Silver Linings in the Cloud of Higher Steel Prices
It didn’t take long for the 65 percent hike in iron ore prices by Cia Vale do Rio Doce (CVRD) to work its way into the Chinese economy. Last week, Baosteel, China’s largest steel producer and the company that negotiated the new iron ore supply agreement with the Brazilian producer on behalf of China’s steelmakers, raised prices by up to 20 percent, significantly increasing manufacturing costs for companies making everything from appliances to cars in the process. The sell recommendations went out immediately, as stock market analysts concluded that China’s manufacturers would not be able to pass along the higher cost of steel to consumers in China’s price competitive industries.
I’m not so sure they are right.
In meetings with several of my managers earlier this week, I was pleasantly surprised to learn that they are already passing along higher raw material costs to customers. In 2005, when we were hit with the first significant run up in raw material prices, input costs had not changed appreciably in more than 20 years and everyone was caught flat-footed. Particularly in a country like China, where prices had only been going one way—down—managers were not used to pressing customers for price increases. Now it seems, they are doing so very aggressively.
When I commented that we had obviously learned a lot over the past three years, my managers shook their heads and said it was true. “We are getting better at negotiating increases, but there is more to it than that. 2008 is different from 2005. Since 2005,” they said, “companies that have not raised prices have either lost all of their cushion, or have fallen by the wayside. As a result, companies that have survived and prospered during this period have a greater ability to negotiate with customers in 2008 than they did in 2005.“
Besides being heartwarming, this conversation confirmed my suspicions as to why inflationary pressures are now coming to the surface, not only in China but around the world. When the first raw material price shockwave hit in 2005, manufacturers the world over, including those in China, were caught in a giant cost/price squeeze. China’s emergence as the world’s workshop had lowered the price for just about every manufactured product, while rising demand in China had helped to increase the price of every raw material. At the same time, competition in and from China prevented manufacturers from raising prices, resulting in decreased profit margins. If what my managers are telling me is correct (rising producer prices suggest that they are), that is bad news for inflation, but good news for manufacturers seeking to restore profit margins. With all their cushion gone, manufacturers have no choice but to pass along higher costs, and consumers have no choice but to accept them.
At the Economist Automotive Conference in Shanghai Thursday, I discovered another silver lining in this latest spike in steel prices. In his presentation, the speaker before me, Jerry Van Alphen, Vice President-Finance of Alcoa Asia Pacific, extolled the virtues of using aluminum in products like automobiles. Cars that use more aluminum are lighter, and lighter vehicles burn less fuel. As a result, automakers have been seeking to replace steel with much lighter aluminum wherever possible as part of their efforts to develop more fuel-efficient, environmentally-friendly vehicles. One impediment to doing so is the fact that aluminum, pound for pound (or kilo for kilo), is more expensive than steel. With the significant increases in iron ore and steel prices, however, steel is now pricing itself out of more and more applications. Whereas the ratio of aluminum to steel prices has historically been in the range of 5 to 1, this ratio has now been reduced to 3.5 to 1, improving the relative economics of using aluminum. Therefore, higher steel prices may actually help the transition to lighter, more fuel-efficient vehicles. That’s good news for everyone.
Admittedly, I may seem to be grasping for straws in trying to find some positives in this latest hike in steel prices. In business, though, sometimes you just have to take good news wherever you can find it.
