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Source: Sage
Finding Opportunity in Rising Fuel Costs: Strategies for Industrial Equipment Companies
Rising Fuel Costs is also known as :
Cost of Fuel,
Price of Fuel,
Fuel Prices,
Price For Regular Gasoline,
Retail Gasoline Prices,
Prices at the Pump,
Gasoline Costs,
High Fuel Costs,
Diesel,
Crude Oil Prices,
Fuel Cost Problem,
Fuel Cost Strategies,
High Fuel Cost Impacts,
Fuel Needs,
Customer's Fuel Impact,
Reduce Fuel Costs,
Demand for Fuel,
Seaze Opportunity High Fuel Costs,
Direct Cost Impact,
Raise Prices,
Strategies Rising Gasoline Prices,
Fuel Surcharges,
Gasoline Diesel Pricing,
Gallons,
Fuel Taxes,
Oil Companies,
Price of Petroleum,
Tariff,
Industrial Equipment Manufacturing Company,
Prepared exclusively for Sage by Cambashi, Inc.
www.cambashi.com
Table of Contents
Introduction
The Fuel Price Trend
Coping with Rising Fuel Costs
Finding Opportunity in Market Changes
Acting Now Can Spell Success
Finding a silver lining in the clouds of a destructive storm is not always easy. Rapidly rising fuel costs have been a devastating force for many manufacturers of industrial equipment. The immediate impact has been an increase in the cost of transportation and freight as well as some raw materials. Some machinery manufacturers may also suffer from fuel costs associated with sales, specification, installation, and support activities. Viewed from this perspective alone, the rising price of fuel is a bad news story for an industry that has experienced growth in both demand and competition over the last few years.
However, the rising price of fuel has set in motion a series of more profound changes in priorities for both consumers and industry. This shift may bring opportunities for incremental business and innovations in what companies offer to the market.
Those companies that take comfort from recent easing of fuel prices and whose management actions go no further than attempts to mitigate the immediate cost impact of fuel price increases are likely to be at a serious disadvantage in the market in the coming months and years.
While fuel prices are down slightly from their record highs, the overall trend is up. Based on September 15, 2008, figures from the U.S. Energy Information Administration, the current price of regular gasoline at the pump was $3.85 per gallon-modestly down from a high of $4.11 in early July but still around a dollar higher than a year before. The picture for diesel was very similar. It was $4.02 per gallon-down from a maximum of $4.76 a gallon but up $1.34 from a year before. While the most recent report from the EIA offers some short-term relief for businesses, Figure 1 highlights a strong underlying upward trend over recent years.
FIGURE 1: Weekly U.S. Regular All Formulations Retail Gasoline Prices
Fuel price increases in excess of 30 percent in a single year create problems for every business. To make appropriate management decisions in many different parts of the business, companies need to anticipate how their business will be affected. This includes direct cost impact as well as the market changes caused by increased fuel prices.
Many industrial equipment companies operate within other supply chains. The rising cost of fuel is a problem that is hurting everyone to a greater or lesser extent. Being in the middle of a supply chain with established contractual obligations is likely to be uncomfortable-so management needs a full and clear picture of all the company's interactions with both customers and suppliers.
There are other situations that are common to this industry that may mask the full extent of the problem or make mitigation more difficult. On the supply side, transportation contracts that are currently in force may not allow suppliers the opportunity to add fuel surcharges. The problem may only show up when the contract is renegotiated, typically annually. On the sales side, the same situation may also apply.
Industry Directions conducted research among the buyers of MFG.com, an online marketplace for buyers and suppliers of manufacturing services, custom or standard parts, and textiles. It appears that 30 percent of companies can charge higher prices to customers, as shown in Figure 2. Most others are learning to become more efficient or are accepting lower margins.
FIGURE 2: Top Response to Rising Fuel Costs
While 30 percent of nearly 500 companies surveyed are raising their prices to offset rising fuel costs, most others are seeking other areas to lower costs or will live with lower margins.
