Steel demand is down…by a great deal. The world’s steel plants are operating at less than 45% of capacity. This operating rate is one of the lowest ever. Yet, some U.S. stainless steel makers have actually raised prices by 5 to 6% since early May. The price increase does not come because of an increase in demand for stainless steel. That demand is off as well.
How do we explain this phenomenon? The answer lies in the cash costs of the stainless steel companies and their customers. (See Diagnose/Pricing/Company Price Environment on StrategyStreet.com.) There are high levels of fixed cost in the stainless steel business. Many of these costs, though fixed, are cash costs that must be paid to keep the plant running. Heating units cannot be shut down easily. Yet, the cash cost of keeping them operating are high. If the plants cannot cover their cash costs, they will close in short order. But, despite the losses that the stainless steel producers are piling up in this period of very low demand, they have raised their prices to cover their fixed cash cost of operating their plants on lower unit volume. The price increases of 5 or 6% represent the increases in cash revenues the companies need in order to keep their plants operating.
Normally, these plants would have shut down at this level of economic activity. Their places would have been taken by off-shore manufacturers who incur lower cash costs to operate. But conditions have changed. Customers are changing their suppliers, replacing off-shore producers with domestic supply. Now the American manufacturers have a lower cash delivered cost than do the off-shore competitors they are now replacing. We then ask, why would a customer be willing to pay domestic manufacturers 5% more than they were paying before May?
Steel service centers are major customers for stainless steel. These are the companies who are paying the higher prices to the domestic manufacturers today. They are paying these higher prices for three, cash-related, reasons. First, even at today’s low level of demand, there is enough demand to pass along the cost increase. Second, the capital markets are often closed to these service centers. They cannot get the financing that would allow them to purchase the same amount of steel off-shore that they would be able to purchase in a normal market environment. Third, purchasing foreign steel involves a long term exposure to the price of steel and its demand. Steel that a service center orders today from an off-shore producer will not arrive at the service center for months. These service center customers are unwilling to bear the exposure to the potential fall-off in steel demand, and the resulting fall in spot prices, for steel over the next several months.
So, basic cash economics explains the price in today’s domestic stainless steel market. The domestic manufacturers are able to raise their prices by 5% to keep their plants operating at cash break-even. They replace off-shore producers whose delivered cost to the stainless steel service center customers is now higher than those of the domestic manufacturers. (See Diagnose/Pricing/Industry Price Outlook on StrategyStreet.com.)
Showing posts with label product supply. Show all posts
Showing posts with label product supply. Show all posts
Monday, July 6, 2009
Thursday, June 25, 2009
Health Care Costs - Our Future
The debate is about to rage over healthcare costs and coverage. So, what might our future look like?
Let me preface this blog entry with the note that I, personally, believe that healthcare should be available to all of our people. What I will question here is the assumption about the effectiveness of what we are about to do, not whether the ends are worthwhile.
We are about to extend healthcare coverage to 47 million people who are currently uninsured. This 47 million figure is a little over 20% of the population below the age of 65, where Medicare and Medicaid cover health insurance. This is a substantial increase in demand.
By definition, the supply today equals the demand. (See Diagnose/Pricing/Industry Price Outlook on StrategyStreet.com.) In somewhat longer version, this is an equation:
Units of Supply X Cost per Unit = Units of Demands X Price Per Unit
If demand increases, either supply must increase or unit costs must fall, in order to keep the equation in balance. If neither supply increases nor cost productivity improves, then price must rise or demand must be forcibly reduced. We reduce demand by rationing.
There are a number of plans to change our healthcare system in addition to extending the system to 47 million new customers. The government plans to:
* Bar insurers from excluding sick people, an increase in the cost of supply.
* Create a national insurance exchange where people could shop for different plans. One of the plans would be a public plan, like the one that covers Federal workers. This is not really an increase in supply. This new exchange is equivalent to an insurance company. These are agents intermediating between buyers and sellers. There is no increase in healthcare beds or workers in this plan. Rather, it is an increase in the cost of the current supply as we pay for a new government bureaucracy.
* Use information technology and “evidenced-based medicine” to reduce the cost of service. This is a potential real cost savings, if doctors will go along.
* Allow the import of drugs from countries where they are cheaper because they are the result of government negotiations with the U.S. drug firms. There is some chance this could reduce cost because it may force drug companies to demand more payments from foreign governments. This is not a real reduction in the cost. Rather, it is a change in who, in theory, will bear the cost. This may or may not work for the U.S. consumer.
In sum, from the initiatives we have noted, there is a high likelihood that the total cost of supply will rise, even as demand increases by over 20%. But it may be worse than that.
