No longer simply a means for manufacturers to manage risk, commodities markets are now value-storage mechanisms for sophisticated investors like hedge funds. The largest of these investor funds have sufficient capital to move markets and, in some cases, benefit from the resulting volatility.

Couple this shift with the move to convert food to fuel and the intervention brought on by government subsidies, then add a weakened U.S. dollar and subsequent change in import/export economics. Finally, consider massive increases in demand for fuel, grain and meat in places like China and India.

Impact on Food Manufacturers For food manufacturers, the initial impact of this new world is obvious — costs are going up more rapidly than prices. This means squeezed margins, reduced earnings and decreased shareholder value. Another impact may be more subtle, but it is strategically more important in the long-run: changing dynamics on how risks are managed and shared between manufacturers and their customers. Food manufacturers have historically functioned as "risk shock absorbers" between distributors/retailers and the commodity markets. With the increased volatility in commodities markets, the risk equation has now changed, and business as usual will unduly increase the risk borne by food manufacturers. Markets have changed fundamentally, and these changes are here to stay.

In the past, annual list price changes were de rigueur. Today, increased supply-cost risks mean that an annual list price may lock in a margin that is insufficient to meet financial expectations. The same is true for customer contracts and deals that persist over longer terms.

Few companies, however, have processes in place to effectively manage these now inherently risky decisions. Many companies now realize that prices need to be adjusted more frequently than once a year. What is needed is a more rigorous, data-driven process dedicated to these more frequent pricing cycles.

Managing Risk To effectively share risk with their customers, manufacturers need a method for quantifying market volatility on an ongoing basis. So, how can a pricing decision maker predict future costs without a crystal ball? For commodities, futures contracts still embody the best market intelligence. While not perfect, these markets represent a best guess as to the direction for commodity prices. They also represent a way to lock in a cost structure using financial hedges. Creating a mathematical model to link futures markets to raw materials and finished products is a way for food manufacturers to dynamically link volatile commodity markets with product costing.

Using models to tie raw-material costs to the market prices of futures contracts allows manufacturers to create a time-phased view of projected product costs. By estimating how volatile commodity costs impact margins, manufacturers can more accurately evaluate the risk inherent in long-term pricing and deal decisions. This process is an opportunity for food manufacturers to rebalance the risk equation with customers and to achieve target financial performance.

These are indeed exciting times — ripe with new opportunities to apply fresh thinking to traditional decisions and decision-making processes.