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Raw Materials: Raw Deal

June 7, 2007
Raw materials prices continue to cut into profits, and with little relief in sight, manufacturers are solidifying supplier relationships and turning toward substitute products as solutions.

Scrap thieves are risking death by electrocution to obtain precious metals. Copper miners in Peru went on a five-day strike in April, demanding a greater share of record profits. And in a chemicals-cost report released in May, consumer products giant Procter & Gamble Co. offered an ominous warning regarding the future of U.S. manufacturing if chemicals prices keep increasing. The reason for all these activities is rising raw materials prices, and manufacturers continue to grapple with what seems to be a never-ending trend.

In fact, P&G predicts "wide-reaching losses" for U.S. manufacturers unless the federal government loosens restrictions on the exploration of natural gas, a critical raw material in chemicals used in many P&G products. Some of these losses could include reduced research and development efforts, as costs increase faster than manufacturers can implement process improvements or technology-based solutions, notes Keith Harrison, P&G's global product supply officer, in a forward to "The Hidden Backbone of U.S. Manufacturing: Weakening Under Chemical Cost and Supply Pressures," authored by AMR Research and the National Association of Manufacturers (NAM). In the report, 90% of the 165 respondents say they're experiencing chemical cost increases, including 62% who say the increases are substantial.Some manufacturers are responding with plant shutdowns and increased offshoring, according to William Canis, acting president of The Manufacturing Institute, the research and education arm of NAM.

"There are a lot of chemicals that are made with oil, but a large chunk of feedstocks come out of the natural gas sector," Canis says. "It's one reason why Dow [Chemical] has shuttered a lot of plants and is building no new ones." Dow Chemical has closed 20 plants in recent years, partly because of rising U.S. energy costs, according to the report. Dow also has seen energy costs increase from 29% of its overall spend in 2002 to 50% in 2005, the AMR/NAM study concludes. At the same time, metals prices continue to increase, with copper hovering around the $7,000 per metric ton mark, compared with approximately $1,500 per metric ton in 2003. Other metals, including zinc, steel and nickel, have also risen substantially. Platinum prices rose 14% in 2006 over the previous year, partly due to an increase in demand for use in light-duty diesel vehicle autocatalysts, according to catalyst manufacturer Johnson Matthey. There is some potential good news, though. Commodity prices may be at or near their peak, says Dan Meckstroth, chief economist for the Manufacturers Alliance/MAPI, an executive education and business research organization. For instance, copper has fallen from its May 2006 high of $8,800 per metric ton, and steel also has likely reached its peak price, according to Meckstroth.

"We have a number of things in the discovery phase at the moment. The ideas are to find alternatives. There's a big push toward bioethanol and biodiesel. These types of things can be leveraged a lot of different ways to look at how some of these types of processes might be used in basic chemistry."
Joe Breunig, BASF Corp."But others like nickel and tin and uranium may not be at a peak yet," Meckstroth explains. "The reason, of course, is an unprecedented demand from China, which is sucking up all kinds of raw materials and then manufacturing things and shipping them back to the U.S., Europe and Japan -- at a time when the mines have gone through a long period of consolidation and reduction." While P&G is lobbying lawmakers for policy change and Dow Chemical is closing facilities, manufacturers also are adopting long-term process, engineering and supply chain strategies to cope with their rising raw materials costs. The No. 1 way manufacturers are accomplishing this is by reducing the use of high-cost commodities, Meckstroth says.

In some cases, manufacturers are finding lower-priced substitutes or engineering certain metals out. As an example, some manufacturers are getting by using carbon steel, which costs substantially less than stainless steel. Others are substituting aluminum for copper, zinc and other more costly metals. When substitution or reduction isn't an option, manufacturers are examining their supplier contracts and establishing long-term agreements or buying in bulk to take advantage of price discounts.

Supply-Side Strategy

Copper price volatility makes short-term forecasting challenging for Highland Heights, Ky.-based fiber cable manufacturer General Cable Corp., which uses copper, aluminum and polyethylene in its products. But strong supplier relationships have helped the company manage pricing pressures, says Brian Schulties, General Cable's vice president of sourcing.

Part of General Cable's supplier relationship strategy includes providing lean training to vendors at the company's cost with the understanding that they'll use those tools to improve their pricing and performance, according to Schulties. In addition to price, the company measures a supplier's lead times, quality (defects per million) and technology investments.

