Falling material prices present a classic good news/bad news scenario for business. The cost of raw materials is lower, but so is the demand for the products.
First, let's start by talking about which prices are down, how far they have fallen, and the reasons for the declining price of production inputs. The primary nonferrous metals price index declined 30.8% from the official start of the recession in December 2007 to December 2008. The decline in steel prices began more recently, but steel mill product prices declined 12.4% from November 2008 to December 2008. Oil prices have declined precipitously as well. For the first time in 20 years, the U.S. Energy Information Administration (EIA) is forecasting no growth in U.S. demand for oil. According to the EIA, the price per barrel of oil is expected to average $60 (in 2007 dollars) during 2009. Steel, copper, and aluminum all owe their declining prices to the same source as declining oil prices—slack in global demand.
As for demand for products, the collapse of the credit markets has made it increasingly difficult to finance commercial and industrial construction projects. Falling corporate profits also have reduced the ability of firms to provide internal financing for projects. Therefore, there is less need for the products that go into the buildings, including fans and louvers.
At the time of this writing, the first quarter 2009 results were not final; however, the preliminary fourth quarter 2008 Gross Domestic Product (GDP ) results showed a 6.2% decline. That is the steepest decline since the 6.4% decline that occurred back in 1982. Embedded in this decline are a 5.9% decline in nonresidential structures and a 22.1% decrease in durable goods. Data from the U.S. Census Bureau on orders for newly manufactured ventilation, heating, air-conditioning, and refrigeration equipment declined 23%, 4%, and 18%, each month from September 2008 to November 2008 when compared to the same time frame in 2007. According to data from AMCA International , dollar volume of orders for power roof ventilators, centrifugal fans, and axial fans declined by 1.7% in 2008 compared with 2007.
Commodity prices have fallen because the demand for the goods that use those commodities has fallen. Businesses can certainly expect their production input prices to fall during the recession. Falling input costs are unlikely to be offset by rising wage costs during a period of deflation or stagnant prices. Overall, it should cost businesses less to produce fans, louvers, etc.
The trouble though, as we discussed earlier, is that there will be less demand for these types of products by way of credit constraints and reduced ability to internally finance. This may create increased competition among manufacturers to acquire what little new business is in the marketplace. This could cause companies to lower prices in an attempt to attract new business. Companies would then be competing for less business at a lower price, but presumably at a profit margin similar to the one they had before the decline in commodity prices. Even though the marginal profit (profit per unit) may be the same with reduced production input costs, it is likely that total profits are lower because fewer units will be sold.
Hans Zigmund is a Chicago-based economist who frequently works with AMCA International, Inc. Have a question? Mark it "Ask Hans" and send to firstname.lastname@example.org
Hans Zigmund is a Chicago-based economist who frequently works with AMCA International, Inc. Have a question? Mark it “Ask Hans” and send to email@example.com .