DWM - 2008 - October

Volume 9, Issue 9 - October 2008

T R E N D T R A C K E R

Fuel Surcharges
Taking Them Under Consideration
BY MICHAEL COLLINS

The recent dramatic rise in the cost of fuel likely will have a continuing effect on door and window industry participants for years to come. This industry is heavily driven by logistics, with most companies servicing, on average, a 300- to 500-mile radius around their manufacturing facilities. Due to the fragmentation of the industry, many companies that attempt to ship products significantly further than 500 miles find that a comparable competitor located closer to the customer offers a lower price because of their shorter shipping distance. The Energy Information Administration, a U.S. government agency, estimates that diesel prices will reach an average level in 2008 that is 45 percent higher than their 2007 level. This increase is reshaping the industry and the way the companies view manufacturing facilities and customers.

Legacy Business
It is probably safe to say that every manufacturer in the industry services at least one customer in a way that is not optimal for its own profitability. A relationship has formed over the years and companies continue to provide service in the face of complications like a long shipping distance. Maybe the manufacturer knows that an able competitor is ready to pounce on that customer the moment they attempt to pass along a hefty (by which I mean fair) fuel surcharge. The current high fuel prices, though, have called relationships such as this under review. That customer isn’t ever magically going to move 200 miles closer. On the other side of the issue, oil prices are unlikely to decline in the future. Instead, the enormous and growing oil appetite of China and India alone will ensure that oil prices continue an overall increase, despite whatever temporary short-term relief we might find at the pump.

Impact of High Energy Prices There are a number of other effects of high energy prices, none of which are favorable for manufacturers in the door and window industry. Higher fuel prices are tied to higher overall energy prices, which increase the cost of heating and cooling plants and producing products. Vinyl manufacturers are particularly affected by rising energy costs, because vinyl is a petroleum-based product. In a macroeconomic view, higher fuel costs have a negative impact on consumers’ pocketbooks and consumer confidence, neither of which is good for the housing industry. A particular scenario that is negatively affected by high energy prices is the aspiration of many city dwellers to trade up to a larger home in a suburban area. Higher energy prices make both ends of that equation less attractive, since heating that larger home becomes more expensive, as does commuting further to work.

Blueprint for the Future
Since we believe that energy prices will only continue to increase in the future, we recommend that companies assess how they will operate profitably in an environment of persistently higher energy prices. The easiest step to take in making that assessment is to look at the distances along which products are currently being shipped. Since there is almost no escaping Pareto’s 80/20 rule in life, it’s highly likely that many companies are maintaining a much wider distribution network than necessary to serve customers that make a disproportionately low contribution to overall revenues. If the decision to cede those customers to competitors is too painful, companies should at least be more aggressive regarding fuel surcharges.

It is always impressive to hear from a company that it manufactures its product in the middle third of the country and is able to pass along sufficient shipping costs to sell profitably to customers on both coasts. It is usually an indicator of a high-quality, highly differentiated product that is not viewed as a commodity by customers. Companies actually can use the ability to pass along shipping costs as a sort of litmus test to determine whether they are focused on a segment of the product spectrum that adds enough value. It doesn’t mean companies should aspire to serve an ever increasing radius. However, becoming knowledgeable of your customers’ willingness to pay to have your product shipped to them is a way to test the perception of your products that a marketing study is powerless to match.

Another aspect of the future of the industry that is virtually assured as a result of higher energy prices is continued consolidation. Being a small company will continue to become more difficult as larger competitors with well placed manufacturing facilities will be able to whittle away significantly at the outer edges of smaller companies’ service areas. In the past, adding to the acquiring company’s product offering has been the most commonly mentioned reason for completing an acquisition. We would be surprised not to see companies begin to mention the logistics advantages of the placement of the acquired company’s plants as being among the primary driving factors more often.

High energy prices are likely to be a reality for the foreseeable future. This is the time for companies to assess the profitability of their most far-flung customers and to redouble their efforts to focus on value-added products for which customers happily will pay additional shipping costs.