Rising Costs In Trickle-Down Times

Last year around this time, the jan/san industry — like so many other industries — was wondering what it would take to keep its head above water. The dike, it seemed, had finally burst. Manufacturers, already reeling from huge cost increases in raw materials, realized they couldn’t realistically hold the line on prices for much longer. Late in 2004, distributors were experiencing price increases as high as 40 percent over the previous year on certain product lines.

No one player along the product pipeline was spared as the torrent of price increases resulting from surging raw material costs, rising oil and natural gas prices and soaring global demand for steel and concrete washed away margins and budgets.

Key jan-san players — manufacturers and distributors — and their customers — building service contractors and other facility service providers — were sent reeling from an economic “perfect storm.”

Every industry was smarting be-cause “everyone was raising their prices,” Sanitary Maintenance reported back in January 2005. Business leaders listed prices and inflation as their most pressing economic concern — ahead of even energy increases and a generally tepid economy. The economic climate produced from this complicated chain of events would only worsen months later as Hurricane Katrina slammed into the Gulf Coast, and the first “storm” took a back seat to an even more palpable economic disaster.

Finding Ways To Stay Afloat
Today, the sheer trauma from the previous years’ economic onslaught has been replaced by an equally challenging period. We’ve dried out a bit, but these are “trickle-down times” and the steady “drip...drip...drip” of profits lost from the last years’ price increases tortures manufacturers, distributors and end users as they struggle with the reality that they may never get back all the profit lost in the last year-and-a-half.

In a recent article,“Dealing with Cost Hikes,” which appeared in Inc. magazine, writer Norm Brodsky notes, “When prices rise as much as they have in the past couple of years, you’re almost certainly going to have to absorb some of the increases, at least for the short term.”

“The best you can do,” Brodsky continues, “is to mitigate the impact, preferably, with minimal harm to your customers and employees, and then try to rebuild your margins over time through regular price increases and increased efficiency.”

Distributors need to develop strat-egies now that will allow them to weather recent — and future — storms and the subsequent threat of profit margin erosion.

Material Matters
The increases that are currently moving along the supply chain are generally due to shortages or difficulties in production. In the past 18 months, virtually every manufacturing sector has suffered the effects of raw material price increases.

According to the Energy Information Administration (EIA), prices for crude oil and petroleum products are projected to remain high through 2006 before starting to weaken in 2007. Following Hurricane Katrina, oil pushed over $70 a barrel and gasoline prices peaked above $3 a gallon. In 2006, EIA projects crude oil will average $63 a barrel and gasoline will average $2.41 per gallon.

“It’s a huge squeeze on the budget, especially if you’re buying commodities,” says David Jacoby, president of Boston Logistics Group Inc., a Wellesley, Mass.-based company that helps manufacturers and their logistics partners optimize supply networks.

While fuel prices are probably the most noticeable, one of the hardest hit segments is plastics, an industry that relies heavily on petroleum, says Deepak Agrawal, managing director of Gotham Consulting Partners, a N.Y.-based management consulting firm.

A recent strategic sourcing report from Boston Logistics Group reported that prices for polystyrene, polyethylene and PVC all nearly doubled over the last 18 months, peaking in late 2005.

Distributors aren’t noticing much change in the amount of plastic and packaging produced — at least not yet. However, the increase in trash liners has been one of the most difficult costs for distributors to absorb.

Dan Ott, co-owner of Facility Supply Systems Inc., Chicago, has had seven or eight price increases in trash liners over the past year. Kevin Smith, operations man-ager for Cherokee Supply, Snellville, Ga., has seen about five trash liner price hikes in the last six months.

Manufacturers are also seeing in-creases in the price of steel. Elevated energy prices are making the energy-intensive process of steel production even more costly.

The cost of the materials that go into steel production have also been subject to increases. According to Boston Logistics’ strategic sourcing report, over the past year the price of flat-rolled and galvanized steel more than doubled; imported coke is up 110 percent; iron ore freight is up 105 percent; scrap is up 47 percent; and iron ore is up 28 percent. To help offset higher costs, some steel companies are adding surcharges or renegotiating manufacturer contracts to raise prices.

Chemical manufacturers and their customers are, likewise, feeling the pinch, especially following disruptions in production due to Hurricanes Katrina and Rita.

“So many chemicals used in the janitorial industry were affected,” says Gerry Bundle, supply manager for fleet maintenance at Calpine Corp., San Jose, Calif., and a member of the Institute of Supply Management’s (ISM) corporate social responsibility committee.

Paper prices over the past 18 months have risen due to that industry’s own resource pressures. Add to that the fact that paper manufacturing utilizes a very chemical-intensive process and another industry staple is hard-hit by increasing materials prices.

Costs From Within
While many of the prices that are passed onto distributors come from suppliers, all businesses are dealing with the impact of rising business costs. With increases in heating oil and natural gas, for example, the cost of heating large warehouses is putting a strain on many distributors’ budgets. Ott’s gas and electric bills were up 39 percent in 2005 versus the previous year. In an attempt to offset his direct costs, he is turning to third-party carriers.

