Pumps & Systems, December 2008
In the past year, the rate of acceleration in the cost of raw materials (including steel, iron ore, copper and aluminum) has reached unprecedented levels in the pump and rotating equipment industries.
According to the U.S. Bureau of Labor, from June 2007 to June 2008, the prices of steel-mill products increased 30.4 percent (a sharp spike, but minimal compared to the 105.6 percent cost increase of crude petroleum). Iron and steel scrap prices increased 96.9 percent during that time period, while diesel fuel jumped 85 percent. The Bureau of Labor predicts that in light of the growing worldwide demand for products such as steel and petroleum-driven by India, China and other surging economies-it is unlikely prices will decrease much, if at all, anytime soon.
The material prices must be passed on to the consumer, industry experts say, which adds even more inflationary pressures to the already volatile global economy.
"It's all about margins, and the big piece of the cost pie affecting margins for standard type pumps is material costs," explains Martin Perlmutter, president of Ebara Fluid Handling (USA). "We are not insurance brokers. We don't walk around with a portfolio and a pen and build up premium costs à la carte. We produce manufactured hardware. Our raw material costs keep going up and up and few of us can raise prices as fast as these costs are rising. You can't keep up with it. Outsourcing for lower material costs adds higher freight costs, with often fluctuating currency exchange making the situation worse.
"The old pump sales adage of making it up on volume doesn't work when cost approaches or exceeds market sale price."
Perlmutter and other pump industry experts clarify that there is a difference between standard and custom pumps. Custom pumps by application are built for demanding liquid handling services that need value added features and accessories. Long term residual parts in "engineered" pumps can actually compensate for initial high material costs. With the many choices available for standard pumps, price and local delivery become the key buying factors. Brand image and service certainly help elevate standard pump pricing, but generally the customer only wants to know how much it costs and how fast it can be delivered, experts explain.
The motor industry meanwhile has taken a huge hit from the increase in steel prices. Transferring the information to the consumer can be challenging. "For motor manufacturers and pump manufacturers, I think the message is that we are really not trying to make a quick buck on anybody here," says Randy Breaux, vice president of marketing for Baldor Electric Company. "We have an extraordinary situation with rising material costs that have to be passed on to the consumer. We are trying to do that as fairly as possible and as minimal as possible.
"The reality is that we cannot absorb it. These rising costs have been unprecedented, at least in the last decade."
Even with the necessity to pass along the increases to the consumer, it is difficult to recoup it all, says Keith V. Tipper, vice president/business leader for Leeson Electric, a Regal Beloit company. "There have been instances where our steel suppliers have come to us and said, ‘Here is the price going forward. If you don't want to pay it, fine. People behind you who want your steel are buying it today at market spot. Take the price increase or not.' Of all the price increases we have charged, we still have not captured 100 percent of inflation.
"We have a business with customers on contract . . . we have what are called MPFs (material price formulas). We have to exercise a material price formula that is associated with copper or steel and whatever the ups and downs will be, this will be the increase. But some of our customers are on 60-day, 90-day or 20-day contracts. So we cannot raise their price until that time. So it is not instant. It is very difficult."
In 2007, U.S. hot-rolled steel cost around $400 per metric ton. According to industry newsletter World Steel Dynamics, the cost had risen to $1,154 per metric ton by mid-May 2008. This spring, many steel companies raised prices. Many companies are also implementing surcharges to cover raw material costs.
For almost two decades, the price of iron ore barely moved. That began to change in 2001 when the Brazilian iron ore companies negotiated a 71.5 percent increase from Japanese and European steel mills. Due to high shipping costs, it became significantly cheaper for Asian companies to buy iron ore from Australia. The price increases have continued. In 2008, for example, the Brazilian producers agreed on a 65 percent increase.
Even steel producers who use scrap metal instead of iron ore are paying record prices. According to trade reports, auto factory scrap sold from $690 to $710 per ton in July 2008, around 70 percent higher than in March.
Another factor in rising steel prices is increased shipping costs. The Baltic Dry Index, a benchmark of freight costs for bulk commodities such as iron ore, coal and grains, has risen by more than 60 percent since the beginning of 2008 due to the surprisingly strong demand for steel.
