Ouch. Ouch. Ouch. Wince. Groan.
Those are the sights and sounds of manufacturers battling raw material prices that sometimes appear completely out of control. Crude oil futures cruised past $75 per barrel in early July. That's bad news for every manufacturer, but even more so for energy-intensive companies and industries that also use petroleum products as feedstock.
Copper prices have doubled in the past year, nickel prices are on the rise, and resin prices may or may not have peaked. What's a manufacturer to do when his product's material costs soar and retreat, only to leap again in reaction to a multitude of factors -- hurricanes, missile tests and terrorist activities, speculation and, of course, supply and demand?
There's no doubt about it. Escalating and extremely volatile raw material prices are challenging manufacturers in their struggle to rein in costs and improve profitability. While it's a challenge companies would prefer not to face, they are implementing procurement strategies to mitigate those cost increases and level out the peaks and valleys. Alternative materials also are being scrutinized.
Big Budget Bite
It's no wonder that rising raw material prices have manufacturers in an uproar. Despite the attention labor costs receive when it comes to manufacturing, it's material costs that take a bigger bite out of most manufacturers' wallets, data show. According to the most recent IndustryWeek/Manufacturing Performance Institute Census of Manufacturers survey, material costs comprise a median 50% of U.S. plants' cost of goods sold.
With material costs such a big part of manufacturing's budget, "People have realized, 'We've got to be smarter about how we're buying these materials, and we've got to be smarter about getting control over this spend," says Pat Furey, a senior manager at Sunnyvale, Calif.-based Ariba, a spend-management solutions provider. "Over the past two years, we've seen a real heightened awareness in the procurement community trickling down to the entire organization around raw materials and what people are spending. This is getting board-level attention."
In an effort to reduce material costs, global sourcing has become widespread among manufacturers. The 2005 IndustryWeek Value Chain survey showed that slightly more than half of U.S. manufacturers are looking beyond their country's borders for direct materials. And many manufacturers, such as furniture maker HNI Corp., the Muscatine, Iowa-based parent company of divisions including HON Co. and Hearth and Home Technologies, have undertaken strategic sourcing initiatives specifically to reduce the size of an unwieldy, fragmented supply base and reduce their direct material costs.
"We're a little bit of labor, a little overhead and a lot of material [costs]," says Matt Sladek, procurement manager at HON Co., Cedartown, Ga., in describing why the manufacturer set its initial strategic sourcing sights on its direct material spend. Indeed, until the strategic sourcing initiative, Sladek says there was little sourcing coordination among HNI divisions, thus little leverage with suppliers in pursuing better prices for steel and such materials as particle board and packaging. A spend analysis initiative, which is a process of collecting and categorizing expenditure data to gain far greater visibility into how and where procurement dollars are spent, accompanied the strategic sourcing effort. "The two [initiatives] are intertwined," Sladek says. "The spend analysis is a crucial tool to a successful strategic sourcing initiative."
Indeed, Sladek says the greater visibility gained by the spend analysis revealed a few surprises, including the number of suppliers with which the firm had less than $100,000 of spend. And that matters, he says, because having more suppliers results in more relationships to maintain, as well as more transactions.
Manufacturers are getting smarter about the product development lifecycle and bringing procurement expertise into the process sooner, such as before the materials are specified, Furey observes. "When I was in engineering, we didn't necessarily worry about how many different grades of a given material we were buying," he says. "We were just [specifying] what worked best and was the easiest to get done to get our product released to the market. We didn't worry about whether our procurement department was buying 20 different grades of the same basic material."
Getting procurement involved early during the design stage helps manufacturers to consolidate material specs where it makes sense, resulting in a rationalized supply base, aggregated spend and more buying power in the market. Furey says, "This is not necessarily something new in a lot of markets. There are companies out there that have been doing this for years, but it is amazing how widespread it is that the engineers and the procurement community don't necessarily talk in the development lifecycle."
Manufacturers also are examining whether they can increase the amount of reprocessed or scrap material that can be used without negatively impacting the end product. "It's one way to significantly cut back on your raw material costs if you can work with your development engineering department to get the use of reprocessed material up," Furey says.
Other ways exist as well. The commodities expert says an aggregated buying technique used by automotive OEMs and large diversified manufacturers has "started to trickle down" to some of Ariba's midmarket clients (companies with annual sales of $500 million to $2 billion). That is, companies' own central procurement departments are trying to lock in raw material prices not only on their own behalf, but also on behalf of suppliers that make parts for them. Not only does it aggregate buying power, but it is also "locking in the raw material portion of the suppliers' price so you don't have to worry about your supplier coming to you every four months saying, 'I got another increase in steel, so I need to increase your prices on the stampings accordingly,'" Furey says.
Today's extreme price volatility also has spawned creative clauses regarding raw material prices in quote requests and contract language. Prompting this language is suppliers' desires not to commit to long-term, fixed priced contracts at a time when their raw material costs could skyrocket, as well as manufacturers' desires not to lose or scare off desirable supply sources.
Then there is simply designing products with the specific goal of introducing less-expensive materials. Goodyear Tire & Rubber Co., for example, reports that it has increased its ability to substitute synthetic rubber for natural rubber, thus taking advantage of the price differential between the two materials. The Akron, Ohio-based manufacturer says it can replace more than 15% of its natural rubber usage without affecting performance.
Goodyear's efforts to increase its substitution flexibility date back to 2004, when escalating prices for natural rubber already were making their presence felt.
"New polymer development is ongoing, but the supply/demand volatility -- which even then showed no signs of subsiding -- created a sense of urgency for our research and development team," says Joseph M. Gingo, executive vice president, quality systems, and chief technical officer.
While the increased substitution flexibility won't reduce Goodyear's total raw material costs, the tire company says it does slow down the rate of increase. "They [synthetics] do give us greater flexibility in the event of further natural rubber price increases or supply disruptions," Gingo says.
Prices for both natural rubber and synthetic rubber have increased in recent years, with natural rubber prices approaching a 20-year high, according to industry data cited by Goodyear.
And many manufacturers' efforts toward sustainable manufacturing also drive product innovations that reduce dependency on expensive raw materials. For example, DuPont says it expects to begin production in 2007 of high-performance thermoplastic resins and elastomer products made from bio-based material innovations. The products, targeted for automotive, electrical, electronic and other industrial markets, will be made from corn sugar rather than petroleum, explains the Wilmington, Del.-based materials company.
"When these new products are commercialized, we will be able to offer our customers the benefits of renewably sourced materials and a reduced dependence on petrochemical sourcing," says DuPont's Keith Smith, vice president and general manager of DuPont Engineering Polymers.
As an added benefit, the company's new bio-based materials require approximately 40% less energy to manufacture than the petrochemical-based counterpart, DuPont says. New products made from bio-based materials will contribute to the company's goal to drive 25% of its revenue from non-depletable resources by 2010.
Back To Basics
Ultimately, mitigating rising raw material costs may simply mean cutting costs in other areas, such as in services, where price increases have been less extreme than in raw materials. One thing is certain, however: Any manufacturing strategy for raw materials that simply rests on waiting for costs to return to "normal" is doomed.
While raw material prices may ebb and flow -- the "what goes up must come down" theory -- "you're not going to see $30 oil prices again," Ariba's Furey opines. "I do think we've hit a new norm, much like in the late '70s with gasoline prices. You saw that spike -- it's not going to give it all back. And because many of those raw material markets are dependent on [petroleum] markets, either for powering their plants or shipping their goods or just the base raw materials that go into making things like plastic resins, they're seeing the same paradigm shift up to a higher-priced level."