Sourcing and Procurement Focus: Our Weekly Feature Article on Topics of Interest to Sourcing and Procurement Professionals or Related Supply Chain Functions  

- April 7, 2010 -

Supply Chain News: Rising Commodity Prices Again Pinches Bottom Lines, as Manufacturers Have Hard Time Passing on Price Increases

Input Costs Rising Unusually Fast versus Previous Recoveries; Low Factory Utilization Levels Limit Pricing Power



SCDigest Editorial Staff

SCDigest Says:
There is likely to be a very delicate dance over the next year between raw materials producers, first level producers, and second level producers as the economy further recovers and prices continue to move higher.

With the economy still tepid, manufacturers are being hit with steadily rising commodity prices that are substantially above the recession-induced lows – but are having trouble passing on price increases to customers.

Of course, leading up to the recession and financial collapse in late 2008, commodity prices had been on the rise for several years across energy, metals, agricultural products, and more. During that time, many companies cited these rising input prices as key factors pressuring their bottom lines or causing them to miss earnings forecasts.

But what was interesting was that even as the commodity prices soared, overall inflation remained largely in check. Companies often ate most of the rise in input costs.

The same phenomenon may be happening again.

Oil prices this weak reached an 18-month high, and are up 70% year over year in April.

Copper is selling at a 20-month high, and was up another 8.9% in March on the spot market. Nickel is a two-year high, and is up more than 30% since December. This theme continues across many commodity areas, though thus far agricultural product prices have largely remained in check.

Input cost rises affect some manufacturers directly and some indirectly. Steel makers are directly affected by rising base metals costs, and then hope to raise steel prices to their customers in automotive, appliances, and many other products. Steel prices have risen some 50% in the past six months, and more increases are coming, industry watchers say.

The Wall Street Journal noted this week that “It's normal for commodity prices to go up when economies begin to recover from recession, as factories ramp up orders and fill their pipelines.” However, it says that “This time, those prices are going up unusually fast. Over the past six months, core intermediate producer prices—prices those manufacturers pay for such things as steel, textiles and lumber—rose 2.9%, which translates to an annualized increase of 5.8%, according to the Bureau of Labor Statistics.”

But manufacturers are finding it hard to pass the price increases on. Demand is still light in most areas. Factory utilization in the US, while off from the bottom levels that fell to a record low of some 65%, are still only at about 69%. The dilemma for manufacturers: raise prices and risk losing business to the competitor that holds off incorporating the rising costs into price increases to keep the factory busy, or take the hit to the bottom line.

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B Murthuraman, vice chairman of Tata Steel Ltd., one of Europe's biggest steelmakers, told the Wall Street Journal that probably only 25% of his company’s cost increases could be passed on to steel buyers right now.

John Lichtenstein, an economist with Accenture, told the Wall Street Journal that if steel prices do keep moving up, customers will simply redouble their efforts to find less-expensive sources. "There is a lot of capacity [in the steel industry] and competition to sell at the lowest price," he says.

There is likely to be a very delicate dance over the next year between raw materials producers, first level producers, and second level producers as the economy further recovers and prices continue to move higher. Procurement managers will face tough challenges in planning buying strategies and resisting materials price increases from suppliers.

In the end, it seems likely that corporate profit margins will take some hits as input prices rise faster than selling prices.

Are you feeling the pinch of rising commodity prices yet? Do you think they will keep rising, or fall back down again? How can procurement managers best navigate these waters? Let us know your thoughts at the Feedback button below.

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