Exclusive studyNew pricing paradigm emerges

An inside look at price/cost trends that affect electronic component buyers.

By -- Purchasing, 8/24/2000

This past spring was murder on buyers of electronics components. Average producer prices charged by U.S. manufacturers soared. For example, according to domestic price surveys conducted by the U.S. Bureau of Labor Statistics, average prices for diodes and rectifier chips rose 4.8% between May 1999 and May 2000. Average prices for dram reported by domestic manufacturers jumped 32.7% over the same period. Ceramic dielectric capacitor average prices rose a surprising 65.1%. Meanwhile, prices for microwave components rose 5.7%, resistor parts increased 5.5%, and electronic enclosures jumped 12%.

In an industry that typically passes along price drops, why have tags for so many products been soaring? Strong demand from the end markets that buy components has clearly been a major factor. With markets that make computers and communication equipment rising at a double-digit pace, suppliers of components clearly have had the leverage they need to hike tags. Indeed, U.S. computer makers saw their production grow 44% between May 1999 and May 2000.

Supply/demand fundamentals are the main price drivers that economists usually look at when predicting future price hikes. But in a special study on the U.S. industries that make components, Thinking Cap Solutions says changes in the underlying cost fundamentals also have been wreaking havoc on the components industries' slow-but-steady history of price declines. Despite in-creasing gains in productivity, rapid in-creases in costs mean margins are under pressure too, so if possible, suppliers are anxious to pass along cost hikes. If hiking prices is not possible, then suppliers will try to slow down the price drops to which buyers have become addicted.

The U.S. semiconductor industry is a case in point. In the 12 months ending May 2000, the cost for direct materials imported into the U.S. rose 0.6% and the cost for domestic direct materials rose 0.9%. Those rates of cost escalation appear minor, but not so when the cost changes are compared to a year earlier. In the 12-month period ending May 1999, costs for imported and domestic materials in the semiconductor industry fell 4.9% and 3.1%, respectively.

Thanks to intense global competition, the recent sharp turnaround in underlying costs in U.S. chip manufacturing is unlikely to be met by sharp price increases for buyers. However, buyers can expect the rate to slow at which chip prices fall. From an 11% annual decline in December 1997, average prices in the U.S. semiconductor industry slowed to a 4.1% rate of decline in May 2000 and will slow further to a 3.1% decline a year later in 2001, according to forecasts by Thinking Cap Solutions.

In the U.S. printed circuit board industry, global competition also means prices will continue to fall despite rising costs. For instance, producers of PCBs saw their average direct manufacturing costs jump 2.2% in 1999 after a 1.5% cost drop in 1998. In 2000, direct costs for labor and materials will rise 3%. Average prices for PCBs made by U.S. producers, however, are forecast to continue falling a half of a percentage point in 2000. That's three times slower than the deflation rate that buyers enjoyed in 1998, but at least prices will continue to fall.

In PCBs the cost problem recently has been across the board. Component costs for everything from resistors, capacitors and transformers rose 3.6% between May 1999 and May 2000. Copper strip and sheet tags also rose 6.6% over the same period and fabricated plastics products, which are used to mount the boards, rose 6.1% as well.

Let's take a look at the price and cost outlook for all the major component industries tracked by Thinking Cap Solutions. The analysis that follows is based on TCS' U.S. industry cost escalation model and does not adjust for changes in productivity or product-line mix. To get more details on any of the industries listed below, please contact TCS for an industry update at ebaatz@ice-alert.com or call 360-452-6159.

Semiconductors and related components

This industry has to deal with a double whammy lately from rising labor and higher materials costs. About one-third of recent cost hikes can be attributed to labor and one-third to materials. The rest of the cost squeeze can be found in increases in shipping and fuel costs. Direct costs grew at a strong year-ago 4.6% rate in the second quarter of 2000. Cost escalation is expected to slow down to 2.2% by the end of 2000 and 1% by the end of 2001, but the damage will temporarily mean buyers in general can expect industry prices for semiconductors to slow their rate of decline to a slow 2.6% drop by the first quarter of 2001. That's a far cry from the 12% price drop that buyers enjoyed in the first quarter of 1998.

