In this section we will first see the variouscommodity price risks Computer industry is facing followed by, how each of thethree firms have established their responses to offset the commodity pricerisk.
Computer Industry is exposed to input commodity price risk primarily dueto price volatility of the following items which are considered as commoditiesby the Computer industry: Dynamic Random Access Memory (DRAM) and NAND flashmemory1.Now let’s get into the details of what a DRAM and aNAND memory is. DRAM is a type of memory that a computer processor needs to doits function. DRAM is that random access memory (RAM) used in personalcomputers (PCs), workstations and servers. The way it works is Random accessallows the processor to access any part of the memory directly rather than processingit sequentially, this increases processing speed and performance. NAND on theother hand is a flash memory which does not need power to retain data unlikesolid state computer hard-drives. NAND memory is found in flash-drives,smart-phones, cameras and a wide variety of smart devices.
The prices of bothDRAM and NAND has been very volatile. Figure3.1 shows the fluctuations in Spot Price and Contract Price of 8GB DDR4 RAMand figure 3.2 shows the fluctuationsin Spot Price and Contract Price of a 128GB Multi-level cell NAND. DRAM and NAND are a commodity product in the Computerindustry, and its prices are largely governed by demand and supply factors2.Device manufacturers need a certain amount of DRAM and NAND to meet theirdevice’s needs for performance requirements of their systems.
Factors which aregoverning the steep increase in the price of DRAM are: a) booming hardwaremarket which is making the price double each year and b) mobile and cloudcomputing, which being the two new technology growth sectors have fueled the everincreasing demand of DRAM. The skyrocketing increasing price of NAND can becontributed to the fact that the manufacturer of NAND are unable to keep pacewith the strong demand of NAND memory. There are tens of thousands of productsthat use NAND memory today, everything from TVs, to smart mobile devices, to thermostats,to coffee makers, to refrigerators and gaming consoles has an NAND inside it. Anythingthat has a power button nowadays has NAND memory in it, and all that demand is puttinga huge strain on NAND manufacturers’ inventory. In figure: 3.3 we can see the growing and diversifying demand for DRAMand NAND memories. Further we find thatthe demand situation for these commodities are even more complicated.
Hugedemand of mobile device forces mobile and smartphone manufacturers produce 100sof millions of units each year, and typically right around the holiday season, thisfurther spikes the demand of both NAND and DRAM three to four months before therelease of new units.Managing Commodity Price RiskNow, let’s explore the strategies how the threecompanies manage their exposure to commodity price risk. From AAPL’s 10K wefind that although most components essential to AAPL’s business are availablefrom multiple vendors, certain key components viz., microprocessors, liquidcrystal displays (LCDs) and certain optical drives are sourced from a single vendor/supplier.This exposes AAPL to supply and pricing risks as well as concentration risk. AAPL’srisk exposure to commodity risk in 2016 was $425 million which is 0.
2 percentof its net revenue. In order to effectively manage its risk exposure AAPLenters into agreements with its suppliers for favorable pricing. As AAPL orders tens of millions of DRAM andNAND chips at a single time which helps keep the cost for AAPL withinthreshold, however with such a high volume of memory being sucked-up by asingle company it drives up the cost for the rest of the market. Lately AAPLthrough Bain Capital has purchased Toshiba’s prized memory chip business for$18 billion3which gives AAPL a lot of leverage in adjusting the chip pricing to its favorin the technology hardware landscape.Next, HPQ’s exposure to commodity price risk in 2016was $120 million, which is equal to 0.3 percent of its revenue. We found thatHPQ’s strategic response to the risk is multifold4: a)HPQ purchases memory components strategically in advance of demand to takeadvantage of favorable pricing, b) HPQ enters into binding long-term purchasecommitment with its suppliers, and finally c) HPQ procures from suppliersoffering pricing discount for firm’s procurement quantity commitments.Lastly we explore the strategy that Lenovo has inplace to offset its commodity price risk exposure.
Lenovo’s risk exposure tocommodity price risk in 2016 was $516 million, which is 1.2 percent of its revenue.Its measures include: a) dynamically adjust pricing and sourcing decision inresponse to random cost changes and b) Lenovo would pass on the price to itsconsumer, typically by reconsidering pricing of PCs to adjust higher componentpricing. Analyzing Response to Commodity Pricing RiskOnanalyzing the strategies put together by the three companies to manage thecommodity pricing risk we find that it would be definitely effective to followa few additional response mechanisms to offset the risk, which include: a) diversificationin selecting suppliers sourcing those commodities and b) establish dual pricingstrategy for procurement, meaning, procure from spot market with immediatedelivery and procure through forward-buying contract with postponed delivery. AsDRAM and NAND are yet to be accepted as trade-able commodities in United States,managing commodity price risk by using hedging strategies like futures, swapsand put cannot be applied to these commodities. Further unlike AAPL it isalways preferable to diversify procurement on critical components by sourcingfrom multiple suppliers, this strategy would not only help offsetting commodityrisk but also help avoid concentration risk for the company.