Coping Strategies — Rising Cost Of Commodities

OVER THE last couple of years, there has been much media attention given to price increases in commodities, particularly oil and other energy- related expenses, even as the economy has continued to strengthen. These increases have had an impact on the cost of doing business for just about everyone, and manufacturers, including those in the graphic communications industry, have certainly not been immune.

As a result, we have seen price increases from the manufacturers of ink, plates and other consumables that many print service providers find difficult to pass along to customers due to the highly competitive nature of the industry.

Since it seems unlikely that prices for consumables and other raw materials utilized in the manufacture of print will decline, or even stabilize in the near term, it is helpful to understand the reasons behind these rising costs, and to consider ways in which the graphic communications service provider can address their impact on margins and the overall health of the business, while still remaining competitive in the marketplace.

The Facts
Since 2000, the consumer price index (CPI)—or inflation rate—is up about 18 percent, or about 3 percent per year. During that same period, commodities prices were up by 29 percent, or about 5 percent per year. Even the core CPI, which excludes food and energy, is up about 18 percent, indicating that many of these higher commodities prices are not being fully passed along to final buyers.

The cost of materials is being driven up by rapidly growing worldwide economies and the slow rate at which new production capacity is being added to meet growing demand. In particular, there is increased new demand from Asia causing an imbalance in supply and demand. Add some geopolitical tensions to the mix, and you have a situation that is hard for many manufacturers to cope with or predict.

Keep in mind that for commodities, or raw materials, such as petroleum, silver, aluminum and others, prices are determined by the market, largely based on supply and demand. Manufacturers that use these raw materials rarely make a profit on the commodities themselves; their margin is generated by transforming the raw commodities into something businesses and people use, such as converting aluminum to a litho sheet and, ultimately, to a printing plate. How effectively those manufacturers manage their manufacturing process and its costs determines how much margin is achievable from the end product.

Meanwhile, we see the sellers of those commodities—the oil companies, for example—making what seem like huge profits as prices escalate. According to Arve Sund, senior vice president of the lithography business unit of Hydro Aluminum, the world’s largest provider of aluminum litho sheets, there is more demand than supply because of the huge growth rate in Asia. “We have an infrastructure which has been adjusted to a certain world demand that has now suddenly changed,” he says.

“In order for the infrastructure to adjust to the new demand, you have to build new capacity, and that takes time. That means that we have to live with higher prices but, at the same time, make investments in new capacity.” Sund points out that higher profit levels are generated when the market drives prices up, yet the infrastructure costs are based on a lower historical market price.

Other parts of the supply chain are not faring as well, especially in our industry. Suppliers to the industry have been unable to pass along all of their cost increases to their customers, reflected in less robust financial performance.

Energy
Energy products have been leading the way in commodity price increases. While the CPI is up by 18 percent, energy prices are up as much as about 10 times that rate. Liquefied petroleum gas is up 168 percent since 2000, and refined petroleum products are up 187 percent for the same period, as reflected in the table to the right.

This has far-reaching effects on the cost of everything, from the manufacturing process itself to the transportation of goods to their ultimate point of use. The difficulty that manufacturers of consumables have in passing along increased costs to their customers can actually have the effect of decreasing capacity as companies strive to remain profitable.

“Although the absolute pricing level of paper hasn’t been at historic lows,” notes Greg Gibson, vice president of commercial print and imaging papers at International Paper, “margins have declined significantly because input costs—energy, chemicals and wood—have risen so dramatically. And that caused a shakeout in the paper industry, leading, in the third and fourth quarter of 2005 and into 2006, to an unprecedented amount of capacity being permanently shut down.”

Also consider that the cost to manufacture ink, as well as the polyester base used to make photographic films and printing plates, has risen with the price of petroleum.

Metals
Metal prices have skyrocketed as well, headlined by the dramatic increase in the price of gold. More relevant to our industry are aluminum and silver. Silver, a critical component of photographic products, is up 158 percent since January of 2000, almost nine times the CPI rate (as shown above). Although aluminum costs have not escalated as rapidly, they are still up 71 percent since December 2003.

Aluminum is energy-intensive to process but, unlike many other commodities, it can be virtually 100 percent reclaimed after use and recycled into new aluminum-based products. Prices for scrap aluminum have also risen, somewhat offsetting the increased cost base for companies that aggressively recycle aluminum.

Additionally, companies like Hydro Aluminum typically generate their own power for their manufacturing plants. Sund shares an interesting perspective: “At the moment, we are building a huge smelter in Qatar using gas as the energy source. To build smelters today in high energy-cost countries is not a very interesting proposition. If you manufacture in Qatar, you transform the lower-cost local gas to aluminum. It is a way of exporting energy and maintaining reasonable margins.”