To raise prices in a fair and competitive way, it helps to have clear visibility to fuel cost impacts. Ideally, the business needs to understand how and where the increased fuel price will show up in terms of increased product costs, overhead, and Selling, General, & Administrative (SG&A). To gain that visibility, customers must have operational data on production and distribution integrated with financial, customer, and supplier information.
Every company must consider its options to mitigate the impact of high fuel prices as an individual industrial equipment manufacturing company. However, suppliers and customers are likely to match any actions a company takes with similar actions.
Our research shows that three-quarters of companies are making changes to accommodate the fuel cost problem. Figure 3 shows that these commonly include some combination of:
- Switching to material suppliers close to factories.
- Reviewing and renegotiating logistics and transportation contracts.
- Changing the approach to production, such as moving to make-to-order rather than
make-to-stock.
As companies have moved to provide not just products but solutions, they may also need to change travel policies or customer pricing. Rising fuel costs impact the profitability of employee travel for engineering, sales, commissioning, maintenance, and service activities to customers.
In addition, there are secondary effects associated with high fuel prices that could have serious cost implications for the business. This paper analyzes a few examples and considers approaches to mitigate the impact of fuel price increases in the short term and further steps that could be taken in the interim or long term to lower the company's exposure to future fuel price rises.
FIGURE 3: Changed Planned to lower or Offset Rising Fuel Prices
Companies are primarily focused on their suppliers of materials and logistics to fight surging fuel costs, but quite a few are also changing their manufacturing approaches.
Source: Industry Directions study of MFG.com marketplace North American buyers.
When selecting suppliers, transportation costs have not traditionally been a foremost
consideration for industrial equipment companies. Most companies have very high standards
for quality and delivery reliability from suppliers. Indeed, these will continue to be primary procurement considerations. However, rising freight costs are now a selection factor that companies must consider.
We are starting to see companies shift from a strict focus on selecting suppliers in low labor-cost countries, such as China and the Far East. In some cases, companies that had focused on global or off-shore sourcing are again seeking on-shore suppliers. The critical piece is to have all of the inventory and supplier performance information integrated with financial data to calculate when various options actually make sense. Companies that work from basic financial systems that are not integrated with inventory and supplier records may make poor decisions that hurt their business as fuel costs continue to fluctuate.
Another critical factor in evaluating suppliers that has changed due to high fuel prices is material selection. Figure 4 shows that nearly 70 percent of respondents have felt the pinch from rising materials costs. Whether direct or indirect materials, anything made of petroleum is likely to cost more this year than last, as well. The fuel costs even extend to metals prices. These are very energy-intensive to produce and are the foundation for most industrial equipment.
Redesigning products to reduce the use of these high-cost materials may not be feasible. Yet it makes sense to develop continuous improvement programs to eliminate wasting them-whether as indirect materials such as oil used in machining or as scrap of direct materials such as plastics
and petrochemicals.
FIGURE 4: Fuel Price Impacts In Addition to Transportation Costs
Beyond transportation costs, most manufacturers are suffering from increased material costs. Many also find production heating and cooling cost rises are a challenge.
Source: Industry Directions study of MFG.com marketplace North American buyers.
The scale of the fuel cost problem for each company will vary depending on a variety of factors. These include the size and weight of components and finished products, supply chain complexity, geographical scope of the supply chain, and the number of staff and site visits required to commission, install, and carry out the ongoing support of the equipment.
Many machinery manufacturers have taken advantage of globalization and moved manufacturing, and in some cases design activities, to lower cost economies. Immediate actions to minimize transport costs include reviewing supply chain network design for facility and supplier location. Another smart move is to review delivery frequency. Often, moving away from small, just-in-time deliveries and shifting to less frequent full truck loads can lower transportation costs. However, in return for lower prices the company must accept longer lead times. The risks associated with this strategy include less agility, higher levels of inventory, and higher levels of risk associated with less accurate demand projections.
