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Trends: The Cost Crunch


In March, metal shop owner Karla Aaron ordered 500 sheets of the same cold-rolled steel she bought for $2 each in January. Aaron knew prices were rising, but when her supplier rang up the sale at $8 apiece, she nearly choked.

That's just for starters. Hialeah Metal Spinning, Aaron's 15-employee manufacturer of parts for medical and industrial uses in Hialeah, Fla., has seen its monthly electric bills rise 17%, and a subcontractor recently raised prices 11%. Fuel costs have driven up freight bills 15% in six months.

Dramatic upturns in commodities prices are wreaking havoc on the cash flow of small companies. Consider: Copper has doubled in two years. Plywood prices rocketed about 100% in the year ended in March; oriented-strand board, a waterproof building fiber, rose 178%. Some types of steel were up 60%. Oil prices were just below a 41-year high at press time. A host of factors share the blame: soaring demand from China, uncertainty caused by the Iraq war, the global economic recovery, record U.S. housing starts, a weak dollar, and even hedge-fund investors buying on momentum.

REACHING A PEAK?

Some economists say we're near the top or already on the downside of a five-year cycle. They cite increased domestic production of construction materials and efforts by Beijing to cool China's economy. A bit of relief for some metals users may come in August, when the Commerce Dept. is expected to rule on one-year export quotas. Within that year, Joseph L. Mayer, president of the Copper & Brass Fabricators Council, a trade organization, expects supply to increase, bringing price relief. But for other commodities, the weak dollar, a dearth of oil discoveries, and continued global growth all point to several more years of stubbornly high prices.

Small companies are in a particularly tough spot. Most buy raw materials in quantities too low for big volume discounts. And asking customers to pay more can be risky.

Aaron is lucky. Generally, she has been able to pass on the steel and freight increases. Not to every customer, though. With one large client she would rather not name, Aaron is locked into a contract through August that will cost her about $200 on each job. She's eating the increases from her subcontractor and electric bill.

Construction companies are getting hit, too. Homebuilders are absorbing an average of $8,000 a house in extra costs, says Michael Carliner, an economist with the National Association of Home Builders (NAHB). "They're likely to pass it on to consumers later," he says. Rich Honeywell, project manager for 30-employee, $5-million (sales) American Drywall Co. in Raleigh, N.C., saw light-gauge steel prices jump 300% between the time he bid to build a school and when he broke ground. His company took a $10,000 hit. "Nobody can predict this kind of escalation," Honeywell says. He used to honor price quotes for six months. Now they expire in 30 days.

SHARING THE PAIN

It may be time for business owners to raise prices. As consumers see prices going up for everything from gas to milk, and with the Federal Reserve talking about inflation, a psychological barrier has been broken, says Arvind Sachdeva, a senior portfolio manager at $50 billion Victory Capital Management in Cleveland. "You won't be alone asking GM for an increase if you're a small supplier," he says. A May survey by the National Federation of Independent Business found that 26% of small companies were planning to raise prices -- nearly twice as many as last year.

You could try inserting a materials-price escalation clause into contracts. That allows for repricing or substituting similar products for those that are expensive or tough to source -- say, fiberboard for plywood -- says Carliner. The NAHB wrote boilerplate for such a provision, and 2,000 companies have asked for copies so far.

Another option is to try to lock in whatever costs you can. Utility companies, for example, often offer average monthly billing that smooths price volatility. Hedging on the futures markets may be an option for high-volume commodities buyers.

The good news: The same expansion that's burning up so many raw materials is also boosting orders. Honeywell says he has a backlog of building jobs, and Aaron's volume is up 20% as her customers sell more and increase their own inventories. That's the kind of cycle a small-business owner can be happy to ride.

By Jill Hamburg Coplan


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