03/14/2011

Oil Prices Spark Cost Challenges for Distributors, Manufacturers

Oil prices continue to have an impact on NAHAD members' bottom lines through increased transportation costs and spiking commodity prices.

A barrel of crude oil has hovered around the $100 mark recently, pushing fuel prices up to nearly $4 a gallon in some areas of the U.S., averaging $3.52 a gallon overall. Diesel was at $3.87 a gallon as of March 7, 2011, inching up over $4 a gallon on the West Coast and in New England.

Michael Lentz, vice president of regional industrial and rubber hose distributor Rubber and Specialties Inc., Pensacola, FL, said that he estimates that for every 10 cents the price of fuel goes up, it costs his company $100 a month to run his five vehicles. Considering average industry margin, he has to sell $5,000 more in product to make that $100 back at the end of the year.

But while fuel costs are a concern, increasing prices due to raw material volatility are an even bigger challenge for the industry. Thanks to oil price-induced rising costs for rubber and plastic products, distributors are being hit with price increase after price increase as manufacturers work to recoup their costs. While most are used to one to two price increases a year, some distributors recently have been hit with monthly or much more frequent increases. In some cases, distributors have even seen weekly increases depending on market conditions. "To my knowledge, that's unprecedented," Lentz said.

In a recent survey from Modern Distribution Management (MDM), more than half of respondents - distributors and manufacturers - expect price increases of 1 percent to 5 percent from suppliers over the next six months. About 35 percent expect an increase of 6 percent to 10 percent. By sector, water & sewer and electrical expected the largest increases.

In the March Manufacturing Report on Business from the Institute for Supply Management, survey respondents in 13 industries reported increased prices. About 66 percent of respondents reported paying higher prices and just 2 percent reported paying lower prices in February than in January. Manufacturers in the Plastics and Rubber Products industry were among the 13 industries reporting paying increased prices.

Manufacturers, who are raising prices in response to increases from their vendors, recognize these price increases are a challenge for distributors, who in the end have to pass them on to their customers - if they can. Distributors sometimes cannot pass on the increases all at once; instead they have to pass them on in waves, or they have to wait until a contract expires before they are allowed to raise prices. "Distributors have the hardest job," said Steven Gray, general manager of Manuli Hydraulics (Americas) Inc. in Pennsylvania.

"Unfortunately for us, it's not quite as easy to pass those price increases onto our customers," Lentz said.

Lentz said that after the last spike in oil prices - in 2008 - a customer asked him to lower prices again. But Lentz was honest with his customer about his increased costs and when and how his costs were being recouped. "Ultimately I didn't roll the prices back because I'm not getting the prices rolled back for me," he said.

Distributors often have to decide whether a customer relationship is at risk if they raise prices. That said, both Lentz and Gray said that customers, distributors and suppliers are all seeing the same rising costs, which is making price increases more palatable. "It's a universal problem in our industry," Lentz said.

Some manufacturers are helping distributors sell price increases to their customers with a justification letter outlining why prices are going up on certain items. In some cases, this has helped reduce pushback at the end-user level. With double-digit increases in some areas, customers are more likely to reevaluate their supplier base. "Anytime you're evaluated as a supplier you're at risk of losing the business," Gray said.

Many respondents to the MDM survey said they plan to pass on the price increases. Others plan to just pass part of the increase on, or to increase prices over time rather than all at once. One respondent said that he may add his own price increases to cover his growing costs, in addition to passing along supplier price hikes. Some distributors said they are going to pass on increases just for specialty or niche products.

Other strategies for dealing with the increases across sectors include trimming inventories to reduce exposure to price increases; increasing internal efficiencies to support margins; and supplying lower-cost, alternative solutions in "certain competitive situations."

Brent Grover, managing partner of Evergreen Consulting, said the decision to pass on price increases often lies with the salespeople. But he says salespeople often are reluctant to pass along increases unless they are confident their competitors are also passing along those increases.

"It could be devastating to the company's profitability to fail to pass along an increase, especially if there are a series of increases going into effect," Grover said. Increases should be implemented systematically, and distributors should actively manage margins as costs go up and down, he said.

Manufacturers and distributors can work together to mitigate channel conflict in price communications, according to Kevin Boyle, president of Industrial Distribution Consulting LLC. He offered these tips:

• Provide ample time for distributors to update their systems with the updated prices before they go into effect, if possible. "I think that's where most of the friction between a manufacturer and a distributor takes place," he said. What's more, a distributor is dealing with price changes from multiple manufacturers, compounding the administrative challenge.
• Consider overall market conditions. "Manufacturers need to have a sense of how the market will respond at different percentage increases," Boyle said. Some manufacturers have used surcharges as way to minimize the impact of price increases by making them appear temporary, though these surcharges usually turn into price increases at a later date.

And finally, a manufacturer should view the distributor as a partner, and work with them to make it easier to pass the price increases onto the end-user.