Frank Knight, the grand old man of Chicago wrote “Risk, Uncertainty and Profit,” one of the five most important economics books of the 20^th century. Among other invaluable insights, Knight proposes that, “The responsible decisions in organized economic life are price decisions; others can be reduced to routine.” Knight recognized that price at which a firm sells its products or purchases materials tends to have greater impact on profitability than any other element. Based on the income statement of an average S&P 1500 company (and assuming constant sales volumes), a 1% improvement in the selling price would generate an 8% increase in operating profits. Conversely, a 1% drop in the cost of goods sold would lead to a 5.36% increase in operating profits. This impact was more than double that of a 1% increase in sales volume^[1]. For commodity businesses where operating margins are typically very low, hedging can have a much greater impact on profitability. Continue reading →