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Raw Materials & the Recovery

The theme for suppliers should be to try to make material neutral in your relationship with customers.
The subheading of the IRN Materials Pricing Survey report published in June 2011 was “Will Raw Materials Help or Hinder Continued Recovery?” How could raw materials help the recovery? By being untroublesome: being priced as expected when suppliers were preparing their quotes; being available to be converted into components in the volumes required by the strengthening automotive market. The ways they could hurt are through volatility, scarcity, and by consuming more than their share, much like having a difficult teenager around the house. From the perspective of suppliers responding to our survey, raw materials have been somewhat problematic, and are expected to get worse before they get better.
 
To some degree, we have to cut raw materials a little slack. We tend to think of raw materials in terms  of steel, but the steelmakers would point out that their own ingredients, particularly iron ore, were the driver of much of the high pricing earlier in the year. The need to bring capacity back up after the economic downturn also create a constraint that pushed prices up. For plastics producers, there have been similar difficulties with feedstocks driving up costs of resins. As manufacturing levels improve, the demand for raw materials drives prices higher. With North American light vehicle production projected by IRN to be up 45% this year over 2009, it is not surprising that there will be a period where demand and supply needs to get re-adjusted to more typical volumes.
 
The respondents to the IRN survey were almost entirely of the opinion that the prices of material inputs were likely to increase in 2011 compared to the average price paid in 2010. The only question was one of degree, and that varied by the type of material. Steel, the bedrock of automotive production, was primarily expected to increase moderately, with 45% of respondents saying that the price increase this year would be in the range of 1% to 10%. Another 32% of respondents envision increases of 11% to 20%, though, and some think it could be higher. The pattern of expectations for users of aluminum was very similar. In other materials, such as plastics and rubber, the respondents are bracing themselves for higher jumps in price. For plastics, 43% of respondents foresee higher prices of 11% to 20%, and another 15% expect prices to go up 21% to 30%. Ten percent of the respondents believe that the average price they pay for plastics could be more than 30% over 2010’s price.
 
In terms of availability, when asked whether their company had experienced material shortages during the first quarter of 2011, 70% of respondents said no. The 30% who said yes indicated they had been put on allocation and could not obtain all that they needed. It should be noted that this represented a full range of materials. There was no sign in our survey results that a particular material would throw a wrench into the ability of the industry to recover. A small percentage of respondents, 9% overall, said that they are currently in a force majeure situation with a material supplier. “Force majeure” means “superior force” and it is sometimes used as an excuse for not performing to a contract. As a side note, in the opinion of our colleague Dan Sharkey, attorney with Brooks, Wilkins, Sharkey & Turco LLC, force majeure has been much overused in the first half of 2011. A variety of events this year—e.g., a tsunami and numerous tornadoes—have brought it to front of mind as a tactic, but Sharkey says that a good purchasing agent will push back on a supplier trying to use it. For the companies responding toour survey, the most typical effect was that the raw material supplier unilaterally adjusted price and/or volumes. That is the kind of incident that makes it difficult to manage your own business.
 
And that is really the crux of the issue: How you manage your business. Broadly speaking, raw material prices should be expected to affect all suppliers similarly. Whether raw materials help or hinder the automotive recovery, as we posed the question in our survey report, depends to a great extent on how individual suppliers handle them. To begin to determine how they are doing, the IRN survey covered topics on the nature and methods of cost recovery with customers, what tools suppliers are using to re-coup material cost escalation, and how they are interacting with customers (whether Tier Ones or automakers) on the subject. The range of responses indicated that for many suppliers, there is room for improvement in protecting their profitability in an environment of rising raw material costs.
 
It appears from the survey that material recovery negotiation is still highly subjective and dependent upon the specific relationship a supplier has with its customer, as well as the contract that governs it. Looking at the survey results, IRN president and founder Kim Korth said, “The theme for suppliers should be to try to make material neutral in your relationship with customers. I’m a little concerned that people are starting to rationalize, ‘I’m making more money, so I’ll just absorb the increases.’ If you are not consistently and actively looking to at least share increased raw materials costs with your customer, you should be.” The current trend in material prices has the potential to de-rail some of the progress that has been made in the financial health of the supply base, unlesssuppliers are vigilant in managing this issue. 
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