Forward buying in the simplest form is buying more goods than needed. The best example is retailer, who buys higher amount of commodity in order to store it and sell in further time. Forward buying is usually associated with price and non-price competition. Producers try to compete with each other by means of lowering prices for established period of time. It is good occasion for cheap purchase, what is used by another company's supply chain management. Also every of us - maybe not aware of it - is part of this scheme, e.g. buying more food on supermarket's promotions.
Forward buying is criticised for generating needless costs. Sometimes it is compared to be addictive like a drug. Manufacturers want to quickly boost their revenue, so they decrease prices and flood the market with their goods. Afterwards they discover, that together with returning normal prices their gains disappear. Downstream supply chain is clogged up with inventory. When market stabilizes, producers are keen to make another low-price period in order to undo their losses. This causes arising of cycles, what leads to long-term debilitating effects for production and distribution branches.
Forward buying increments company's costs. Manufacturers which want to offer low price sale must gather wares. This generates expenditures on warehouses. Distributors, who want to take advantage of discounts have to pay for storing commodity excess. In fact they increase revenue because of small purchase expense, but this is only short-term profit. In some cases keeping fixed prices whole time would be more profitable for producers as well as a distributors because of avoiding inventory spendings. A lot of storehouses exist only as buffer essential for forward buying phenomenon (Foti C., 2000, p. 7).
Many researchers tried and still tries to answer how to make the forward buying really beneficial. At the first look it seems to be trivial and feasible with just simple mathematics. In fact, estimating optimal amount of goods to buy during concrete trade promotion is more complicated and demands taking into account multiple aspects, e.g. (Rose R., 2010, p. 1):
- already possessed and ordered stock quantity
- payment conditions
- possible expenditures on shipment and special handling
- estimation of storage costs
- buyer's interest costs and ability of capital acquire
- demand prognosis
- date of making the transaction
It is hard to thoroughly analyse all these factors, so some simplifications can be made. Of course as consequence estimation of profitability will be more risky. For many retailers decision of forward buying is large investment and can result in serious problems with financial liquidity, including bankruptcy.
Forward buying as reducing loss
Sometimes forward buying is treated not as occasion to multiply revenues, but as possibility to decrease risk of price fluctuations. It is very distinct in particular in brands which require raw materials for production. As example: in second quarter of 2012 the Coca-Cola company profit reduced by 0.4% in spite of 3% raise in income. This situation is an effect of sugar and corn syrup price increases. Numerous proactive entrepreneurs attempts to adjust their strategy to costs fluctuation. Forward buying of raw commodity and gathering stock when prices are favourable is part of reasonable company financial policy (Manikas A., 2016, p. 1).
- Manikas A. (2016), Improved Forward Buying of Commodity Materials, "International Journal of Production Research", vol. 54, issue 15
- Desai P. (2010), Forward Buying by Retailers, "Journal of Marketing Research", vol. 47, no. 1, p. 90-102
- Rose R. (2010), An Optimal Approach To Forward Buying, "Optimal Decisions", New Jersey
- Foti C. (2000), Reducing Forward Buying through Derivatives, Massachusetts Institute of Technology, Cambridge
Author: Maciej Blak