Cost Increases, Major Steel Inputs, Past Three Years
|
|
April 2005 |
April 2008 |
Percent Increase |
|
Thermal coal |
$54.9 per ton |
$123 per ton |
124% |
|
Iron ore |
$0.65 per unit |
$1.41 per unit |
117% |
|
Natural gas |
$182.2 per 1000m3 |
$428.4 per 1000m3 |
135% |
Source: Steelonthenet.com, from the International Monetary Fund (IMF)
For the motor companies, it is not just the steel prices that continue to climb. Steel, copper and aluminum are the three primary metals used in motors, Breaux explains, with steel being by far the largest percentage. Cast iron, rolled steel frames and lamination steel prices also affect the industry.
"We have seen the prices escalate extremely fast over the last nine months here," Breaux said in July 2008. "It is to a point where they cannot be absorbed internally any longer. You have to pass those costs along to your customers. Along with steel, everybody has seen the pinch on gas prices, and we have transportation costs that come into play as well as other components we use in the processes that are petro-based.
"I have been in this business for about 25 years now, and the last time I remember seeing materials inflation to this degree was in the early 1990s. I can remember one year we were seeing three price increases per year to try to keep up with material escalation. The issue for the manufacturers is that we get very little notice from steel companies when prices are going up. We will get less than 30-day notification that the materials we are going to be buying 30 days from now are going to be 20 percent to 30 percent higher than what we are paying today. Those are real numbers, too.
"Twenty to thirty percent are the type of increases we are getting almost on a quarterly basis from the steel suppliers. And we are not in any different position than our competitors. I was listening to a conference call from one of them yesterday, and he said their steel prices were up 86 percent from the first of the year. When that is the largest component in the product you produce, it is pretty hard to absorb that kind of increase, so you have no choice but to pass it along. In fact, they even went so far as to say that they were likely going to have another price increase before the end of the year, and they just announced one about a month ago."
Informing the end user is simply a difficult reality, Breaux says.
"When you have contracts out there, you enter into them with good faith," Breaux says. "You will honor those contracts as long as you possibly can tolerate it, but at some point, either the end user or the OEM you have the contract with recognizes that these are circumstances beyond your control. Typically, you try to write something in the contract that says when circumstances are extraordinary you have the right to go back and re-negotiate.
"In our case, we pretty much only pass on material cost increases to our customers. If our health insurance and whatnot goes up, we do not try to recoup that through price increases with customers. It is difficult, particularly when you have contracts, because those customers are also in the same position that we are in . . . seeing prices escalating . . . and they have to go back to their customers and do the same thing. But it is the reality of the situation.
"We are in a period of inflation right now with these materials that is extraordinary. There are a lot of individuals that have only been in the industry for 10 or 15 years. They graduated with an MBA 10 years ago, and they have never experienced inflation like this. They say, ‘What do you mean you need a 5 percent price increase? You just had one six months ago. No.' It is difficult for individuals who have not had the histories of seeing these periods of inflation."
There was a period in the early 1990s when material increases continued to rise, then they leveled off toward the end of the ‘90s, Breaux explains. In the 1970s, oil embargos forced record inflation and the mid-1980s saw interest rates jump to record highs, which affected the industry.
"If you remember back into the early part of 2000, we had an industrial recession," Breaux says. "2001 through 2003 was pretty tough for our industry. Then a lot of companies scaled back-particularly steel manufacturing. A lot of steel mills in the United States closed down. A lot of people were following that low labor cost to China and to India and to other countries, so our industrial manufacturing base had shrunk a bit. Now you get into this period where we got into a little bit more robust economy, more global economy. China's economy is just booming. The demand for steel has skyrocketed again because of the global demands for it. So you have a shortage of supply. With that shortage of supply, here comes price increases. Right now, with the whole energy side of that, it just compounds the problem. My theory is that it goes back to pure supply and demand and the economic cycle that we are in. At some point it will level off again, but we are not seeing that right now."
