Key takeaways
- While raw material costs are dropping, they remain much higher than prepandemic levels
- Raw material costs are ultimately influenced by supply and demand, as well as the costs involved in procuring the raw materials which can be impacted by various factors
- Companies can effectively manage and mitigate the impact of raw material cost fluctuations by employing seven practical strategies
26 June 2023 – The global business climate is increasingly uncertain, and manufacturers are facing a myriad of challenges, including high energy prices and unexpected fluctuations in raw material costs.
With events such as the COVID-19 pandemic and the ongoing Russia-Ukraine conflict disrupting global supply chains, many raw materials are also becoming harder to secure. As such, commodity price volatility may not be just a temporary phenomenon, and it is up to manufacturers to either absorb additional costs, find new ways to mitigate the expenses, or pass price increases along to customers who are already reluctant to spend.
Raw material costs dropping, but the pressure remains
According to the World Bank’s April 2023 Commodity Markets Outlook, raw material prices are dropping but they still remain much higher than prepandemic levels.
The report notes that price surges following Russia’s invasion of Ukraine have largely reversed due to slowing global economic activity, favorable winter weather and redirected commodity trade.
Energy prices have also dropped recently, with the brent oil price of March 2023 being 35% lower than its record high of June 2022. Furthermore, Europe’s mild winter weather, a surge in imports of liquefied natural gas (LNG), and a concerted effort to increase energy efficiency and conservation contributed to natural gas prices dropping by about 80% from their August peak.
However, the World Bank notes that overall, prices are only expected to drop by 21% in 2023, before stabilizing in 2024, whereas 2022 saw a 45% increase. While this is the steepest decline in prices since the pandemic, raw material costs will remain a challenge for manufacturers as the current price declines are not significant enough to absorb the impact of the past few years’ increases.
Furthermore, food and fertilizer prices are still near their record highs – with prices even higher than during the 2007/8 food crisis – and are expected to remain as such for the time being.
What causes the rise in raw material costs?
Raw material costs are ultimately influenced by supply and demand, as well as the costs involved in procuring the raw materials. The availability of raw materials – or supply – can be impacted by various factors, including world events, economic disruption, and climate and environmental factors – and whenever demand outstrips supply, prices will rise. Similarly, if energy prices go up, the cost of the production, transportation and extraction of raw materials will rise, which, in turn, will affect their market prices.
Raw material costs can have a significant impact on the profitability and pricing of products. Fluctuations in raw material prices can directly affect the overall production costs and, in turn, influence the final price of the finished goods or services.
Over the past few years, the following key events contributed to high raw material prices and will potentially continue to do so in future.
- Covid-19
The COVID-19 pandemic had a major impact on global supply chains and raw material costs. Lockdown restrictions disrupted the production and transportation of raw materials, leading to reduced supply and ultimately higher prices, as demand outstripped supply - Russia-Ukraine War
The Russia-Ukraine conflict disrupted the production and traceability of several commodities, especially those where Russia and Ukraine are key exporters, including energy, fertilizers, and grains, leading to a surge in prices in early 2022, the World Bank reported. - Political and trade tensions
Trade tensions between major economies, such as the United States and China in recent years, have resulted in the imposition of increased tariffs on various raw materials such as oil, propane and soybeans – which disrupted supply chains and increased the prices of these commodities. - Logistical disruptions
The blockage of the Suez Canal by the Ever Given container ship in 2021 also had a major negative impact on global supply chains and affected the prices of various commodities, specifically those used in steel and steelmaking, including iron ore, pellets and hot-briquetted iron, S&P Global noted.
The impact of environmental factors and legislation
Environmental factors and legislation also have the potential to significantly impact raw material prices, especially as companies incur costs to shift to cleaner modes of production.
In a survey conducted by the European Central Bank, 90% of respondents agreed that climate change and their firm’s adaptation to it would require investment in new facilities or processes and changes to their supply chain, while also making inputs more expensive.
Furthermore, 80% or more of respondents in the same survey agreed that mitigating climate change would make the raw materials, components and energy they use more expensive. Almost as many agreed that this would increase the price of the goods and/or services their company provides.
That said, transitioning to more environmentally friendly ways of procuring raw materials and greener manufacturing processes will soon no longer be optional as the fight against climate change becomes more prominent.
The landmark agreement from the recent COP 15 Biodiversity Conference, that targets the effective conservation and management of at least 30% of the world’s lands, inland waters, coastal areas and oceans by 2023, confirms this.
It is now up to each individual country to implement the framework through domestic and international action. While it is still unclear how this will be done, there will certainly be an impact on the mining and manufacturing sectors.
What is clear, however, is that companies that embrace environmentally friendly practices now, like renewable energy, will be poised for future success. In fact, according to the International Energy Agency, renewable energy is set to become the largest source of global electricity generation by early 2025, surpassing coal.
Which industries are most impacted by rising raw material costs?
Most manufacturers are significantly impacted by high raw material costs due to their heavy reliance on these commodities as inputs for their production processes.
Industries that have been severely impacted in recent years include:
Food and beverage industry
The food and beverage industry is influenced by fluctuations in the prices of agricultural commodities such as wheat, corn, sugar, coffee and dairy products.
As noted in an article by food industry publication BBM Magazine, any rise in energy prices also has a significant impact on the food production industry. From the transportation of goods to the processing and packaging of food, energy costs are an essential component of food production. Furthermore, as the food and beverage industry relies heavily on packaging materials it has also been affected by price fluctuations of packaging materials like plastics, paper and aluminum.
Packaging industry
The packaging industry utilizes raw materials such as plastics, paper, cardboard and metals to produce packaging materials and containers. According to Agron Food Processing the prices of essential raw materials like paper and aluminum foil increased by 70% during the pandemic, while carriage charges to foreign countries have also increased fivefold, putting the packaging sector under significant pressure.