Paper
Prices for paper and the wood pulp used to make paper have grown at a rate less than the CPI. Most prices rise when there is increasing demand, and this most likely reflects that there has not been a significant increase in worldwide demand for paper products—although that supply/demand balance could quickly change in light of the reduced capacity that IP’s Gibson highlighted.

Sund adds, “We have been in a 10-year period where [commodities producing] companies have worked toward productivity increases every year, historically absorbing cost increases. But, today, the increases that come from energy are so enormous that you can’t achieve enough productivity gains to absorb those costs.”

For the graphic communications industry, the picture may be somewhat brighter. First, as an industry we have increased productivity by cost center fairly effectively, but those islands of automation have delivered about all that they can. Now connecting those islands is an area that could generate significant productivity gains that can decrease overall costs and make our businesses more competitive.

By investing in print MIS solutions and workflow, productivity gains could potentially be exponential. Additionally, by moving to processless platemaking, graphic communications service providers can reduce costs by removing chemistry and energy-intensive developing, as well as time, from the platemaking process. It goes without saying that if you are still using film-to-plate, a move to CTP is becoming a necessity.

Another area of opportunity for the graphic communications service provider is supply chain management; that is to say, improving the process by which you work with your suppliers. Suppliers are busy improving their supply chain management practices in a number of ways to gain added efficiencies.

According to Mark Levin, president of Sun Chemical, “Every industry has been hit dramatically by consumables cost increases, mainly tied to petroleum. To offset that, we look at all of the dynamics to find ways to eliminate duality. We give a lot of thought to how to move product more efficiently by using full truckloads, minimizing shipments and managing the way we take shipments from our suppliers.”

Likewise, there are significant opportunities for graphic communications service providers to improve supply chain management by working closely with key suppliers to improve efficiencies. This can often result in more favorable pricing in recognition of the costs savings the supplier can realize. “Consolidating purchases gives printers leverage and their supplier some scale to be able to help manage costs,” Levin points out. “If printers take larger quantity shipments less often, freight costs go down.”

He also suggests using electronic ordering and payment to streamline administrative processes, saving time and reducing error. Levin adds that last-minute orders of small batches of product can also result in serious cost increases due to less efficient transportation methods.

And with a smaller supplier base goes the need for frequent communication. This includes making sure that the products you use, whether they are ink, plates or other consumables, are scoped properly for the job, taking advantage of online resources most suppliers make available, and standardizing where possible.

“There is no magic to it,” Levin concludes. “Suppliers want to supply as much standard product as they can and get away from specialties.” Standardization also offers synergies to the graphic communications service provider, with less inventory, fewer deliveries and reduced manufacturing setup times.

IP’s Gibson adds, “Printers should ask their paper merchant how they can buy in a manner that will lower the cost of doing business. If a printer is ordering from a merchant five days a week and getting relatively small deliveries five days a week, it might make sense to order three days a week with deliveries three days a week.”

Speaking of commodities, to the extent a graphic communications service provider can differentiate offerings and design a portfolio of products and services that solves specific and quantifiable business problems, that service provider will change the way customers think about his services.

This often shifts pricing structure to more than compensate for rising consumables costs. Graphic communications service providers who are following this strategy are reporting growth rates far in excess of industry averages. Talk to your customers. Find out what keeps them awake at night. And be creative about helping them to sleep better.

Recycling is another way to lower costs and, of course, it’s also good for the environment. As Sund points out, scrap aluminum prices are rising with the increase in aluminum prices, so recycling used aluminum-based plates is a natural, as is recycling paper scrap. If you are still using film-based processes, silver extraction and recycling is also worth the effort at today’s silver prices.

It is also important to ensure that your employees have access to adequate training, and that you work on employee retention strategies. It would be a shame to lower costs for materials acquisition only to squander those savings because employees are poorly trained.

It’s hard to say whether prices will come down. As all business managers know, costs are dynamic, and while some go down, others go up. This makes for a tough balancing act for executives, and having the discipline to manage costs requires a longer-term perspective.

Cost management at Southwest Airlines has become a weapon against larger competitors—they deliver profits despite selling tickets at lower prices. At WalMart, costs are lower than competitors not just because of their legendary ability to negotiate better prices from suppliers, but because their investments in logistics and computing have been larger, more strategic and more effective than their competitors.

As we continue to deal with increased competition in our industry, not only from each other, but from alternative media such as e-mail and the Web, we don’t have the luxury of simply raising our prices. But by deploying some of the strategies discussed here to reduce costs and to increase your value to your customer base, you can improve your profitability in spite of today’s challenges. PI

About the Author
Dr. Joe Webb is one of the industry’s best-known consultants. A veteran of the graphic arts industries for almost 30 years, he recently launched PrintForecast.com, a blend of data and advisory services for industry executives. Webb also writes for WhatTheyThink.com, where he analyzes trends in the economy, technology and industry.