Health care costs are another huge consideration for many employers — large and small. In February, the report “Health Spending Projections Through 2015: Changes on the Horizon” appeared in Health Affairs, a policy journal for the health sector.

The authors of the report used data from the federal government and other sources to conclude that health care spending will double to $4 trillion a year over the next decade.

By 2015, one in every $5 spent in the United States will be devoted to the health-care sector. Projections estimate that — whether the health care plan is publicly or privately funded — spending will increase from $6,683 per person in 2005 to $12,320 per person in 2015.

With all of these increases in costs, and the subsequent trickle-down effect, every business needs to have a solid long-term plan for coping. Continually passing costs on to customers is becoming difficult to justify — and is starting to raise a few eyebrows.

“Every time we try to pass on cost increases to our customers, it’s an indicator for them to shop elsewhere,” says Ott.

Finding Alternatives
So should distributors join the fray by adding fuel surcharges to their deliveries? Many agree that customers just won’t stand for it — at least not for any length of time.

“It’s easy to add a fuel surcharge,” says Kevin Burke, president of Retailers Supply, New Albany, Ind., “but customers may eventually want that removed, and then you haven’t accomplished anything long-term for the company.”

Some distributors are taking a different approach and collaborating with customers to maximize delivery options. Jerry Garbett, general manager of Arkansas Bag & Equipment, Little Rock, Ark., has not instituted any delivery or fuel charges — and doesn’t plan to. Instead, he’s training his salespeople to promote the company as a value-added partner. “We’re asking our customers to be considerate of our needs and not have us run out there with one or two cases,” he says.

Smith is also “working smarter” with customers to optimize routes: “If we’re heading in a certain direction, we’ll call the customers in that area and tell them to check their supply levels because we’ll be in their area.” Most customers are obliging, say distributors, because most of them are facing the same increases.

Third-party carriers might be a good option for some companies, but Jacoby cautions: “Small companies have bigger problems with transportation costs because they have the least leverage with carriers.”

In such cases, he advises distributors to join a shipper’s association or approach customers that have a good rate on transportation and see if they can buy at the same rate.

Electricity prices are largely absorbed and distributors say there’s not much that can be done, short of turning down the heat and lights, buying energy-conserving appliances or making a facility more “energy tight.”

While there are some options for dealing with increases in fuel and energy prices, drastic increases in the cost of other items have distributors scrambling to find alternatives. For example, to deal with increases in plastic prices, Garbett has switched from high-density to linear-low can liners.

But some distributors say there is no feasible alternative for some of the plastic products they buy. The fact is jan/san suppliers rely heavily on plastic products — not to mention the plastic used for equipment and packaging.

Agrawal says some suppliers are starting to redesign products and packaging to reduce plastic or remove it completely. For example, one of his clients — a household goods manufacturer — is redesigning the handle on a plastic bottle, making it thinner to reduce the amount of plastic used.

Options for dealing with increases in the prices of other items, such as paper and chemicals, are even more limited. Many distributors will simply ride out the storm.

Health care is one cost that distributors have worked with — and often re-worked — over the past couple of years. That is likely to continue, as it is an extremely fluid sector.

According to an annual survey by the Kaiser Family Foundation and the Health Research and Education Trust, the percentage of all firms offering health benefits to employees has fallen from 69 percent to 60 percent over the last five years.

The 2005 findings also show growth in the percentage of firms offering high-deductible health plans to at least some of their employees. Garbett and Burke have increased de-ductibles on their employees’ health insurance, and Burke is also looking into health savings accounts as an alternative.

Some businesses are turning to consortia or buying groups to purchase healthcare, says Bundle. “An organization may not have the size or critical mass required to get the best bargains on healthcare,” he says, “so that’s one area where they’re combining with other companies to get the best deals.”

Time For Catch-up
Many distributors SM spoke with say overall economics could be slightly better this year compared to the past 18 months.

Agrawal feels that prices have hit a plateau: “I don’t think they’ll go down, but I don’t think they will go up significantly in the next 12 months,” he says.

If prices do plateau, as many believe, it could provide a good opportunity for distributors to take advantage of or otherwise tinker with business plans.

Smith says, “We got hit hard with [price] increases the last four months of ’05, but prices do seem to be leveling out.” His strategy to capitalize on stagnant pricing? Buy in bulk to avoid freight charges.

Garbett views the Gulf Coast rebuilding as an opportunity to grow his business, while others will focus on expanding their product lines to regain lost margins.

Ott plans to introduce new products like green cleaners and microfiber cleaning supplies. “I think we’ll be able to capitalize on those changes that are taking place in the industry,” he says. “I’m very optimistic because we’ve had double-digit increases over the past five years.”

Burke says his company — which sells jan/san products, office supplies, safety equipment and lighting — had a great year last year, and he believes it will continue. He anticipates that consolidating product lines will build his customer base.

There’s no doubt price increases have hit the jan/san industry from several fronts over the past year, but sentiment is still generally positive. Distributors are proving that they’re armed with a “sink or swim” attitude, and they are quickly developing new business plans and creative ways to boost sales.

Kassandra Kania is a Charlotte, N.C.- based freelance writer.