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Auto Focus

By Melissa Anderson
Vice President, IRN Inc.
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“Commodity price increases threaten profits again,” said a headline in a recent issue of the automotive trade magazine Automotive News. That may be true, but IRN’s recently completed survey on material pricing indicates that the level of concern in 2010 is much lower than it was during our inaugural survey on the subject back in mid-2008. The following is a brief summary of findings from the June 2010 IRN report, Industry Update: Dealing With Volatility in Raw Material Pricing. The report presented the results compiled from 202 surveys received from 170 companies buying a wide array of raw materials including steel, aluminum, plastics, copper, rubber and others.

There is evidence of rising material prices. The majority of survey respondents (almost 60 percent) are expecting material price increases of between 1 and 20 percent for 2010 compared to the average price paid in 2009. Input costs are on the move once again, but these are relatively modest price increases.

Many suppliers took precautionary measures to protect their near-term material requirements. After enduring the extreme and rapid increase in material costs in mid-2008, suppliers developed an acute awareness of the hazards that volatile material pricing and supply can pose. To the extent possible, they have sought measures to insulate themselves from these risks. For example, almost two-thirds (65 percent) of the respondents had contracts in place to protect first half 2010 material requirements.

Material shortages required some suppliers to make spot market purchases. Approximately 35 percent of respondents reported that their company experienced material shortages in the first quarter of 2010 due to material suppliers putting these customers on allocation. Steel and plastics were the most commonly shorted materials, however, electronic components/semiconductors and nickel were also noted as particular problems.

Cost recovery provisions are a popular form of insurance and relief. A significant percentage of survey respondents, 39 percent, indicated that more than 50 percent of their material contracts are protected by cost recovery provisions. Twenty-seven percent have protection for 50 percent or less of their contracts, and 34 percent of respondents did not have any protection on material contracts. This pattern of a concentration at the high and low ends indicates that suppliers either had a significant portion of their needs protected by contracts or none at all. Most suppliers would benefit from some form of protection, though, since a significant number, 63 percent, of respondents are seeking material cost recovery from at least one customer.
Index-based adjustments are still the preferred solution for suppliers. Suppliers are using a number of methodologies to address the problem, but the most common one is the index-based adjustment, which ties the component price to the movement of the raw material price.

The survey results suggested that fewer suppliers are feeling the need to take aggressive action as a result of extreme circumstances. For example, only 12 percent of respondents in the 2010 survey stated that they would be willing to stop shipments if they did not receive relief, compared to 25 percent of respondents in 2008.

So, are material price increases now a known and manageable risk? After all, only 10 percent of our survey respondents are anticipating increases of more than 30 percent. Thinking back to the behavior of steel prices in particular two years ago, this seems like a much more moderate climate. Suppliers don’t have to worry. Or do they?

IRN’s analysis indicates that, going forward, we will see much greater volatility in vehicle sales and production. The period from the early 1950s to the early 2000s was characterized by cycles within a fairly narrow band of variability, but since then we have seen sharper and steeper changes in the automotive market. This will make it more difficult for suppliers to manage their business, and obtaining the appropriate amount of raw materials at predictable prices is likely to be difficult. For many suppliers, availability is a much bigger issue than pricing. The lessons learned from the past couple of years suggest that suppliers need to stay on top of material price trends and be proactive in addressing these with customers.

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