Printed circuit boards

Producers have been facing significant increases in manufacturing costs. A roundup of per-unit spending patterns between May 1999 and May 2000 shows costs for raw materials purchased from domestic sources, up 4.7%, imported raw materials, up 3.9%, inbound freight rates, up 3.5% and production worker wages, up 2.1%. Combined, these spending increases boosted the overall cost of making a unit of output in the PCB industry by 3.8%. Unfortunately for suppliers and luckily for buyers, meanwhile, industry product prices fell 1.6% over the same period. But buyers need to know this could mean trouble for marginal producers. The ICE model calculates that inflation-adjusted industry margins hit a new record low in May.

Capacitors

Here we see an industry that has leapt on the opportunity to pass along cost hikes to buyers. After hardly budging in 1999, average prices in the U.S. capacitors industry rose 14.2% in a single month in April 2000 and again by 6.3% in May. By the time the second quarter of 2000 was history, TCS estimates capacitor industry tags jumped 21.7% from year-ago levels. The impetus comes from a combination of tight margins, strong demand, and plenty of cost justification. For example, average prices for a basket of precious metals (excluding gold) rose 17.1% between May 1999 and May 2000. Aluminum sheet and foil tags also rose 9% over the same period. Forecasting costs and prices for the capacitors industry is tough since recent activity has been outside the realm of typical trends. Nonetheless, TCS predicts average prices in the capacitors industry will fall 12.8% in the final quarter of 2001 after an 18.2% hike in the final quarter of 2000. Looking at annual price escalation, prices are forecast to fall 5.3% overall in 2001 after a 16% annual hike in 2000.

Resistors

Buyers who are looking for opportunities to negotiate a better deal for their electronic components might want to take another look at resistors. Here, inflationary pressures in materials also are taking a toll on suppliers. Per-unit direct materials costs for imported materials rose 8.2% between May 1999 and May 2000. The cost for domestic materials increased 5.3% over the same time. However, inflation-adjusted margins in the resistors industry remain strong even though average prices rose just 1.6% between May 1999 and May 2000. Why? The reason harkens back to 1992 when resistor tags took a large leap upward and outpaced costs. By May 2000, for every $100 of resistors sold by U.S. manufacturers, only $42.50 was being spent on materials, production labor and inbound freight costs. In contrast, between 1987 and 1990, costs were consistently above $50 per $100 sold. The margin windfall that U.S. resistor manufacturers appear to enjoy may be a negotiation leverage point for buyers.

Connectors

Almost half of all the cost inflation that U.S. connector manufacturers have endured has come at the hands of higher materials costs. In particular, the ICE model speculates pressure from rising costs for metal stampings, fabricated plastics and copper strip and sheet are delivering the damage. In the 12 months ending May 2000, direct materials costs in the connectors industry rose 2.1% on the heels of a 3.4% cost drop in the previous 12-month period ending May 1999. Meanwhile, over the 12-month period ending May 2000, average prices for connectors actually fell 0.3%. The combined impact of falling prices and rising costs has lopped off $1.68 from margins for every $100 worth of products that connector makers sell. The outlook ahead, however, calls for some gains for suppliers. TCS predicts average connector prices will rise modestly throughout the rest of 2000 and all but the final quarter of 2001. At an annual rate, prices are forecast to rise 0.3% in 2000 and 0.5% in 2001.

Thinking Cap Solutions Inc. is an applied economic research company started in 1994 with the goal of developing a new generation of business information products. The company's business model ensures that customers get high-quality, reliable and timely applications-oriented economic analyses at an extraordinarily affordable price. To date, the two principals, Victor Maliar and Elizabeth Baatz, together have more than 30 years of experience in business economics.