Under Pressure

Under Pressure

Manufacturers are citing rising raw material costs for missed earnings, shrinking profits and in some cases, bankruptcy. But in this environment, leaders have developed strategies to protect their companies -- without drastically raising prices.

In a perfect world, profitability and competitive pricing are balanced quotients. But in today's world, with commodity prices rising across the board and competitive pressure keeping finished goods prices down, manufacturers are streamlining and innovating in a wild chase just to stay afloat. Others are sinking or already have sunk.

"We've had five automotive parts manufacturers go bankrupt in the last year and a half," says Ana Lopes, director of government relations for the Triangle Park, N.C.-based Motor Equipment and Manufacturing Association. "All of them cited high raw material costs as part of their reasons for going Chapter 11."

In April, $171.7 billion Ford Motor Co. lowered its earnings forecast for 2005 by a staggering $900 million. The reason? Among other things, high prices for steel and crude oil. This comes despite process improvements that have cut $4 billion in production costs since the raw material increases started.

Despite massive efficiency improvements internally, some manufacturers still have been forced to raise prices or cut earnings outlooks because of material costs.

According to Dave Huether, chief economist for the Washington, D.C.-based National Association of Manufacturers, during the past two years manufacturers have seen price increases of 65% for some metals, 50% for fuel and natural gas, 40% for petroleum (an ingredient in materials as well as fuels) and 19% for chemicals. Many companies are being forced to absorb these costs internally to compete in markets that are too competitive for comparable finished goods price increases.

"Some vehicle manufacturers are passing some price increases on to consumers," Lopes says. "But, on the most part, they try to avoid that, of course, given the very competitive market. It's not a clear translation for us from additional raw material costs to end higher cost for consumers."

So what are the companies doing? They are turning to internal product and procedural innovations; they are re-evaluating their supply chains; they are absorbing all they can.

One bright spot: Recent data suggests a saturated steel market is cutting demand on a global scale and slowly driving down prices. After last year's price explosion, six months of declines in the U.S. has the steel price index sitting a little under 4% less than last year and as much as 20% less for some coils.

Plastics, on the other hand, is a different story.

Plastics

"If you look at our raw materials, most of them are petroleum-based, and the largest component of our raw materials is polypropylene," says Dennis Norman, vice president of planning and communications for Polymer Group Inc. (PGI), North Charleston, S.C., a producer of non-woven materials. "Polypropylene, in 2004, increased more that 50%, and even through the first part of 2005, we've seen increases in excess of 10% to 15%."

It doesn't appear that this is a short-term spike, says Huether of the thousand-day run -- the longest "spike" in a propylene product in more than 10 years. "Firms are starting to plan on these prices staying high. They're starting to think about how they manufacture their products and where they can make substitutes or redesigns."

PGI, for instance, instituted a set of core strategies to combat the rising costs, including "continuous focus on streamlined manufacturing," Norman says. The plant was able to cut costs in excess of $20 million and still more in 2004, a year in which the company had $844.7 million in sales.

"Our customers demand it [lean manufacturing]," Norman says. "As part of the quality in supplier requirements, they require that we have efficient manufacturing processes. It's getting to the point where it's a cost of entry into the market."

Still, like most companies in this market, even that wasn't enough. Though PGI has been able to offset a portion of the cost increases by process improvements, it has passed a relatively small portion on to consumers. Across the board, however, pricing increases have been heavy, averaging about 10-cents-per-pound increases on resins and petrochemicals. Some companies have increased prices up to 20%.

"It's really something that's effecting the whole industry," Norman says.

Indeed, all of manufacturing seems to be suffering. As the following manufacturers have demonstrated, however, there are strategies for reducing this pervasive wave of raw materials price increases.

Pendaflex/Esselte: Taking Lean To A New Level

Facing cost increases of 18% to 20% for such basic commodities as paper, steel and oil, the already lean Esselte, a Melville, N.Y.-based office supply manufacturer, has started 2005 with a strong attack on cost with a new, lean leader.

Office products manufacturer Esselte is spreading its lean philosophy, such as continuing to reduce the above inventory, throughout its supply chain to offset raw material costs.

Gary Brooks, carrying a hefty load of experience in lean manufacturing, took control in March as vice president of Esselte and president of Pendaflex, the organizational solutions division of the company. He has bold plans to create new levels of efficiency in production, instituting a holistically lean approach.

"Fortunately, Esselte had already started down the lean journey, so I'm coming into a situation that's not a complete stranger to lean," Brooks says. "A lean philosophy, a lean journey, takes a substantial amount of time and effort and consistency and purpose.

"We've gone through the easy stuff. We've organized ourselves, we're building things through a one-piece flow, we're using pull systems within our factory to our suppliers. We've freed up capacity in people and space, we've reduced our inventory in the factory and from our suppliers so WIP is down and the raw material is down, so we're freeing up a lot so space and freeing up capacity."

The hard part, he says, will be applying that lean approach through the entire supply chain. "Our goal is, when one of our customers sells a product, we want to have a signal that we make another product to replace that demand. That's a difficult thing to do: It challenges your computer systems, it challenges accounting systems, it challenges all the other functions in your organization. Esselte has done a good job operationally, but now we have to spread that to all the other functions of the organization."

With Esselte's previous lean work, combined with Brooks' plan, he says pricing hasn't been an issue so far, noting that he hopes to be able to mitigate more of the material costs with increased efficiencies. When it comes to pricing, the company is looking to end-users to determine what the market will bear. "A customer is going to pay a certain price for a product, and if your price is too high, they won't buy it and, sometimes, if your price is too low, they won't buy it. We're trying to understand what the end market is and make sure that our cost structure allows us to make some profit based on what the market is willing to pay for our products."