Information systems and software applications must be able to support decision making at all levels: Strategic, tactical, and operational. Systems also ideally cover all aspects of supply chain activity-network design, route planning, demand planning, sales and operations planning, production planning and scheduling, load optimization, and others. Procurement and sales may also benefit from introducing some flexibility into delivery windows or order quantities.
Beyond freight, transportation costs will accrue for employees to travel. There are two main categories of essential travel that show up directly for the company:
- Direct cost associated with engineering visits to honor service contract obligations
- Sales visits, which show up as an SG&A expense
In both situations, there may be opportunities to achieve major cost savings by adopting new ways of working. Adopting technology, such as remote diagnostics or on-site video feeds that personnel can access, could reduce the need for site visits. Likewise the use of Web-based presentations and other collaboration or visualization systems could cut costs and improve responsiveness in sales. For times that an on-site presence is essential, having data accessible on mobile devices can allow field staff to change priorities and ensure that travel plans meet up-to-the-minute needs.
Most industrial equipment companies will face the same issues from their equipment and machinery providers. It is reasonable to anticipate that service contractors will try to raise prices or introduce travel charges when the contract is next up for renewal. To be in a position to assess, minimize, and manage maintenance activities to minimize service visits, companies need production systems that report performance of processes and equipment. With that visibility, companies can negotiate support contracts or consider bringing service in-house in some cases.
What may not appear directly but should be considered is that employees may be less able to afford long commutes, prompting shift schedule changes for those in plants and warehouses and a desire for office staff to work at home. Facilities with public transportation may become more attractive. Options such as allowing staff to work a four-day week must not be allowed to impact customer satisfaction. On the other hand, skilled workers are in short supply, and retention will generally be far less expensive than recruiting and training new workers.
In any of these cases, the software running the business must be accessible from remote locations. Having full visibility to do their jobs right is essential to keeping employees engaged and productive. The software system must also be flexible to accommodate changes to shift schedules.
Many midsize equipment manufacturers have some mix of make-to-stock and custom products. As fuel costs increase, companies may gain benefits from shifting away from standard products that sit as finished goods and move toward to-order models. Holding finished goods is problematic in that all of the energy and time has already been put into the product, so it's higher value-add than raw or work-in-process material. To-order models can lower finished goods inventory, and thus expended fuel, as a hedge against inherently inaccurate forecasts.
Many companies are also moving to a postponement model. In this environment, the plant builds a product up to a platform level or builds standardized subassemblies. Specific features and options are added only when the actual customer order arrives. This mitigates forecast inaccuracy and still allows relatively fast customer order delivery.
Redesigning products or factoring in production and distribution energy cost requirements can lower overall costs significantly. Reducing product size and weight can often cut logistics costs significantly and may also reduce materials usage. Changing packaging in which equipment is shipped can also create savings in space and weight for shipping. In our study base, most companies are not doing that (see Figure 5). However, since over a quarter are, their competitors may find themselves at a disadvantage since higher energy consumption is required to build their products and the associated shipping containers.
FIGURE 5: Developing New Products to Reduce Own Fuel Needs
Most companies are not yet changing their products to counteract high fuel costs, but over a quarter are, and these may find themselves at a competitive advantage over others.
Additionally, companies will find that they can often reduce energy consumption in production facilities by running more efficiently. Improving both production and maintenance schedules (and adherence to schedules) can improve this aspect of energy consumption. Another leading practice that more industrial equipment companies are using is sales and operations planning. This helps coordinate between plants, so that rather than working simply to utilize equipment fully, plants work to hit sales forecasts more exactly.
All of these efforts require that companies have enterprise software that can help them plan, procure materials, and produce equipment in multiple ways. If the software cannot handle a changing mix of manufacturing models, then the inefficiencies of manual information flows can damage the company's ability to improve its performance in the face of high fuel costs.
A change to fundamental cost structures on this scale is a catalyst that will drive significant changes to purchasing behavior across all markets, industries, and product sectors. These market changes are potentially more significant for the business than a swing of a few points on gross margin based on increased cost of transportation alone.
