November 4th, 2010
By Jennifer Maule, Arizona State University A.S.U. School of Business, Intern for E.C.A.

This month's newsletter is a continuation of October's newsletter, in which examples were given of social and economic indicators that lead to volatility of the markets involved with recyclable materials. A key tool used to mitigate the price fluctuations caused by such volatility is reliance upon business relationships. The following is a discussion on what business relationships require to flourish and why such relationships are so important in this industry.

A useful model in describing the stages to fostering a strong business relationship is known as the VCP model; standing for visibility, credibility, and profitability. The first stage of visibility refers to the moment that two parties realize the existence of one another. Visibility can lead to a working acquaintance relationship with one another, where there is little known about either party. If the acquaintances continue working with each other, the second stage of credibility in the relationship should be met. Credibility is the stage of a budding relationship where each party shows they are reliable and worthy of trust by keeping appointments, rendering services, or acting upon and keeping promises. If both parties are deemed credible the last stage of profitability can be realized, which occurs when both parties believe that the relationship is beneficial and is worthy of continuing and fostering. Profitability is the most important stage because people respond to incentives; if there is no incentive to continue the relationship then the necessary work will not be put into maintaining the relationship.

To relate this to the recyclable materials industry, lets take an example. There is a salvage company that had decided to begin procuring recyclable metals and the selling them on the open market. To negotiate the best deals and receive the best prices for such materials, the salvage company hired a broker to do the “dirty” work of negotiations. The broker relied on his/her network of business relationships to negotiate the best deal for his/her client and was able to get the salvage company a one-year contract with a metal processing firm. In which the salvage company was guaranteed a premium over the market price for their metals for the duration of the contract.

The first aspect seen here is that there is a profitable relationship between the salvage company and the broker, as well as the broker and the metal processing firm. The salvage company is satisfied with the results the broker has given them, and is willing to continue doing business with that broker as well as refer him/her whenever possible. The metal processing firm is satisfied that they now have a steady supply of metals for a year because of the broker they dealt with. In the future if the broker has more business for the firm, the firm would be more than willing to work with the broker to possibly create more contracts. This is a circle of benefits that can be called upon for favors, more business, or even advice; a win-win situation for all involved.

Now to look at business relationships as a mitigation tool towards price fluctuations within the markets, lets continue with this example. For the salvage company that now has a contract that locks them into receiving a premium on the market price for their metals, they now have a safeguard to some of the volatility in the market. Given that an extreme drop in demand and prices will completely devastate their business, the strong relationship that they have fostered will be able to help them better deal with the less extremes within the market. The salvage company has an incentive to continue to supply the metals when the market prices are relatively low because of the premium guaranteed in their contract. They obviously always have an incentive to supply when the market prices are relatively high, that's the situation they will always be betting on. For the processing firm, when there is a steady or high demand for the metals, the contract they negotiated will procure a steady supply of metals from the salvage company, allowing them to cash in on the high demand. When the demand is low or the market prices are relatively low the contract will still be beneficial, the firm could drop other suppliers and continue business with the salvage company that they have the best business relationship with. They might be paying a premium on the price but the relationship has many benefits that they are willing to incur the extra expense.

Hopefully through this example, it is seen how the benefits of having strong business relationships can help mitigate the fluctuations of market prices. There is an obvious problem with this idea: there is always the possibility of a market collapsing or resting at an extreme low. In such cases there is not much that a business relationship can do, those times are saved for the economists to fix. However, a strong business relationship can help a business or a person make the most out of what it is they got.