Commodity Prices and Purchasing: Understanding and Cushioning Swings

Why commodity prices become a margin question for small businesses

An electrical contractor calculates an offer for wiring a commercial building. Four months pass between the offer and the work. In that time, the copper price rises by a fifth. The contract is at a fixed price, and materials make up a large part of the costs. In the end, nothing is left over, even though the business did good work.

Such situations are more frequent again in 2026. According to Germany’s Federal Statistical Office, producer prices for industrial products in September 2026 were 6.7 percent above the same month of the previous year, driven by energy and metals. This piece asks: How can a small or midsize business understand swings in commodity prices and cushion them so that they do not endanger its margin and plans? To answer it, we clarify terms and causes, introduce a mental model for when hedging pays off, sort four levers, and weigh two views.

Terms and causes: why commodity prices swing so much

• Commodity: A largely uniform good such as copper, steel, aluminum, wood, grain, or natural gas, traded on exchanges or in large markets. Because the goods are interchangeable, a world market price forms.
• Spot price and forward price: The spot price applies to immediate delivery; the forward price applies to delivery at a later date agreed today.
• Hedging: A transaction that offsets a loss from a price change with a gain elsewhere, for example through a fixed-price contract or a forward contract.
• Price adjustment clause: According to the definition in Price adjustment clauses in contracts, it links the price in a contract to a reference value, such as an index for materials or energy. If the reference value rises or falls, the price adjusts according to a defined rule.

Commodity prices fluctuate more than most other prices because supply and demand hardly react in the short term. A new mine takes years, and a factory cannot cut its copper needs overnight. Small changes in supply or demand therefore move the price strongly. Then there are conflicts, tariffs, and export restrictions, as described in Geopolitics as a business risk, and exchange rates, because many commodities are traded in dollars. A weaker euro makes them even more expensive for German buyers.

The mental model: hedging to stay able to act

Kenneth Froot, David Scharfstein, and Jeremy Stein (1993) asked a simple question that owners often skip: why should a business hedge at all? According to a classic argument in finance, hedging does not change a company’s value, because it costs money and merely trades risk for certainty. The authors show when this is not true: when outside money is more expensive than internal funds. Then every drop in internal cash flow leads either to expensive additional financing or to good projects being canceled. Hedging pays off to the extent that it ensures enough internal money is available for these projects.

For a small business, this is a useful test question. It is not the size of a possible price increase that matters, but what it would trigger. If the business would have to postpone a planned machine, not hire an employee, or max out its overdraft, hedging is valuable. If it can absorb the increase from its own funds and pass it on immediately, hedging is often unnecessary. An analogy: an umbrella is worth carrying not because it is raining, but because you are on your way to an important appointment you need to arrive at dry.

Hedging is not a bet on the price. It is insurance that a price does not decide your plans.

Worked example: what a material price increase does to the margin

In the example, a metalworking business has accepted an order worth 200,000 euros at a fixed price. Materials account for 40 percent of the price, or 80,000 euros, and the pre-tax margin is 8 percent, or 16,000 euros. If the material price rises by 10 percent before purchase, that costs 8,000 euros, half the margin. At 20 percent, the margin is completely eaten up.

The example shows why the material share is the most important figure. A business with a 10 percent material share hardly notices the same price increase; one with 60 percent loses money even with small swings. The second factor is the time between offer and purchase. Those who buy materials when the order comes in bear the risk only for the validity period of the offer.

The four levers: pass on, buffer, fix, diversify

For most small businesses, the most effective lever is passing on. It brings costs and revenues into step, creating the natural hedge shown at the end of the mental model table. Customers accept this more readily if the increase offsets higher costs rather than exploiting a favorable situation. This rule of dual entitlement is described in Energy prices and pricing following Kahneman, Knetsch, and Thaler (1986). How a fair clause is built is checked by the fairness test in Price adjustment clauses in contracts: symmetry, suitable reference value, share, threshold, and transparency.

Buffering is the second lever and the most dangerous. Anyone who stocks up when prices are rising in order to be cheaper is speculating. Buying in advance only makes sense when a certain order stands against it. How much inventory a business needs is described in Inventory management. Fixing and diversifying complement the first two levers. For commodities that make up a large share of costs and whose supply is risky, the Kraljic matrix from Evaluating suppliers suggests a closer relationship with a few suppliers under framework agreements.

What studies show about hedging

Froot, Scharfstein, and Stein (1993) draw two conclusions from their model that are instructive for small businesses. First, full hedging is rarely right. How much should be hedged depends on how strongly the business’s own projects are linked to the commodity price. If costs and revenues move together anyway, less hedging is needed. Second, hedging becomes more valuable the more expensive and harder to access outside money is. That affects small businesses more than large ones.

Dangwung, Lee, and Kim (2026) found among companies in the metals industry that firms under stronger competitive pressure are more likely to hedge commodity price risks. That fits the mental model: those who cannot pass on price increases because of competition have no natural hedge and need another one. The authors also find a link between hedging and smoothed earnings in financial reporting. The study looks at listed companies and does not allow conclusions about cause and effect.

The figures show how unevenly a price surge can be distributed. Excluding energy, producer prices rose only 3.2 percent, while copper rose by almost a third. A business should therefore not look at general inflation but at the two or three commodities that determine its costs. How inflation overall has affected price negotiations is described in After inflation.

Two views: hedge or absorb swings yourself?

The first view advises hedging. Those with fixed prices to customers and few reserves cannot afford a price shock. Fixed prices with suppliers, clauses, and targeted advance purchases make costing predictable and protect planned investments. Banks also rate predictable results more favorably.

The second view advises absorbing swings yourself. Hedging costs money, ties up liquidity, and forgoes advantages when prices fall. If a business hedges but its competitors do not, it is left with expensive materials when prices fall while the others offer more cheaply. And anyone who starts working with forward purchases easily slides from hedging into speculation.

I consider the mental model the referee between the two. The first question is not whether the price will rise, but whether the business can pass on the increase. If it can, it is largely naturally hedged and needs little more. If it cannot, because contracts run long or competition prevents it, it should hedge, and only to the extent that a price shock does not endanger planned projects, no further.

The next step

1. Identify cost drivers

   List the three commodities or materials that account for the largest share of your costs and how their prices have developed over the past year.

2. Calculate material share by type of order

   What percentage of the price is materials, and how much time passes between offer and purchase?

3. Check pass-through

   Which offers and contracts contain a price adjustment clause or a short validity period? Where is it missing for large orders?

4. Test resilience

   Calculate what a 20 percent increase in your most important material would mean for margin and liquidity over the next six months.

5. Talk to suppliers

   Ask your most important suppliers about fixed prices, framework agreements, and volumes for the coming months.

Conclusion: how a business cushions commodity price swings

To the guiding question: a small or midsize business cushions swings in commodity prices most effectively by passing them on where this is fairly justified, with price adjustment clauses, short validity periods, and an open reference to the material share. Buffering, fixing, and diversifying complement this when passing on is not possible. The mental model of Froot, Scharfstein, and Stein provides the yardstick: hedging pays off to the extent that a price shock would otherwise force expensive additional financing or prevent good projects. The limits of this article: the model is a general theory for companies, the study on the metals industry looks at listed firms, and the worked example uses freely chosen figures.

Anyone who knows which commodity determines their margin and how much of it they can pass on has already done the most important part of hedging.