Breaux explains that there is also difficulty in tracking the material increases against some of the standard commodity indexes since the motor industry uses raw materials such as steel, copper and aluminum that are further processed. "Those additional costs are not accurately reflected in the commodity indexes," he says. "You can rest assured that if the commodity index for scrap steel, copper or aluminum is on the rise, so are the processed commodity costs . . . not to mention the additional costs that fuel and other items affected by inflation have on our business."
Increasing costs for labor also plays a role, even in the lower cost manufacturing regions.
"As a percentage ratio of the dollar, labor rates have grown dramatically," says Tipper. "When I lived in India, to watch television you used to have to go into the village and there would be one TV screen hanging from a tree with a big piece of wire. It was the only TV in the whole village. Things have changed since then. The labor rates are going up. You must have material, regardless of whether you build a motor in China or India or Europe or Scandinavia or America. Material is material. There is no advantage for material. It's the cost of labor."
Some companies have invested in technology, using automation and robotics to remove the costly human labor element.
Offsetting Price Increases
There is no way to avoid purchasing materials, Tipper says, but there are some things that can be done to offset the higher prices.
"Efficiency and effectiveness is the key," Tipper says. "It is as simple as that, because you cannot get away from materials. That is not going to change. We cannot get enough material. We just can't. Who wins is who uses it most efficiently. That is where you're going to make it: quality. We work on ppms, part per million. You have to get your ppms to a level that is acceptable in Six Sigma. If you scrap it, you are wasting material. With motors, you make it, you break it, you throw it away. You can't just recycle, although certain parts can be recycled."
Taking steps toward improved energy efficiency is an important issue. Thanks to the Energy Independence & Security Act of 2007, companies without premium efficiency products will be hit hard starting in 2010.
Motor industry experts report that only 2 percent of the cost of a motor is the initial purchase price. The other 98 percent is the energy costs produced over its expected 10-year life. So the initial cost of a motor is nominal in comparison with the energy costs over a motor's lifetime.
"We are also a big believer and proponent of lean," Tipper says. "Every one of our plants, every one of our facilities, whether it is from the office through to the manufacturing, we are introducing lean into every single operation. In all our letters that we send out to our customers when we notify them of price increases, we make mention that we are still striving to implement Six Sigma/lean processes and lean tools."
Breaux says it is important for end users to realize that material prices have increased and are continuing to increase. Therefore, pump and motor manufacturers are faced with higher material costs which will have to be passed along to the consumer.
Breaux agrees with Tipper that by focusing on higher efficiency motors and pumps and considering the return rather than the purchase price is another important step toward understanding. "It is important for the consumer to make sure that when they put a system together, they are optimizing the efficiency of that system as opposed to just putting in the least expensive component for the system," Breaux explains. "Maybe it is using a variable frequency drive in that pump system now when they did not use it before. Maybe it is using a premium efficient motor where they did not use one before. Maybe it is using a different type of pump that is more efficient than what was in there before.
"I think that consumers have to start thinking along that line. If they don't, they may pay a cheaper price up front for the components, but they are going to pay a lot more money in the cost of operation, and really, that is what they need to be considering. What is the cost of ownership? What is the cost of operation? When you consider that over the lifetime of a motor, the purchase price is less than 2 percent of the total cost, why would anybody in their right mind buy the less efficient motor and save $75 when, if they bought the premium efficient motor, in one year, the energy savings alone might be $1,500?
"I think what the energy bill is going to do is force everyone to have to buy a premium efficient motor. I think the energy bill is a good thing in that regard, and it is going to force people into doing the right thing. I just wish people would be early adopters and do it on their own. Then we would not have to have the government step in and mandate legislation."
End in Sight
What is the outlook for surviving the rising cost of materials in this industry? Breaux has a theory.
"It will definitely level off again at some point. We just don't know when," Breaux says. "We used to always talk about a seven-year business cycle where you had this inflationary period and this recession . . . inflation and recession . . . and it was usually about seven years. Back when I went to school, that is what they taught us. Well, my theory is that because of the age of information now, that cycle is shorter. I think that there is still a cycle there, but I think instead of seven years it is probably in the four-to-five year range.
