In a) booming hardware market which is making

In this section we will first see the various
commodity price risks Computer industry is facing followed by, how each of the
three firms have established their responses to offset the commodity price
risk. Computer Industry is exposed to input commodity price risk primarily due
to price volatility of the following items which are considered as commodities
by the Computer industry: Dynamic Random Access Memory (DRAM) and NAND flash
memory1.

Now let’s get into the details of what a DRAM and a
NAND memory is. DRAM is a type of memory that a computer processor needs to do
its function. DRAM is that random access memory (RAM) used in personal
computers (PCs), workstations and servers. The way it works is Random access
allows the processor to access any part of the memory directly rather than processing
it sequentially, this increases processing speed and performance. NAND on the
other hand is a flash memory which does not need power to retain data unlike
solid state computer hard-drives. NAND memory is found in flash-drives,
smart-phones, cameras and a wide variety of smart devices. The prices of both
DRAM and NAND has been very volatile. Figure
3.1 shows the fluctuations in Spot Price and Contract Price of 8GB DDR4 RAM
and figure 3.2 shows the fluctuations
in Spot Price and Contract Price of a 128GB Multi-level cell NAND.

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DRAM and NAND are a commodity product in the Computer
industry, and its prices are largely governed by demand and supply factors2.
Device manufacturers need a certain amount of DRAM and NAND to meet their
device’s needs for performance requirements of their systems. Factors which are
governing the steep increase in the price of DRAM are: a) booming hardware
market which is making the price double each year and b) mobile and cloud
computing, which being the two new technology growth sectors have fueled the ever
increasing demand of DRAM.

The skyrocketing increasing price of NAND can be
contributed to the fact that the manufacturer of NAND are unable to keep pace
with the strong demand of NAND memory. There are tens of thousands of products
that 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. Anything
that has a power button nowadays has NAND memory in it, and all that demand is putting
a huge strain on NAND manufacturers’ inventory. In figure: 3.3 we can see the growing and diversifying demand for DRAM
and NAND memories.  Further we find that
the demand situation for these commodities are even more complicated. Huge
demand of mobile device forces mobile and smartphone manufacturers produce 100s
of millions of units each year, and typically right around the holiday season, this
further spikes the demand of both NAND and DRAM three to four months before the
release of new units.

Managing Commodity Price Risk

Now, let’s explore the strategies how the three
companies manage their exposure to commodity price risk. From AAPL’s 10K we
find that although most components essential to AAPL’s business are available
from multiple vendors, certain key components viz., microprocessors, liquid
crystal 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’s
risk exposure to commodity risk in 2016 was $425 million which is 0.2 percent
of its net revenue. In order to effectively manage its risk exposure AAPL
enters into agreements with its suppliers for favorable pricing.  As AAPL orders tens of millions of DRAM and
NAND chips at a single time which helps keep the cost for AAPL within
threshold, however with such a high volume of memory being sucked-up by a
single company it drives up the cost for the rest of the market. Lately AAPL
through Bain Capital has purchased Toshiba’s prized memory chip business for
$18 billion3
which gives AAPL a lot of leverage in adjusting the chip pricing to its favor
in the technology hardware landscape.

Next, HPQ’s exposure to commodity price risk in 2016
was $120 million, which is equal to 0.3 percent of its revenue. We found that
HPQ’s strategic response to the risk is multifold4: a)
HPQ purchases memory components strategically in advance of demand to take
advantage of favorable pricing, b) HPQ enters into binding long-term purchase
commitment with its suppliers, and finally c) HPQ procures from suppliers
offering pricing discount for firm’s procurement quantity commitments.

Lastly we explore the strategy that Lenovo has in
place to offset its commodity price risk exposure. Lenovo’s risk exposure to
commodity 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 in
response to random cost changes and b) Lenovo would pass on the price to its
consumer, typically by reconsidering pricing of PCs to adjust higher component
pricing.

Analyzing Response to Commodity Pricing Risk

On
analyzing the strategies put together by the three companies to manage the
commodity pricing risk we find that it would be definitely effective to follow
a few additional response mechanisms to offset the risk, which include: a) diversification
in selecting suppliers sourcing those commodities and b) establish dual pricing
strategy for procurement, meaning, procure from spot market with immediate
delivery and procure through forward-buying contract with postponed delivery. As
DRAM and NAND are yet to be accepted as trade-able commodities in United States,
managing commodity price risk by using hedging strategies like futures, swaps
and put cannot be applied to these commodities. Further unlike AAPL it is
always preferable to diversify procurement on critical components by sourcing
from multiple suppliers, this strategy would not only help offsetting commodity
risk but also help avoid concentration risk for the company.

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