Pricier products make buying a high-stakes game

Gordon Graff -- Purchasing, 2/16/2006

The $109 billion specialty chemicals market in the U.S. is enjoying robust growth in many of its sectors (see table), says the American Chemistry Council. But like all chemical product categories, specialties have been buffeted by runaway costs of oil, natural gas and transportation. The resulting escalation in selling prices has created some unique challenges for buyers of specialty chemicals.

John B. Simolike is the strategic sourcing manager for Puratos Corp., a Cherry Hill, N.J.-based supplier of products to the bakery and confectionary industries. In this role, he purchases both edible food ingredients and many food-related chemicals. Those chemicals include flavorants and taste-enhancing ingredients such as calcium propionate, fumaric acid, acetic acid, lactic acid, as well as citric and ascorbic acids.

Typically the chemicals Simolike buys run in the $1-2/kg price range, so that even a jump of a few cents in the tags of these materials or the freight rates for transporting them can have a big impact on the bottom line as opposed to buyers in the pharmaceutical industry, for which Simolike sourced specialty chemicals in his previous jobs at Lonza and GlaxoSmithKline. Chemical raw materials used by pharmaceutical companies can cost anywhere from several dollars to several hundred dollars per kg, he says, "so you see less of an impact from oil and transportation increases" in the drug industry.

To better manage mounting raw materials and transportation costs, Simolike and his team at Puratos have adopted several strategies. For example, Puratos is promoting a dual sourcing policy for specific chemical products. Getting materials from more than one supplier challenges the suppliers to improve processes and can help keep rates in check.

The process of searching for additional suppliers can provide benchmark data on the going rate for particular materials in the marketplace, Simolike notes. With this benchmarking, he says, "We may find that we could have bought a material for less by dealing with another supplier." To take advantage of the rapidly shifting price situation, Puratos is streamlining the process for evaluating and approving new suppliers.

"We're also looking for suppliers with a better logistical situation," Simolike adds, "so that they don't have to transport their materials as far." Meanwhile, he is evaluating freight costs for incoming materials to see whether switching from truck to rail, or to trailers carried piggyback on railcars, can save money.

Puratos also tries to help its long-term chemical suppliers to moderate their own costs in hopes of sharing these savings. This assistance can take several forms, Simolike explains. "We try to make sure our suppliers are sourcing their raw materials as cheaply as possible," he says. This may mean advising the suppliers of alternative raw materials vendors or more economical purchasing practices.

Some chemical suppliers Puratos deals with have fixed costs for changing over production from one product to another, making their costs sensitive to run size. According to Simolike, by ordering larger lots, say "two truckloads instead of one," Puratos can help these suppliers reduce their costs, since fewer changeovers are needed in the course of a year.

Puratos is also signing longer term contracts with its suppliers, says Simolike. This lets suppliers extend the contract period with their own vendors, and lock in prices for a longer period of time. Hopefully, he adds, "the savings from larger orders and longer contracts can be passed on to us."

Jim Rhodes is vice president for corporate purchasing at Fiber Glass Systems, a San Antonio manufacturer of glass fiber-reinforced epoxy pipes used for enhanced oil recovery. The specialty chemicals he buys are "absolutely critical" to the company's operations, he says. Among those chemicals are epoxy resins, triethylenetetramine (TETA), acid anhydrides, and methylene dianiline (MDA).

In the 14 months between early 2004 and the third quarter of 2005 Rhodes watched with growing dismay as the cost of these essential raw materials nearly doubled. "We basically had to eat those increases," he recalls, since it was difficult to pass them along to the company's customers.

It wasn't always necessary to absorb the full magnitude of cost increases for raw materials, Rhodes notes. Prior to the 2004-2005 run-up in tags, Fiber Glass Systems' suppliers typically gave the company a 90-day notice of price increases. That was just enough time, says Rhodes, "to put together our own price increases for our customers and work off the inventories that were quoted at the old price."

But in 2004, Fiber Glass Systems' chemical suppliers switched to a 30-day notice policy of price increases. This was followed by price increases for several months in a row. "We managed to get through a few of our own price increases" during this period, Rhodes says, "but they were never enough."

In the last quarter of 2005, prices for Fiber Glass Systems' essential chemicals had stabilized, says Rhodes, and the company has been able to "catch up a little bit" in its margins. But there are limits to how high the company can raise its rates without driving away customers, he points out. Rhodes is hoping that low-cost imported chemicals from Asia will put the brakes on another round of price hikes for the raw materials he buys, as has happened in the past. But this Asian influx is an occasional thing and hard to predict, he adds. In the meantime, Rhodes thinks his raw materials tags will remain steady through much of the year and might even decline somewhat.

Another perennial concern to Rhodes and his competitors is reliability of raw materials supplies. Limited availability of tanker trucks, for instance, often delays deliveries of the raw materials needed for epoxy pipe production. If the delays last long enough, they can force a pipemaker to shut down. Rhodes says his firm has negotiated contracts with its chemical suppliers that guarantee deliveries no matter what snags develop in the transportation pipeline. The suppliers are willing to be accommodating on this point, he adds, "because of our long-term relationship and the [large] volumes of materials we buy."

Al Lee is one of three general managers at Marubeni Specialty Chemicals in White Plains, N.Y. His job involves sourcing the chemicals that the company buys for distribution throughout the U.S. The company supplies a wide range of specialty chemicals, mostly to Fortune 500 manufacturers. Like a lot of chemical dealers, Marubeni is squeezed between its own rising raw materials and transportation costs and its inability to pass along all those costs to its own customers, who face the same issues.

Many users of chemicals, facing rising rates for products they buy, would switch to new suppliers. But this is not an option for a distributor such as Marubeni because its business is to resell the products of well-known manufacturers. Instead, says Lee, Marubeni seeks to save money by trimming some of the fat in its own operations.

"Sometimes we relocate our warehouses to be closer to our customers," says Lee, a move that can save on delivery costs. Such shifts are made regularly as the company's customer base changes, he adds.

To keep up its margins Marubeni also continuously adds high value-added materials to its catalog. According to Lee, these are usually "niche products with some unique performance properties that give us some pricing power."