"So if we say right now we are at the height of the inflationary period-and let's assume we are-over the next couple of years we may see it level off and start to decline a bit. And then three years from now it might take off again. It is just my thought on it as I've watched it over the last few years. It seems like that economic cycle is getting shorter."
Steelmaking Raw Material and Input Costs
|
Year/ Month |
Thermal Coal |
Coking Coal |
Iron Ore |
Natural Gas |
Steel Scrap $/ton |
Electricity |
|
2006 M1 |
46.3 |
90.2 |
77.35 |
275.8 |
185-190 |
5.78 |
|
2006 M2 |
51.1 |
77.35 |
275.8 |
215-220 |
5.98 |
|
|
2006 M3 |
53.3 |
77.35 |
275.8 |
210-215 |
5.88 |
|
|
2006 M4 |
56.7 |
94.2 |
77.35 |
293.0 |
220-225 |
5.93 |
|
2006 M5 |
56.4 |
77.35 |
293.0 |
240-250 |
6.00 |
|
|
2006 M6 |
56.1 |
77.35 |
293.0 |
255-260 |
6.41 |
|
|
2006 M7 |
56.5 |
93.5 |
77.35 |
302.4 |
250-255 |
6.61 |
|
2006 M8 |
54.6 |
77.35 |
302.4 |
245-250 |
6.65 |
|
|
2006 M9 |
50.5 |
77.35 |
302.4 |
230-235 |
6.37 |
|
|
2006 M10 |
47.2 |
95.4 |
77.35 |
311.4 |
230-245 |
6.16 |
|
2006 M11 |
49.3 |
77.35 |
311.4 |
230-245 |
6.04 |
|
|
2006 M12 |
53.3 |
77.35 |
311.4 |
245-250 |
6.00 |
|
|
2007 M1 |
55.0 |
94.3 |
84.7 |
302.0 |
264-270 |
6.09 |
|
2007 M2 |
56.7 |
84.7 |
302.0 |
280-285 |
6.18 |
|
|
2007 M3 |
59.3 |
84.7 |
302.0 |
295-310 |
6.16 |
|
|
2007 M4 |
60.1 |
94.6 |
84.7 |
281.9 |
315-320 |
6.19 |
|
2007 M5 |
60.0 |
84.7 |
281.9 |
295-305 |
6.20 |
|
|
2007 M6 |
66.0 |
84.7 |
281.9 |
295-300 |
6.51 |
|
|
2007 M7 |
72.1 |
95.1 |
84.7 |
280.4 |
280-290 |
6.61 |
|
2007 M8 |
74.3 |
84.7 |
280.4 |
275-285 |
6.83 |
|
|
2007 M9 |
73.3 |
84.7 |
280.4 |
280-290 |
6.55 |
|
|
2007 M10 |
80.2 |
97.8 |
84.7 |
308.2 |
275-280 |
6.44 |
|
2007 M11 |
90.6 |
84.7 |
308.2 |
280-290 |
6.22 |
|
|
2007 M12 |
97.5 |
84.7 |
308.2 |
295-310 |
6.25 |
|
|
2008 M1 |
98.3 |
106.1 |
140.6 |
369.7 |
385-400 |
6.27 |
|
2008 M2 |
141.4 |
140.6 |
369.7 |
390-405 |
6.38 |
|
|
2008 M3 |
126.7 |
140.6 |
369.7 |
490-510 |
6.51 |
|
|
2008 M4 |
131.8 |
113.9 |
140.6 |
428.4 |
510-530 |
6.71 |
|
2008 M5 |
142.7 |
140.6 |
428.4 |
570-580 |
6.77 |
|
|
2008 M6 |
171.2 |
140.6 |
428.4 |
635-660 |
7.42 |
|
|
2008 M7 |
192.9 |
n/a |
140.6 |
517.0 |
630-640 |
7.75 |
|
2008 M8 |
169.7 |
140.6 |
517.0 |
385-390 |
n/a |
|
|
2008 M9 |
160.7 |
140.6 |
517.0 |
240-245 |
n/a |