IT WAS ONLY A LITTLE LESS THAN one year ago that Ron McCracken, president of RJM Waste Equipment Co., Easley, S.C., grinned as he looked over December 2003 figures from his company's three manufacturing plants. One of the companies that bought scrap steel from RJM had bumped up the price it paid by a substantial percentage. McCracken dashed off e-mails to the superintendents of his other two plants and told them to see if they could get more for scrap steel. They could, and did.
But January 2004 was the last time McCracken enjoyed the thought of higher steel prices. “When we first saw the new prices we were getting for scrap steel, we thought, this is great,” McCracken recalls. “Then we learned the other side of the story. China was sucking all the scrap steel out of the United States and generally driving up the price of steel for everyone, including us.”
By the middle of 2004, RJM's costs for raw steel to make containers and compactors had tripled. Making matters worse, the cost of steel components also had jumped by huge margins. Steel accounts for about 65 percent of the cost of materials in a container and 40 percent of the cost of materials in a compactor, McCracken says. To keep pace, RJM raised prices. By November 2004, the company's container prices had increased 40 percent, while compactor prices were running 20 percent and 40 percent higher.
Shocking Steel Prices
No one in the waste industry is immune from the effects of higher steel prices. Waste equipment manufacturers across the country and across all categories, seeing increases in steel prices, are passing the costs onto their customers.
Mack Trucks Inc., Allentown, Pa., tried to hold the line on costs but ended up tacking on a $650 surcharge to its truck chassis, in addition to its regular model year price increases. Both McNeilus Truck and Manufacturing Co., Dodge Center, Minn., and Heil Environmental, Chattanooga, Tenn., have raised prices three times this year for waste truck bodies because of rising steel costs. Steve Wilson, manager of marketing services for Bomag Americas Inc., Kewanee, Ill., estimates that prices for landfill compactors generally have risen from 3 percent to 7 percent across the industry.
Fuel and Insurance Costs
Unfortunately, steel costs and the resulting prices equipment manufacturers are charging are not the only money problems plaguing the waste industry. Waste hauling and disposal companies in particular are struggling with price increases for fuel and insurance, while girding for an increase in truck engine costs that will accompany new diesel emission standards set to take effect in 2007 and 2010.
Houston-based Waste Management Inc., has been passing the rising cost of fuel onto its customers since April 2000, when the company implemented a fuel surcharge.
According to eTrucker, an Internet publication that tracks fuel costs paid by the trucking industry, diesel prices sailed past $2.20 per gallon for the first time in October 2004. Diesel's national average retail price of $2.212 recorded on Oct. 25 was 71.7 cents higher than one year ago.
Premiums for insurance of all kinds also rose dramatically this year, with healthcare leading the way. According to a study released in September by the Kaiser Family Foundation and the Health Research and Education Trust, Menlo Park, Calif., employer health plans logged premium increases averaging 11.2 percent in 2004, the fourth consecutive year of double digit increases. Annual health care premiums for single employees now average about $3,700, while family coverage averages nearly $10,000. Of these total premiums, employers pay approximately $3,140 for single employees and $7,600 for families.
General liability, commercial auto and worker's compensation premiums have been rising by double-digit percentages.
Managing Higher Costs
While rising steel prices have ravaged the cost structure for equipment suppliers, rising fuel and insurance costs have been burdensome on waste hauling and disposal companies that need to purchase fuel for large truck fleets and insure the safety of their larger employee rosters.
For example, Ft. Lauderdale, Fla.-based Republic Services Inc., the nation's third-largest private waste company, employs 12,700 people and manages a fleet of approximately 5,000 waste collection trucks, not to mention the cars, dozers, landfill compactors and other vehicles required to support operations at the company's 142 collection units, 52 landfills, 93 transfer stations, and 35 recycling facilities.
According to Spokesman Will Flower, Republic spends between $180 million and $200 million per year on heavy metal equipment ranging from collection trucks to dozers. A 5 percent increase in the cost of those equipment purchases would reduce the company's operating income (about $413 million in 2003) by about $10 million.
Add fuel costs to operate equipment and the cost burden becomes even heavier. Waste collection trucks burn about 3 gallons of diesel fuel per hour. A company with 5,000 trucks on the road for 40 hours a week, or 2,000 hours per year, must buy approximately 30 million gallons of diesel fuel annually. Between the third and fourth quarters of this year, fuel costs rose 43 cents per gallon, from $1.77 to $2.20. And that's just for trucks. Waste companies own plenty of other vehicles that need fuel.
Insurance costs also add to the problem. If a company's share of health insurance premiums rises an average of $500 for single and family coverage, it can strip millions more from a large waste company's bottom line.
Liability insurance premiums for general coverage, as well as for vehicles, employment practices, pollution, directors and officers, employers, and worker's compensation have risen. So have premiums for umbrella liability policies that provide excess coverage above the limits of primary policies.
“Rising steel, fuel and insurance costs are having a significant impact on the bottom line,” says James O'Connor, Republic's chairman and CEO. “We're spending a lot of time educating our managers in the field about this because we cannot continue to eat these costs.”
The key message O'Connor wants to deliver to his division managers is the importance of protecting margins, which requires recovering more than $1 in costs when costs rise by $1.