The speed with which these changes have occurred has exceeded the pace at which many companies can respond and may dictate a major rethinking of business strategy. Making the right management decisions is tricky, since these market changes are, by their very nature, difficult to identify, analyze, and quantify. As a consequence, companies need to be alert to subtle changes in the pattern of demand since these could be early indicators of opportunity or threat.
Thus far, this paper has presented some of the most significant challenges. This leads to the groundwork for examining opportunities.
Leveling the Global Playing Field: High fuel prices work in the market in the same way as import tariffs. They can act as a brake on globalization-especially if the long-term trend is for continuing fuel price increases. Some experts suggest that current fuel prices equate to an import tariff on Asian goods of around 9-10 percent. In some cases, outsourcing and off-shoring decisions have been reversed and some production jobs have been repatriated. The essential point is that the economics of "make or buy" decisions have been fundamentally altered. Being closer to suppliers and customers is, increasingly, an advantage. Companies must be able to market, sell, and deliver effectively as prospects seek suppliers closer to home.
Shifting Markets: Fuel prices and other issues are impacting which industries are likely to buy industrial equipment. Those making valves and pumps can actively serve both the waning construction and the booming energy markets and be ready when demand shifts again. Anticipating future demand patterns means understanding your customers' customers. Shifting markets often lead to product proliferation, which requires robust systems in every department to handle the diversity of designs, materials, suppliers, and processes. It may also require the ability to shift contract and billing terms for various types of markets.
Offer Solutions to Customers: Industrial equipment is often used for running the customer's business, so the opportunity either to make the products more energy efficient or to offer engineering or maintenance services that can reduce the customer's fuel impact throughout the lifecycle of the product can be extremely attractive. Redesigning products or offering additional services to help customers reduce their fuel costs in using your product is an excellent opportunity. As Figure 5 shows, most companies have not yet made proactive efforts to lower their customers' fuel costs related to using the equipment they provide. Companies with solutions for fuel use may enjoy a
sales differentiator.
The fuel price increase of the past year represents a discontinuity-"business as usual" is being redefined. Those who assume the attitude that fuel prices have dropped again and report no changes to their business or products are hiding their heads in the sand. The upward trend is clear, and emerging economies such as China, India, and Vietnam will continue to increase the demand
for fuel.
Every company in the industrial equipment industry and supply chain is facing similar challenges, choices, and opportunities. The companies that will thrive in the coming months and years will be those that are able to:
- Identify market opportunities at an early stage.
- Work with customers to define current and future needs.
- Make decisions on accurate and timely information.
- View financial and customer impacts of operational outcomes.
- Integrate between manufacturing and distribution to coordinate on-time shipments.
- Respond quickly and in a coordinated fashion to ongoing change and customer demand.
All of these capabilities are limited by the software systems that the company uses-their sophistication, functional coverage, and integration across the business. Winning companies will no doubt need many qualities beyond a sound and integrated business software system. However, management talent in the absence of reliable business information serves little purpose.
About Cambashi
Cambashi, based in Cambridge UK and Cummaquid, MA USA, provides independent research and analysis of the business reasons for use of IT in industry, world-wide. Its specialist fields include engineering and enterprise applications and the infrastructure to enable industrial firms to use IT effectively.
www.cambashi.com
About Sage North America
Sage North America is part of The Sage Group plc, a leading global supplier of business management software and services. At Sage, we live and breathe business every day. We are passionate about helping our customers achieve their ambitions. Our range of business software and services is continually evolving as we innovate to answer our customers' needs. Our solutions support accounting, operations, customer relationship management, human resources, time tracking, merchant services, and the specialized needs of the construction, distribution, healthcare, manufacturing, nonprofit, and real estate industries. Sage North America employs more than 4,100 people and supports nearly 3.1 million small and medium-size business customers. The Sage Group plc, formed in 1981, was floated on the London Stock Exchange in 1989 and now employs 13,400 people and supports 6.1 million customers worldwide. For more information, please visit the website at www.SageNorthAmerica.com or call 866-308-2378.
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