250-Constrictions in Components Supply Support Higher Prices

Years ago we were doing some work in the roofing business. In one study, we were working on the asphalt shingle roofing manufacturing business. At the time, this was a terrible business. Returns were low, growth rates were modest, at best, and there was a good deal of overcapacity in the industry. Then the industry caught a break. A shortage in asphalt developed. This shortage of asphalt rolled through the asphalt shingle plants and restricted their output. Immediately, prices jumped, returns became attractive and industry participants breathed a sigh of relief. Unfortunately, this asphalt shortage did not last very long. The industry shortly returned to its previous hostile condition. (See the Perspective, “What Ends Hostility?” on StrategyStreet.com.)

A shortage in any component, or labor, will restrict industry capacity and tend to raise prices. A labor shortage is, in part, responsible for some of the high prices in mining today. Miners work in areas that are often hard to reach. They also are skilled employees. The run-up in commodity prices, especially those related to ores such as silver, gold and copper, has increased the demand for these skilled miners. In addition, the mining industry faces competition for skilled workers from the oil and natural gas industries, which are also growing.

Mining companies are now going to great lengths to attract and retain these skilled workers. Some of these miners are now earning 25% more in compensation than they were a year ago. Some companies are flying workers to and from remote mines. For example, BHP Billiton plans to fly 500 workers from Brisbane, about 500 miles away, to a coal mine site that they are opening and then fly them back home after a couple of weeks.

If this commodity boom continues, the industry’s total capacity will be determined more by labor availability than by its more traditional measures of capacity. (See “Audio Tip #117: Capacity Constraints and Pricing” on StrategyStreet.com.)

Posted 2/14/11

Update:

We are living in the same world in 2022. It is common knowledge that “supply chain” problems have affected many industries. The lack of components restricts supply of finished products and significantly raises their prices.  The auto industry serves as a contemporary example of restrictions in semiconductor chip supply causing auto prices to rise to unheard of heights.

Here is a brief explanation of what happened. First, demand for semiconductor chips, especially the newer more expensive and more profitable chips, took off with the Covid shutdown. People wanted to make more use of their time at home using their electronic devices. Semiconductor firms began to focus on meeting the needs of these electronic product manufacturing companies.  Electronic manufacturers contracted with semiconductor manufacturers for most of the capacity of those manufacturers.

Next, the auto manufacturers severely cut back their manufacturing as the Covid lockdown took hold. They manufactured fewer cars for their inventory. The automakers chip demand centered on “legacy” chips. These are older, less sophisticated and less profitable chips for the semiconductor industry to produce. Accordingly, the semiconductor manufacturers focused all their attention on the newer chips.

In 2022 as fear of Covid waned, demand for new automobiles rebounded back to near normal. About 40% of US consumers purchase a new car every year. The problem? There were few “legacy” semiconductors available for the automobile manufacturers. The auto manufacturers responded by focusing all their attention on their newer models using newer semiconductors. They either could not produce the older models or would produce them and leave them in inventory because they lacked certain semiconductors. Fewer new cars were available to consumers.

Prices took off.  In August 2022, new car prices were up 30% and used car prices were up 48% over the last three years. The used car market soared because so many consumers could not purchase a new car.  For a brief period, used car prices were higher than new-car prices.

These have been profitable days for semiconductor and automobile manufacturers. But the good times may not last. The significant rise in interest rates throughout 2022 have had a drastic negative impact on the affordability of new and used cars. At the end of 2022, prices have begun to come under some pressure. See HERE for some thoughts about the future for the automobile manufacturing industry as it returns to a period of greater competition.

12/22

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