Margins deteriorate in two ways, he explains. Suppose a company billed $1 for its services and spent 80 cents to cover its costs. The remaining 20 cents would represent the profit margin. If fuel costs rose by 10 cents on the same $1 of revenue, the profit margin would decline to 10 percent. But if the company passed along the 10 cent cost increase to customers, revenues would grow to $1.10, while costs would rise to 90 cents, maintaining the 20 cent profit. On the surface, these numbers sound fine. The trouble is that the profit margin has deteriorated from 20 percent to 18 percent, he says.
“Every investment analyst following our sector is asking every public waste management company about margins and margin deterioration,” O'Connor says. “Their questions are, ‘How much of these price increases can you pass along? Can you recoup cost increases dollar for dollar? More importantly, can you recoup margins?’”
Easier Said Than Done
Recouping costs is easier to talk about than to do. When a local Republic collection company buys a new waste truck for, say, $104,000, the local manager sees those costs in the form of an eight-year depreciation schedule, which shows the cost as $13,000 per year. When rising steel prices push the cost of a new truck up to $112,000, the depreciation schedule shows a cost of $14,000. “These folks have a lot to think about, and a $1,000 increase can get lost in the daily routine,” O'Connor says. “Republic might buy 500 new trucks a year. Add to that the effect of container prices rising from $400 to $450, plus other equipment cost hikes. In the end, you're talking about a lot of money company-wide. So we have to make sure that local managers understand the company-wide impact of these rising prices.”
To aid its staff, Republic has provided local units with special software to assist in decisions on raising prices for customers. Designed to calculate return on investment pricing, the tool computes a customer's contribution to the company's profitability. “Price increases depend on how profitable a customer is,” O'Connor says. “Our managers are evaluating the market pricing for services and comparing that to the contribution different customers are making to our profitability. If a marginally profitable customer becomes a break-even customer because of cost increases that we are paying, at the end of the day, we don't need practice picking up garbage.”
O'Connor's approach to raising prices appears to be working. During the past 12 months, Republic's revenues have increased, which he attributes to hikes averaging about 2.3 percent. “That's not enough to maintain margins,” O'Connor adds. “To get to that point, we'll need to be up around 2.8 percent. We're slowly but surely escalating our prices to get there.”
Another Republic program aims to control worker's compensation and general liability costs. Republic is working with safety consultants in an attempt to modify procedures with an eye to safety. Additionally, O'Connor says he is studying the value of using automated side loaders instead of rear loaders for residential collection. This would help with labor costs and eliminate the need for employees to lift containers, which could reduce back injuries, a major worker's compensation claim.
Waste management companies are trying to hold the line against current cost increases, and more increases are looming in the future, industry experts say. In 2007, new diesel emission regulations will require new engine technologies that may add as much as $10,000 to the cost of a new truck. In 2010, an even more stringent emission standard will raise engine prices yet again.
Yet these potential price increases are years in the future. Right now, waste companies are focused on paying the price of tomorrow's cost increases.
Michael Fickes is Waste Age's business editor based in Cockeysville, Md.
RECOVERING FUEL COSTS
According to Waste Management Inc., Houston, the fuel surcharge it has been passing on to customers since April 2000 is calculated using spot prices for low sulfur No. 2 diesel fuel, as published by the Energy Information Administration of the U.S. Department of Energy, Washington, D.C. The surcharge is adjusted monthly to reflect Department of Energy diesel fuel prices for the last business day of the month and will be eliminated if fuel prices drop below the 1999 average of 51.8 cents, the company says.
WHAT'S BEHIND RISING STEEL COSTS?
According to a March 2004 bulletin issued by the Waste Equipment Technology Association (WASTEC), Washington, D.C., a worldwide shortage of raw materials combined with a weak U.S. dollar set off the run-up in prices for hot-rolled steel and steel scrap.
During 2003, hot-rolled steel prices moved from about $250 per ton to $330 per ton. This year, however, prices took off. In March, rolled steel reached $480 per ton. Another round of increases struck in May and June, sending prices up to $560 per ton to $580 per ton.
Scrap steel has seen even larger percentage increases. It moved from $90 per ton to $120 per ton between 2002 and 2003. In February 2004, scrap shot up to $228 per ton, an overall increase of 300 percent.
The WASTEC bulletin attributes the shortage of raw materials to the booming economy in China. Firms in that country are purchasing as much scrap metal as they can get. China also ranks as a leading exporter of coking coal, which is required to make rolled steel. According to analysts, China has diverted much of its coking coal to its domestic industries. As a result, prices for this material rose to $400 per metric ton this year, from less than $70 per metric ton in 2001.
Other components of rising steel prices include the weaker U.S. dollar, which raises the price of imports; rising shipping prices due to a shortage of ocean-going vessels; consolidation within the U.S. steel industry that has reduced pricing competition; rising prices for other raw materials such as iron ore and nickel; and rising energy costs, which raise the cost of steel production.
And there's no end in sight. In September, the Wall Street Journal reported that U.S. and international steel companies negotiating contracts for next year are demanding prices 20 percent higher than the contracts being replaced.