North American heavy-duty truck sales are surging as fleets respond to the increasing freight volumes and some look to pre-buy new equipment to beat the new engine emissions deadline of 2007. By May the surge in new truck orders was enough that Class 8 truck sales in Canada were 32.5% ahead of last year’s pace and 11.6% ahead of the five-year average. In fact, carriers’ new thirst for power units made this May the best month for truck sales in the past 12 and the best May since 2000.

With such busy order boards one would expect truck OEMs to be rejoicing. Instead they’ve been scrambling to adjust to raw materials increases that are cutting into their profit margins. And the end result, in most cases, is higher truck prices for buyers.

Consider that the spring of 2004 saw price increases in all commodities and raw materials like copper, rubber and steel, which often represents up to 75% of the metal in a truck cab. A ton of hot-rolled coil steel cost $482 in March, reported the Canadian Transportation Equipment Association (CTEA), and peaked as high as $550 in that same month from around $180 in December 2003.

The main reasons cited for the spike were US tariffs on imported steel (which ended in December); skyrocketing demand from China’s rapidly expanding economy; hoarding by some steel-using firms; energy prices; and the falling value of the US dollar, says Mike Whelan, of the CTEA.

In Canada, domestic use of steel is booming, increasing by 8% a year on average, and growing far faster than the economy – (at 8% versus 3.7%), reports the Canadian Steel Producers Association.

So how have equipment suppliers been coping with the steel issue?

“The first thing that everybody saw was a lot of pressure on parts suppliers, because the assemblers and OEMs are pushing the prices down, and suppliers are caught in the middle between escalating prices of steel, other prices, and the downward pressure that the OEMs are exerting,” says Jayson Myers, senior vice president, chief economist, Canadian Association of Manufacturers and Exporters.

Myers says some of them have been able to pass some cost increases along.

“Others have not, and we’re in a situation where it’s still very difficult for some of the suppliers to increase their prices in line with the highest cost. Otherwise they’re having to absorb costs in their profit margin or cut costs somewhere else, perhaps not going for some of the contracts they might have gone for before, or operating more efficiently by pushing lean manufacturing,” he says.

Steel, as the main material cost, is putting tremendous pressure on the bottom lines of these companies and, notes Myers, this is coming at a time when the Canadian dollar has gone up in value by 15% over the past year, and when energy costs have also risen.

“So companies are having to operate in as lean a way as possible to overcome some of the cost increases,” says Myers.

Larry Harrison, general manager, Kinedyne Canada, says that Kinedyne did not initially implement a price increase, because it had pre-bought sufficient supply.

“We were fortunate in the fact that we had a China partner, and we saw some of this coming. We pre-bought a lot which saved us a little longer than most. Only in the last two to three months, now that we’re buying steel at the higher prices, we’re starting to feel the ouch part of it,” he says.

“I have personally been able to put off an increase until July so that we only had the one increase. I’m anticipating that this might be a one and only for us. How I handled it was we treated normal volume orders the same way we always have, but if somebody ordered a large volume of something, we quoted it separately with a very short time frame, (in case we had to buy at higher price),” says Harrison.

Truck OEMs have found various ways to meet demand and offset costs.

Freightliner LLC informed its customers on April 5 that it would impose surcharges on all new truck orders.

Volvo Trucks North America says customer demand is being met without interruption, and the company did not implement a surcharge per se for rising steel prices.

“However, to offset higher costs for materials and components, we implemented a permanent 1.5% increase on the base model prices for all truck orders entered into our system beginning June 14, 2004. The price increase also affects all trucks built after Nov. 1, 2004, regardless of when they were ordered,” says Scott Kress, senior vice president, sales & marketing.

“We believe a price increase is a more realistic method of passing along these higher costs than a surcharge. We don’t anticipate that these costs will decrease to their previous levels in the near future,” he says.

Kress notes that increased costs for EPA’02 emissions technologies were added to the price of the Volvo VN and Volvo VHD at the time the new regulations took effect in late 2002.

“We do not separate out the costs of the other increases,” he says.

At Mack Trucks, Tom Kelly, vice president of marketing, says the truck OEM has made a number of internal changes and sacrifices within its control to hold the line on pricing. However, Mack was ultimately forced to pass some of the burden associated with the increase in steel and other raw materials costs on to the end user.

As such, Mack Trucks imposed a temporary surcharge of about $US 1000 by May 2004 to recoup steel costs.

“This increase in the cost of our vehicles is intended to ensure that Mack and its dealer network are able to maintain profitability levels necessary to deliver the quality service and support required by our customers. Fortunately, our suppliers have been able to meet demand despite the shortages,” he says.

While Kelly notes that circumstances can change, he says at this point in time, the worst appears to be over.

“We believe the tendency over the next six months is stability at current price levels – but again, time will tell,” he says.

Maintaining close communication with suppliers to minimize increases and to ensure continuity in production has been a key coping strategy for OEMs.

Caterpillar spokesperson Ben Cordani says that approximately 10% of Caterpillar’s direct material cost is for steel purchases directly by the company and another 10% for steel purchased by suppliers.

“In most cases, Caterpillar has long-term purchase agreements in place with our steel suppliers that help reduce price fluctuation and ensure delivery. However, in order to ensure continuity in our production, Caterpillar has paid surcharges and, in some cases, increased prices to secure steel purchases. We continue to work closely with our suppliers to minimize the increases and maintain positive, long-term relationships,” he says.

In general, even with steel price increases, Caterpillar’s total direct costs and material costs per unit will be reduced in 2004 relative to 2003 reflecting other material cost reduction efforts created through the company’s ongoing Six Sigma focus, says Cordani.

“The other side of the steel issue is the fact that increases in metals pricing drive the mining sector, which is a major market and a profitable business for Caterpillar,” he notes.

Over the next several months, the direction China’s economy takes will have a major effect on the world’s steel prices. “Certainly the economic growth occurring in China (and India) is absorbing a lot of the scrap and pushing the cost of raw materials up at the same time as finished steel. At the same time you’re getting a lot of competition from Chinese and Indian steel producers in the North American market, so you’re sort of getting caught on both sides,” says Myers.

He says that price spikes are cyclical and it’s only a matter of time before more supply is brought on to the market. He predicts steel prices will come down to a level that is higher than what we’ve seen on average over the past 3-4 years.

“People are wondering if industry in China is going to continue to grow 10-12% or just 7-8%. I think 7-8% is a more sustainable growth, and may be one of the reasons why metals prices are beginning to come down a bit,” notes Myers.

According to MEPS (International), a consultancy operating in the steel sector worldwide, the heat is already going out of the Asian steel market.

Chinese steel production rose by only 14.1% in May, its lowest year-on-year percentage increase since December 2002, while it had been rising at 20% for many months prior, says MEPS in its June International Steel Review.

Down the line, Harrison believes the price increase they have implemented will cover things if prices stay stable as they have in the last quarter.

“I can say we’re not pre-buying now because we don’t know where it’s going.. When we pre-bought before (without putting through an increase) we thought it would get us through the year, but then customers ended up buying more so we ran out of steel. We didn’t choose, at that time, to implement a price increase which might have deterred them from purchasing. We didn’t choose that strategy but as business managers that would be something you’d really have to weigh,” he says.