Wednesday, March 11, 2009

What Do Bananas and Fixed Price Positions Have In Common?

Have you been to Sam's Club or Costco lately to buy bananas? They try to sell you a bunch - no pun intended. At least twice if not three times as much as the typical bundle size in the local shopping center. Some times, my family "goes long" bananas from Costco...and man, do we eat them. We have to be committed to eating them. Bananas on our shredded wheat, bananas in school lunches, bananas suspended in green jello...We just hate to waste them. Of course, if we can't muscle through our banana storage position, there is always the Hancock family equivalent of the ripcord on an emergency parachute...baking banana bread - where completely brown, ripe bananas can still be used as an ingredient.

Does any of that sound familiar? Or am I bananas? (Pun intended.) I hope you can relate. Fixed price positions are similar. They have a "shelf-life," too. Without discipline to use them quickly (either to manage front month margin risk or to offset heating season fixed price program risk) they can wind up turning brown on you, as the market turns lower and starts eroding any equity previously garnered by your position. When that happens, bad things (like compressed operating margins and supplier margin calls) can result. And those bad things adversely affect the performance of your most important asset, your business.

Before you enter a fixed price deal, make your decision can pass the following litmus test. Does my purchase fill an immediate consumption need (like eating a banana for breakfast)?

Alternatively, if the purchase does not fill an immediate consumption need, then does my business have an outlet for the inventory I am taking on (like pulling the ripcord and processing old bananas into banana bread)?

If you can't answer a hearty "Yes!" to either one of these questions, then your position is a speculation and unnecessary. It is just the siren's song of the market tempting you into wanting to take a position, just like the sirens of myth tried to lure the Argonauts to the rocks.

Many folks like to layer into positions over time. But layering in to positions involves risk. As you think about your next purchase think about your business's banana inventory.

One can eat only so much banana bread. After my recent trip to Costco, you can take my word for it!

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