we see it right now, we believe that, that (sic) we’ll take good advantage of that in the pricing environment as well.”

Well there you have it. While airfares may indeed decrease over the coming months, be prepared to discover (like I did) that they may not move as much as you initially thought. So you just might have to find another way to earn that high five from your boss. Here’s a hint to get you started.