Skyrocketing Raw Material Costs Force Manufacturers to be Innovative

By barb schmitz | Published: April 21, 2011

The manufacturing industry is finally showing some signs of life, expanding at the fastest pace since 2004. The Institute for Supply Management (ISM) reports that its manufacturing gauge rose to 61.4% in February, up from 60.8% in the prior month, marking 19 consecutive months of growth. That’s good news, right? Well, yes, and no. Though overall the statistics are promising, the increased cost of oil and raw materials is making the overall picture a bit less rosy.

As the cost of oil continues to skyrocket amidst continued political instability in the Middle East, the cost of raw materials has also increased considerably. Expanding economies in Asia and Latin America are generating greater demand for raw materials, boosting prices.  These rising costs are causing manufacturers to make changes to avoid having to pass along cost increases to the recession-weary market.

The record-high cost of copper has forced manufacturers of products such as cars, air conditioners, commercial refrigerators, and industrial components to switch to another electricity-conducting metal: aluminum, a much cheaper metal.  The cost delta between the two is enough to justify the costs of retooling some manufacturing processes and pay for the additional aluminum it takes to conduct a comparable amount of electricity.

Such substitution has been on the increase over the past decade as demand from China and constrained mine supply have pushed copper prices upwards. If this trend continues, aluminum could end up being substituted for 20% of the global 19-million metric ton annual refined copper market, according to aluminum maker Alcoa Inc.

Other base metals—essential to the manufacturing industry as a whole—are also increasing in price. According to the ISM, commodity prices in the primary metals sector are rising across the board. Aluminum and steel prices have been rising for six straight months, and copper for seven straight months. A very common grade of steel that not long ago sold for $520 a ton today would cost $740, up 42 percent.

As the economy improves, the demand for raw materials, such as steel, strengthens and supports higher prices. Bottom line: inflation of raw material costs could cause the manufacturing industry to experience a slowdown. So how can manufacturers deal with higher raw materials costs without passing along those costs to customers in the form of higher prices?

“The challenge is going to be to offset the increase in commodity prices through either increased productivity, expanding volumes, or price recovery,” says Nobert Ore, chairman of the ISM’s factory survey. “You try to work all three of those levers. No one wants to raise prices to their customers or they will kill demand.”

Overall manufacturers have become very adept at cutting labor expenses by boosting efficiency to combat increasing raw material costs. According to the U.S. Labor Department, factory productivity climbed four percent from the third quarter of 2009 to the same period last year, and year-over-year gains in productivity for all companies peaked at a 48-year high of 6.3 percent in the first three months of 2010.

One way manufacturers can reduce their use of raw materials is my optimizing their designs using finite-element analysis (FEA) software. By analyzing their designs using FEA tools, product designers can “lightweight” their designs, finding the optimum material thickness needed to save on materials costs, without sacrificing the product’s structural integrity.

There are other tactics to deal with price fluctuations in raw materials costs, but some come with risks. Some manufacturers will search for new suppliers that allow them to maintain revenue targets, which often means outsourcing to lower-cost economies. The downside: near certain disruptions in the supply chain. Another tactic involves buying raw materials in bulk, which can provide extra leverage when working with a supplier.

Another way to weather raw material increases is to concentrate on building close, collaborative relationships with all of your suppliers. The stronger the relationship, the most likely the chance of compromising with them to reach fair price balances that benefit everyone.

Aggregate buying of raw materials is another strategy to weather raw material fluctuations. Smart manufacturers work to lock in raw material prices that can protect not only their own company from price fluctuations but for their suppliers as well. Developing these types of relationships to leverage aggregate buying power helps to insulate the entire supply chain from volatility and skyrocketing costs.