Additionally, Brooks says he is using the leverage he has obtained with his lean work to provide added innovation to the company. "We would prefer, instead of just passing on savings, or mitigating the savings, to use our lean philosophy to be able to develop more features and benefits for our customers so the customer perceives that they're getting more value for the product in the long term."

Though the effort has provided the company with a comfortable position in the turbulent period of raw materials, Brooks doesn't claim he's near the end. "The good news is you can start [lean manufacturing] at anytime. The bad news is it never ends."

Tyco Plastics and Adhesives: Consolidating, Buying Smarter

Considered the world's single largest buyer of polyethylene, pulling in a revenue of about $1.2 billion annually, Tyco Plastics and Adhesives (TPA) has found itself with an enormous hand in a commodity whose price won't stay down.

"Back in April of 2002 is when polyethylene started increasing," says Terry Sutter, TPA president. "On that basis, it was probably selling, on average somewhere around 27-28 cents a pound. Today, that same grade is approaching 60 cents per pound." To offset that increase, the company has instituted a five-part cost-saving initiative.

The first stage of the plan was to close 30 manufacturing and warehouse facilities and reduce 20% to 25% of manufacturing square footage.

"We moved a number of our facilities. We've integrated a number of our facilities," Sutter explains. "Tyco had done a number of acquisitions in the past and, when we came in as the new management team, we looked at it, saw what was going on with raw materials and went ahead and moved forward as quickly as we could to try to right-size our overhead structure. That exercise alone probably resulted into a reduction in census [employees] of about 1,200."

After condensing the operating space of the division, Sutter's team attacked inefficiency within the remaining facilities. "We've gone from essentially not much effort around productivity and cost out in the operating system, to today, we have about 50 full time [Six Sigma] black belts, going to 80 black belts." That effort alone was able to take out $20 million in operating costs the first year, and aims to cut $30 million in 2005.

Next, the company eliminated single facility buys and consolidated them into total, division-wide purchases, saving the company about $10 million in indirect spending.

To help do this, TPA also initiated their LCC (low cost country) sourcing effort that "went through all our major raw materials as well as a number of our finished products," Sutter says. "We did some calculations, and we came up with what we call a "shopping basket" of products and raw materials that are candidates to source offshore. We went from having nobody on this to today we have full time employees in India and China working on $220 million plus of opportunities in the business."

While these efforts have saved the company millions in production costs, it simply hasn't been enough to fully beat the effects of the price increases on polyethylene.

"We're working hard to get as much out of productivity as we can," Sutter says. "But because of the magnitude of the increases and how quickly they came upon us, you really can't get there completely on just cost savings alone. So, the last thing we've had to do is get with our sales force and get out into the marketplace and really work with our customers. We've had to raise price across the line in all of our product lines as another way to keep up."

Those increases are unavoidable given the current commodity cycle, which he describes as the strongest in the U.S. since the mid-1970s. It's a cycle he expects to last through 2007.

"It's something that all of us have got to get our heads around and really work hard on," he relates. "Our suppliers need to work on that as well. The polyethylene guys need to get out there and drive their own productivity. They need to get out there and work their supply chain. They need to start balanced LCC efforts and try to work this and de-bottleneck."

Standen's Limited: Redesigning, Outsourcing

Calgary-based Standen's Ltd., manufacturer of truck, trailer, and farm machinery parts has taken some novel and rather drastic steps to offset the kind of raw material costs that have saturated the market with increases between 40% and 100% in the last few years, says President and CEO Mel Svendsen.

Efforts to absorb those costs, no matter how drastic they may seem, he reports, are absolutely necessary. "As an example," he cites, "what used to be one of the most successful spring manufactures in North America recently went into bankruptcy. I would attribute it to a lack of reinvestment to be able to keep up with the state of the art."

Truck-and-machinery-parts manufacturer Standen's Limited has redesigned some of its products, shown in production above, to remove certain price-volatile raw materials.

To avoid that fate, Svendsen has turned to lean manufacturing in a major way, including remodeling one of the company's product lines. "We've worked with our customers to redesign springs to take the steel out. Obviously, if you take steel out, you take significant dollars out. Now, you might have to put more technology in, but the payback comes in terms of having less material operating at high stresses, yet getting the same kind of life through advanced technology and advanced manufacturing processes."

That emphasis on R&D, he says, is essential to keep the system efficient and profitable. The primary objective, he notes, is: "reduce cost while improving quality."

Following that sentiment, the company has taken steps to push its entire supply chain into a position to meet the pricing crisis. "In order to try to have a competitive position, we've had to turn to putting a lot of effort into helping our suppliers be more competitive, working with them in partnerships to do a better job trying to adopt lean manufacturing techniques inside our plants, and also working with our other vendors so far as to encourage them to join lean manufacturing consortiums so that lean manufacturing techniques can be adapted to their plants," he says. "Our R&D team is working with our vendors today to bring them into the mix to try to get them to help develop their technologies along with our technologies to create a more cost-effective blend. For instance, we would have our team deal with steel people to develop special alloys that would work better with our technologies so that we can create suspension components that use less steel, but do a better job."

Along with that effort, Standen's has also used outsourcing to remain profitable. Svendsen says that there are certain products the consumer will accept from Canada and the U.S. and other products they are willing to accept from Mexico and China. The effort there has been to balance cost effectiveness and customer acceptance.

But even these steps have failed to be completely effective. "If steel made up the majority of the costs, then no matter what we did technologically, we haven't been able to avoid price increases." But in his industry, he explains, that isn't the issue. What keeps a company competitive and productive isn't the lack of price increase, it's the amount of the increase. With lean work, innovation and supply-chain manipulation, Standen's has been able to keep those increases down. "We're really doing well, and because we're probably one of the more efficient manufacturers in our field, we're growing, we're getting ahead," he says, no matter the increases.

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