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Auto Focus

By Melissa Anderson
Vice President, IRN Inc.
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The auto industry is making its way up out of the trough, but what impact will the price of raw materials have on its recovery? IRN is projecting that North American light vehicle production will be up 5 percent in 2011 over 2010, which was, in turn, up 38 percent over 2009. As industrial production has recovered, however, so have the prices of its inputs. That is all right, to a point, but as we set out to conduct our third IRN Material Pricing Survey, we were curious to see what suppliers have been seeing. Will this trend throw a wrench into the recovery that many suppliers have been experiencing?

On average, 34 percent of the suppliers responding to our survey said that they expect prices of their primary raw material to increase 1-10 percent in 2011 as compared to the average price paid in 2010. Another 35 percent see increases of 11-20 percent coming. Sixteen percent of respondents said 21-30 percent would be the range of additional costs for their purchases, and the last 10 percent are bracing themselves for price increases in their purchased raw materials of more than 30 percent. Virtually no one had any hope that prices would go down this year. The biggest increases are expected in plastics, rubber and copper, which are expected to command higher prices at a faster rate than steel or aluminum.

What happens when material prices go up? Attorney Rick Paige of Bush Seyferth & Paige PLLC explained to the audience at a breakfast briefing for the Original Equipment Suppliers Association on the IRN survey results, you could be out of luck. As he put it, the general rule in contracting is that the seller is obliged to supply the buyer’s requirements at the specified price, in the agreed-upon quantities, for the duration of the contract. If your costs increase significantly, that’s just too bad. The fact that a contract has become unprofitable does not mean that the supplier does not have to fulfill the requirements anyway. Suppliers can take legal action to argue about changed circumstances or defects in the contract, but a much better approach is to minimize risks at the outset.

One option for a supplier, according to Paige, is to negotiate a supply agreement for inputs that mirrors the risks it has assumed as the purchaser of raw materials. Another option that appears to be favored by many automotive suppliers is to attempt to work with the customer to negotiate an agreement that will adjust their component prices according to what is happening with raw material prices. This involves using a commodity price index from an appropriate source as an external data benchmark to measure price changes as some specified interval. Developing the details of a price adjustment mechanism in advance can be much more attractive than duking it out later, although that might be a matter of personal preference.

Automotive suppliers responding to IRN’s survey showed quite a range in their responses to the question of how much of their contracts are protected by cost recovery provisions. Suppliers using aluminum were most likely to have a large percentage of their business protected, with 50 percent of respondents saying over 75 percent of their contracts were protected. Approximately one-third of the steel and copper users also had at least 75 percent of their contracts covered by a provision to re-coup rising material costs. The figures were quite different for companies involved with components using plastics, rubber and other raw materials, however. More than half of these survey respondents said that none of their contracts carry these protections.

When we conducted our first survey in June 2008 on how companies were dealing with the rapid rise in raw material prices, it was clear that suppliers of steel components were severely stressed. At that time, 96 percent of the steel-using respondents said that they had experienced price increases over the prior three months that were significant enough to require relief from their customers. Our sense is that those companies emerged from their trial by fire better equipped to deal with future volatility of their raw material. While there have certainly been periods where resin prices are problematic, it appears that companies using plastics have been less active in their recovery efforts.

Every supplier is facing increased costs this year. Some are better prepared than others to deal with the situation. As Kim Korth, president of IRN, said at the OESA presentation in June, if you are not consistently and actively looking to at least share the cost of increased raw materials with your customer, you should be. To protect your financial health, don’t be tempted to avoid tough conversations with your customer by just absorbing all the increases.

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