Automotive industry
The automotive industry relies heavily on raw materials such as steel, aluminum, copper and rubber, many of which have seen significant fluctuations. As noted by the World Bank in an October 2022 report: “Over the past three years, the pandemic, the war in Ukraine, and concerns about global recession buffeted global aluminum and copper markets and contributed to large swings in global prices.”
Energy industry
The cost of electrical power, of course, is of direct relevance to every industry and every company. But probably one of the starkest proof-points of escalating raw material costs is the energy sector. Russia’s invasion of Ukraine generated the biggest surge in crude-oil prices since the 1970s, while coal and gas prices have all reached historic highs in nominal terms.
Practical advice for organizations to manage raw material price fluctuations
Companies can effectively manage and mitigate the impact of raw material cost fluctuations by employing these seven practical strategies.
- Conduct financial modeling of all raw material inputs
Through the financial modeling of all raw material inputs your procurement departments will be able to create wider hedging opportunities and mitigate the risks associated with raw material price fluctuations.
The financial modeling process will include analyzing and projecting the costs associated with acquiring and using various raw materials in a business under various scenarios. It is also important to incorporate risk analytics by evaluating the potential risks and uncertainties associated with raw material prices, such as supply disruptions, geopolitical factors or regulatory changes. - Engage in strategic sourcing
Engaging in strategic sourcing practices can help companies identify and secure the most cost-effective and reliable sources of raw materials. This involves evaluating suppliers based on factors such as quality, reliability, pricing and stability of supply. Many manufacturers are also moving toward nearshoring to mitigate supply chain disruptions.
Nearshoring – or partnering with suppliers within your immediate region – allows a company to have more control over its supply chain, and as materials will be less impacted by delivery delays, prices will remain more consistent.
Companies can also reduce their vulnerability to supply disruptions and price fluctuations by diversifying their supplier base. To ensure supply chain sustainability and resilience, you should review your supplier base, not just in terms of cost and quality, but also with a view to build redundancies and fallback options into your network. - Create an agile supply chain
Creating an agile supply chain has many benefits, including improved inventory management resulting in reduced inventory holding costs, minimized stockouts, and improved overall inventory management efficiency and lower costs due to reduced waste and improved process efficiency.
These factors, combined with enhanced supply chain visibility, enabling better decision-making and faster problem-solving and stronger stakeholder relationships, enables manufacturers to mitigate risks more successfully. - Explore manufacturing process changes
In addition to overall supply chain optimization, companies could also explore ways to optimize or adapt their manufacturing processes to reduce their reliance on specific raw materials or find alternatives that are more cost effective or readily available. - Conduct scenario planning
Companies should closely monitor market trends, global events and factors influencing raw material costs. By staying informed and conducting scenario planning exercises, companies can anticipate potential price fluctuations and proactively develop strategies to mitigate risks and adapt to changing market conditions. - Focus on continuous improvement
One of the main benefits of a continuous improvement approach to manufacturing is that it improves an organization’s resilience and ability to mitigate risks and disruptions. It does this through streamlining processes for improved flexibility and adaptability, reducing costs and waste to increase revenue and pushing an organization toward overall operational excellence which gives it a competitive advantage. - Adopt sustainable practices
Adopting sustainable practices is one of the best ways an organization can mitigate the impact of high raw material costs. Sustainable practices such as waste reduction, recycling and resource efficiency can minimize the consumption of raw materials.
Furthermore, incorporating renewable or recycled materials into the sourcing process can make the company less reliant on traditional raw materials, with the added benefit of significantly reducing its environmental footprint. Companies can explore options such as using recycled plastics, reclaimed metals or bio-based materials derived from renewable sources as alternatives to conventional raw materials.
Companies are also encouraged to investigate closed-loop systems to recover and reuse materials from their own operations or external sources. By closing the loop and recycling materials, companies can reduce their raw material procurement costs.
Another environmentally sustainable way to combat high raw material costs is to prioritize optimizing your organization to embrace energy – and water-efficient processing methods. Not only does this help reduce greenhouse gas emissions, but it will also make your business less vulnerable to energy and water price hikes.
Conclusion
When it comes to raw material costs, the only constant is change. The global business climate will remain uncertain for the foreseeable future, and companies that are able to adapt to and thrive in uncertainty are the ones that will survive.
To deal with raw material cost fluctuations and remain competitive, organizations have to embrace new ways of working. From rethinking and optimizing their supplier relationships and supply chains, to embracing environmentally friendly manufacturing practices the opportunities are endless for those companies brave enough to commit to change.
Related questions
What are raw materials?
Raw materials will vary depending on the industry and product being produced. However, common raw materials include:
- Metals: Metals such as iron ore, aluminum, copper and steel that are used in manufacturing automotive parts, machinery, electronics and many more products
- Natural fibers: Natural fibers like cotton, wool and silk are key raw materials in the textile manufacturing process
- Wood: Wood is often used in furniture and packaging manufacturing
- Chemicals: Chemicals such as ethylene, propylene and benzene are often used in the production of plastics, synthetic fibers, fertilizers and pharmaceuticals
- Minerals: Minerals like limestone, gravel and sand are used to produce products such as ceramics, glass and concrete
- Agricultural products: Crops such as wheat, corn, soybeans, rice, sugarcane and other agricultural commodities are used as raw materials for food production, animal feed and biofuels
What do raw material costs include?
Raw material costs comprise all the expenses associated with acquiring the basic, or raw, materials and resources used in the manufacturing process. The cost of raw materials typically includes expenses related to extraction, harvesting, processing, transportation, storage, and any other necessary steps to make them usable in the production process.