Sorting Through the Commodity Price Boom
By now, chances are that even your elderly grandmother has complained about rising commodity prices—from the cost to put gasoline in a car to the surcharges that some transportation companies and airlines are levying on top of base pricing. Fueled by massive economic growth in emerging countries, commodity prices have boomed across the globe in the past year. In the U.S., steel prices alone have increased 60%. Prices for oil, scrap, copper, nickel and other commodities are way up as well.
Economists agree that demand from China has been the largest contributor to the rising prices. Today, China alone consumes 36% of the world’s steel, fueling the manufacturing engine that is driving tremendous commodity price inflation in the region and globally. The People’s Bank of China, the country’s central bank, recently reported that prices for copper have increased over 40% in China in the past year, while aluminum is up almost 80%.
What’s most interesting about the rise in commodity prices this time around is that pass-through price increases to end-consumers are greatly overblown. While grandma loves to kvetch that her social security check does not go as far as it once did, she’s most likely just airing her complaints for the sake of it. In fact, prices of household consumables have stayed in check in most world markets—and are down in some cases. In China, despite the massive inflation in underlying commodities that we’ve highlighted above, the price for consumer appliances actually fell 3.2% year-over-year, while the price of automobiles dropped almost 10%.
What does this mean lor the U.S. economy? For the most part, we believe that the commodity price boom is overblown and will be short lived—thanks to free market reforms since the 1970s, the world economy is far more resilient than it ever has been before. And even in the near term, the impact on the U.S. economy will be confined to certain sectors. Today, manufacturing is only 15% of the U.S, economy, and commodity prices represent “a much lower percentage of GDP (Gross Domestic Product) than they did, say in the 1970s,” according to Forbes.
For companies like Delphi, which spend nearly a billion dollars a year on steel, near-term commodity inflation will significantly impact the bottom line. And market dynamics have changed this time around: historically, manufacturers would often pass on commodity inflation costs to their customers, who would in turn pass on costs to consumers, driving overall inflation. But in today’s increasingly competitive economy, passing on costs is not always an option—especially when a low-cost supplier in an emerging market region has a significant labor cost advantage.
Instead of seeking government assistance, manufacturers should look at rising commodity prices as an opportunity to evaluate their overall strategy. We believe that manufacturers should look at the current situation as an opportunity to:
- Become more efficient and source more competitively (especially in areas where labor costs and machine time have a larger impact on total cost). Try to get suppliers to quote commodity prices separate from labor and machine time
- Build price fluctuation hedges into contracts with suppliers―by following step 1 above, create clauses that allow you to benefit when commodity prices also come down
- Check pricing strategies to customers―seek to eliminate loss-leading SKUs or parts. If you sell uncommon parts to the aftermarket, look to increase pricing
As we’ve said on this page many times before, tough economic challenges are not an excuse to whine to Uncle Sam to change policies that support free market growth and opportunity. We’d all be better off if me lobbying dollars manufacturers spend on buying political favors would go to improving their underlying business strategies rather than the fat cats on K-Street.