Lumber is mission-critical to every component manufacturer (CM). On average, it represents two-thirds of your cost-of-goods (CoG), roughly half of the value of your product (Revenue – Pretax Profit). So, what are the market dynamics that surround the purchase of lumber? And how/why can CMs exert market power?
The forces shaping the North American lumber market
The North American lumber market’s core drivers are: fragmented wood fiber basins, high transportation costs to move fiber from forest to market, high fixed manufacturing costs (high fixed costs create a strong motivation to drop prices to fill excess capacity), competition for fiber supply for non-construction uses, difficulty and cost of holding/storing sawn lumber, and short-term price-inelastic demand. The market is characterized by frequent 30% lumber market price swings.
The market is “noisy.” On a given day, even when prices are stable, the spread between comparable offers from comparable vendors averages 2–4%, and when the market is moving, it can be 15+%. On a given day, a mill or wholesaler is under no obligation to sell its products/inventory, but rather seeks to optimize yield from its current (and variable) log supply/inventory based on current market prices.
The SBCA’s Construction Industry Workflow Initiative (2019) developed a comprehensive overview of the supply channel and lumber procurement dynamics that discusses this further: How dependent are you on your lumber supplier?
Lumber’s outsized impact on CM profitability
Last spring, BuyMetrics modeled the impact a 1% change (+/–) in the cost of lumber has on CM profitability for the SBCA’s Innovation Committee. For data, we used the SBCA 2019 Pro-Forma Financial Data (pre-pandemic data). The only variable changed was lumber cost. The methodology/results are online and shown in the image [for image, See PDF or View in Full Issue].
What we found was each 1% decrease in lumber cost produced a 10.36% increase in pretax profit. A 4% decrease produced a 41.46% increase in profit. And, the opposite was also true, every 1% increase in lumber cost drove a 10% decrease in profit.
Every market is local, and every CM has their own production mix, their own competitive environment, their own cost-to-produce, their own go-to-market strategy. I recommend trying this exercise using your own P&L data.
No CM can optimize production until the cost of lumber is optimized
When competing products are nearly identical, with few switching costs (i.e., known grades/standards, design values) the BUYER has market power – the ability to reduce prices, improve quality or sale terms, or “generally play industry participants off one another.”
The function of the commodity wood buyer is to minimize net delivered cost plus inventory carrying expense while maintaining acceptable service levels. CMs buy more than seven billion board feet of lumber annually. Given the need to discover price and availability for each load, the lumber buyer’s core tactic is to aggressively shop each purchase. With volatile commodities, it’s never enough to measure against plan or budget; to stay competitive, you need to measure against the market, and exert your market power.
Valerie Hansen is the Founder and Chairman of BuyMetrics Inc. She is a 45-year industry veteran and the former owner/CEO of Custom Components Company, Racine, WI (sold 2008). From 2000–2019, she earned 21 U.S. patents for inventions in the technical areas of finance and data management. Privately serving industry-leading CMs since 2000, the BuyMetrics® commodity procurement platform automates and informs the purchase of lumber and other volatile commodities.