The government financed plan option may drive some of the current insurance companies out of the market. The insurance companies, as private firms subject to stringent public market accounting demands, must account for their long term liabilities under the insurance plans they offer. The government, as we have seen with Medicare and Social Security, is under no such requirement. Without the need to provide for the real long-term cost of the healthcare insurance, it is likely that the government will under-price the cost of the insurance it will offer as an agent. As a result, some of the current agencies, that is, insurance companies, may have to leave the market. This will shift more costs to a government bureaucracy like the one we have in Medicare. Again, the outlook for costs is bleak. Where has the government ever been more efficient as a cost manager than has the private sector?
Returning to our supply/demand equation above, there seems to be very little hope that the cost of future healthcare will fall, or even remain steady, as demand increases. Prices are likely to skyrocket. An alarmed government must then ration healthcare to bring demand into balance with supply at some acceptable price.
However, there is something missing from the discussions to date. Why is there no discussion of an increase in supply that would help alleviate the cost and price pressures, while at the same time, providing more relief to the about-to-be-super-heated demand?
It appears that we could increase supply with a bit more political will. In particular, we could increase the number of doctors over the next few years. In 2007, in the United States, there were 42,000 applicants for medical school. Only 18,000 places were available for these applicants. 57% of our applicants did not find a place in a U.S. medical school. Our political process has restricted the supply. It does take a lot of capability and training to become a doctor. It also takes a lot of ability and training to become a proficient engineer, lawyer, college professor and professional scientist. Do the day-to-day requirements of our medical doctors justify the restriction of the supply that the political system has put on the places in medical schools?
Let me preface this blog entry with the note that I, personally, believe that healthcare should be available to all of our people. What I will question here is the assumption about the effectiveness of what we are about to do, not whether the ends are worthwhile.
We are about to extend healthcare coverage to 47 million people who are currently uninsured. This 47 million figure is a little over 20% of the population below the age of 65, where Medicare and Medicaid cover health insurance. This is a substantial increase in demand.
By definition, the supply today equals the demand. (See Diagnose/Pricing/Industry Price Outlook on StrategyStreet.com.) In somewhat longer version, this is an equation:
Units of Supply X Cost per Unit = Units of Demands X Price Per Unit
If demand increases, either supply must increase or unit costs must fall, in order to keep the equation in balance. If neither supply increases nor cost productivity improves, then price must rise or demand must be forcibly reduced. We reduce demand by rationing.
There are a number of plans to change our healthcare system in addition to extending the system to 47 million new customers. The government plans to:
* Bar insurers from excluding sick people, an increase in the cost of supply.
* Create a national insurance exchange where people could shop for different plans. One of the plans would be a public plan, like the one that covers Federal workers. This is not really an increase in supply. This new exchange is equivalent to an insurance company. These are agents intermediating between buyers and sellers. There is no increase in healthcare beds or workers in this plan. Rather, it is an increase in the cost of the current supply as we pay for a new government bureaucracy.
* Use information technology and “evidenced-based medicine” to reduce the cost of service. This is a potential real cost savings, if doctors will go along.
* Allow the import of drugs from countries where they are cheaper because they are the result of government negotiations with the U.S. drug firms. There is some chance this could reduce cost because it may force drug companies to demand more payments from foreign governments. This is not a real reduction in the cost. Rather, it is a change in who, in theory, will bear the cost. This may or may not work for the U.S. consumer.
In sum, from the initiatives we have noted, there is a high likelihood that the total cost of supply will rise, even as demand increases by over 20%. But it may be worse than that.
The government financed plan option may drive some of the current insurance companies out of the market. The insurance companies, as private firms subject to stringent public market accounting demands, must account for their long term liabilities under the insurance plans they offer. The government, as we have seen with Medicare and Social Security, is under no such requirement. Without the need to provide for the real long-term cost of the healthcare insurance, it is likely that the government will under-price the cost of the insurance it will offer as an agent. As a result, some of the current agencies, that is, insurance companies, may have to leave the market. This will shift more costs to a government bureaucracy like the one we have in Medicare. Again, the outlook for costs is bleak. Where has the government ever been more efficient as a cost manager than has the private sector?
Returning to our supply/demand equation above, there seems to be very little hope that the cost of future healthcare will fall, or even remain steady, as demand increases. Prices are likely to skyrocket. An alarmed government must then ration healthcare to bring demand into balance with supply at some acceptable price.
However, there is something missing from the discussions to date. Why is there no discussion of an increase in supply that would help alleviate the cost and price pressures, while at the same time, providing more relief to the about-to-be-super-heated demand?
It appears that we could increase supply with a bit more political will. In particular, we could increase the number of doctors over the next few years. In 2007, in the United States, there were 42,000 applicants for medical school. Only 18,000 places were available for these applicants. 57% of our applicants did not find a place in a U.S. medical school. Our political process has restricted the supply. It does take a lot of capability and training to become a doctor. It also takes a lot of ability and training to become a proficient engineer, lawyer, college professor and professional scientist. Do the day-to-day requirements of our medical doctors justify the restriction of the supply that the political system has put on the places in medical schools?
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