The Impact of the Rising Cost of Raw Materials

In the past year, the rate of acceleration in the cost of raw materials (including steel, iron ore, copper and aluminum) has reached unprecedented levels in the pump and rotating equipment industries.

According to the U.S. Bureau of Labor, from June 2007 to June 2008, the prices of steel-mill products increased 30.4 percent (a sharp spike, but minimal compared to the 105.6 percent cost increase of crude petroleum). Iron and steel scrap prices increased 96.9 percent during that time period, while diesel fuel jumped 85 percent. The Bureau of Labor predicts that in light of the growing worldwide demand for products such as steel and petroleum-driven by India, China and other surging economies-it is unlikely prices will decrease much, if at all, anytime soon.

The material prices must be passed on to the consumer, industry experts say, which adds even more inflationary pressures to the already volatile global economy.

"It's all about margins, and the big piece of the cost pie affecting margins for standard type pumps is material costs," explains Martin Perlmutter, president of Ebara Fluid Handling (USA). "We are not insurance brokers. We don't walk around with a portfolio and a pen and build up premium costs à la carte. We produce manufactured hardware. Our raw material costs keep going up and up and few of us can raise prices as fast as these costs are rising. You can't keep up with it. Outsourcing for lower material costs adds higher freight costs, with often fluctuating currency exchange making the situation worse.

"The old pump sales adage of making it up on volume doesn't work when cost approaches or exceeds market sale price."

Perlmutter and other pump industry experts clarify that there is a difference between standard and custom pumps. Custom pumps by application are built for demanding liquid handling services that need value added features and accessories. Long term residual parts in "engineered" pumps can actually compensate for initial high material costs. With the many choices available for standard pumps, price and local delivery become the key buying factors. Brand image and service certainly help elevate standard pump pricing, but generally the customer only wants to know how much it costs and how fast it can be delivered, experts explain.

The motor industry meanwhile has taken a huge hit from the increase in steel prices. Transferring the information to the consumer can be challenging. "For motor manufacturers and pump manufacturers, I think the message is that we are really not trying to make a quick buck on anybody here," says Randy Breaux, vice president of marketing for Baldor Electric Company. "We have an extraordinary situation with rising material costs that have to be passed on to the consumer. We are trying to do that as fairly as possible and as minimal as possible.

"The reality is that we cannot absorb it. These rising costs have been unprecedented, at least in the last decade."

Even with the necessity to pass along the increases to the consumer, it is difficult to recoup it all, says Keith V. Tipper, vice president/business leader for Leeson Electric, a Regal Beloit company. "There have been instances where our steel suppliers have come to us and said, ‘Here is the price going forward. If you don't want to pay it, fine. People behind you who want your steel are buying it today at market spot. Take the price increase or not.' Of all the price increases we have charged, we still have not captured 100 percent of inflation.

"We have a business with customers on contract . . . we have what are called MPFs (material price formulas). We have to exercise a material price formula that is associated with copper or steel and whatever the ups and downs will be, this will be the increase. But some of our customers are on 60-day, 90-day or 20-day contracts. So we cannot raise their price until that time. So it is not instant. It is very difficult."

In 2007, U.S. hot-rolled steel cost around $400 per metric ton. According to industry newsletter World Steel Dynamics, the cost had risen to $1,154 per metric ton by mid-May 2008. This spring, many steel companies raised prices. Many companies are also implementing surcharges to cover raw material costs.

For almost two decades, the price of iron ore barely moved. That began to change in 2001 when the Brazilian iron ore companies negotiated a 71.5 percent increase from Japanese and European steel mills. Due to high shipping costs, it became significantly cheaper for Asian companies to buy iron ore from Australia. The price increases have continued. In 2008, for example, the Brazilian producers agreed on a 65 percent increase.

Even steel producers who use scrap metal instead of iron ore are paying record prices. According to trade reports, auto factory scrap sold from $690 to $710 per ton in July 2008, around 70 percent higher than in March.

Another factor in rising steel prices is increased shipping costs. The Baltic Dry Index, a benchmark of freight costs for bulk commodities such as iron ore, coal and grains, has risen by more than 60 percent since the beginning of 2008 due to the surprisingly strong demand for steel.

Cost Increases, Major Steel Inputs, Past Three Years

Source: Steelonthenet.com, from the International Monetary Fund (IMF)

For the motor companies, it is not just the steel prices that continue to climb. Steel, copper and aluminum are the three primary metals used in motors, Breaux explains, with steel being by far the largest percentage. Cast iron, rolled steel frames and lamination steel prices also affect the industry.

"We have seen the prices escalate extremely fast over the last nine months here," Breaux said in July 2008. "It is to a point where they cannot be absorbed internally any longer. You have