"It comes down to much more of a long-term strategy than, What am I paying for this widget today?' It's, What am I going to pay for that widget five years from now, and what is that widget going to look like?'" he explains.

Agreements also come into play. Contract length with suppliers varies depending on order size. That means if General Cable has a multimillion-dollar agreement with a particular customer, the company may require a multiyear agreement with its supplier because of the value of the deal, Schulties says. For the most part, General Cable hasn't run into much resistance from suppliers in response to its contract requirements. If there are issues, it's typically because the supplier is experiencing stability problems.

Gorman-Rupp's manager of manufacturing operations Scott King (pictured above, at left) says the company likely gains pricing and delivery advantages by paying bills on time.For Gorman-Rupp Co., a Mansfield, Ohio-based maker of industrial pumps, gaining supplier trust trumps demands for price reductions. The company uses scrap iron and copper to produce various pump components and purchases electric motors that also contain copper, which suppliers are selling at a premium. Even so, the company isn't pressuring vendors for guaranteed price reductions.

"We aren't going to do things like what some of the automotive outfits did historically or some of the larger equipment manufacturers are doing, like asking for 5% year-over-year cost reductions on an ongoing basis," says Scott King, manager of manufacturing operations for Gorman-Rupp. "We've been very much focused on Purchasing 101. We focus on the relationship being solid for the long term."

Simply put, the company pays its bills on time, King says. "We know that gets us extra attention from a delivery standpoint, and we're confident that gives us an advantage from a pricing standpoint as well. Beyond that, we focus on just good old-fashioned negotiation." Since the company produces high-mix/low-volume quantities that don't produce high-volume profit for vendors, it seeks suppliers that are accustomed to its industry, according to King.

Like General Cable, Gorman-Rupp enhances its relationship with suppliers by helping its vendors improve efficiency. The company invites suppliers into its headquarters and shares with them a scorecard that monitors pricing, quality levels and on-time delivery. "Rather than bring folks together where the beatings occur, as some other organizations handle it, we treat it as an opportunity to get our expectations out in front of folks and fairly let them know what it is that we're asking for and give them an opportunity to ask questions and respond," King says.

In some cases, manufacturers may consider bringing suppliers on board with their research and development operations to help reduce costs, says MAPI's Meckstroth. "That's primarily what they do -- work with the supplier, get them involved in the engineering process so the supplier can help develop new products." The supplier also can help determine where the manufacturer is using too much of a particular material.

Alternative Actions

Even with supplier cooperation, manufacturers still face pricing pressures that are beyond their trading partners' control. This is when manufacturers turn their attention toward alternative materials and creating in-house efficiencies.

Florham Park, N.J.-based BASF Corp., the North American affiliate of chemical giant BASF AG, is exploring several different options to address rising raw materials costs. In addition to chemicals, the company produces plastics, coatings, agricultural products and fine chemicals.

BASF has raised prices on several products in the past few months because of "unprecedented costs for raw materials." To offset rising energy costs, the company has integrated, or co-located, several plants so that waste streams at one plant are transferred into fuel for another facility, says Joe Breunig, executive vice president and president of market and business development for BASF Corp. As an example, the company's Freeport, Texas, acrylic acid facility generates large amounts of heat that are captured and used to produce steam that's supplied to another plant.

Another way BASF hopes to mitigate raw materials costs is through the development of alternative raw materials. The company has five major R&D growth platforms, three of which directly address the raw materials situation, Breunig says. They include testing of plant biotechnology and industrial biotechnology, which will not only address traditional raw materials costs but energy sources as well.

"We have a number of things in the discovery phase at the moment," Breunig explains. "The ideas are to find alternatives. There's a big push toward bioethanol and biodiesel. These types of things can be leveraged a lot of different ways to look at how some of these types of processes might be used in basic chemistry." Most of the company's biotechnology efforts have been focused on the agricultural side of its business.

While composite materials are always a possibility, the reality is some of them have experienced the same cost increases as traditional products, says King of Gorman-Rupp. That being said, it's unavoidable that some costs will have to be passed on to customers. If that is indeed the case, Tom Seymour, vice president of marketing and sales for Gorman-Rupp, says his company will need to focus on providing additional value to the customer so the higher-priced products are "somewhat more palatable."

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