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MARKET WATCH

How Rising and Falling Prices Affect Wood  Cost Components?

Posted by Pete Coutu on February 8, 2016

Navigating the dynamic wood supply market in North America can be challenging. As supply and demand factors constantly affect prices on a regional—and even countywide—basis, price volatility due to supply and demand exists independent of supply chain efficiency efforts. This means that any realized cost benefit is usually passed between members of the wood supply chain. It’s an ever-changing relationship: generally speaking, when price goes up, the supply side benefits; when price goes down, the consumption side benefits.

Last fall, I was discussing the changing nature of this relationship with a customer who was seeking answers about the various supply chain cost components and how they typically affect one another. More specifically, he was asking how the Forest2Market benchmark accounts for the allocation of cost components since not all subscribers to the service report individual components. Furthermore, the cut/skid rates in the Forest2Market benchmark conflicted with what he was hearing from his own suppliers.

With so many moving parts and pieces of data to consider, the process is anything but simple. Let’s start with the process that Forest2Market uses to arrive at the individual cost components in its benchmark.

First and foremost, we begin the process by analyzing Forest2Market’s proprietary transaction-based data, which includes more than 262 million unique records (40 million in 2015 alone) of forest industry data. This transactional data provides a full-spectrum view of all market dynamics and includes information supplied by forest products companies, wood dealers, loggers, consultants and landowners. For each of these transactions, Forest2Market’s data is very detailed; at a high level, it includes:

  • Source cost
  • Commission cost
  • Freight cost and distance
  • Harvest cost
  • Total delivered price per ton
  • Seller type geographic origin
  • Total tons

When each transaction has been verified and expertized, Forest2Market then reports a fully-loaded delivered price that is broken out into five primary cost components:

  • Stumpage
  • Cut/Skid
  • Freight
  • Overhead
  • Margin

Since Forest2Market knows the exact total price delivered to a wood-consuming facility, total delivered price is a constraining factor. Furthermore, overhead is a reported number that is absolute. Freight and cut/skid are values reported by a large portion of our subscribers; we use these reported transactions and apply them to all facilities within a given procurement zone. Since we also collect origin and destination data, freight is calculated and subsequently applied on a per-ton, per-mile basis. Lastly, margin is calculated as fallout from the other numbers. The interpretation of margin varies by region; it is meant to represent the profit to the supplier, which could be the logger, the trucker, the dealer or whoever holds the contract with the facility. For instance, the US South has a well-developed dealer network so the margin is typically representative of dealer profit. However, in the Great Lakes, the logger typically holds the contract with the facility so the margin is often representative of logger profit.

With this information as a backdrop, why would Forest2Market’s reporting conflict with information provided by specific suppliers? In point of truth, both Forest2Market and the supplier are correct. As with all data, understanding the goal of the analysis as well as the interpretation of the results is key. For example, consider the cost components in the hypothetical chart below.

 cost_components-1.png

 

In the short term (assuming the same freight distance), more dollars are allocated to margin. But as time passes, more of the total price increase goes towards stumpage because of free-market competition for the resource. In areas where the logger holds the contract, margin and cut/skid are overlapping components, so in this case it really depends on the way cost components are reported.

Another factor that may cause variation in reported prices is that not all contractors are paid at the average rate that Forest2Market reports in its benchmark. There is a range around the average for each mill and for the larger market. Variability around that average can be substantial, particularly when supply and demand are tight. For example, if landowner A has a quality supplier that is considered to be valuable, that supplier is likely paid at a higher-than-average rate. If another landowner or mill tries to lure that supplier away, then his price for cut/skid or margin may increase above the area average.

With the transactional data that Forest2Market collects, as well as the specialized analysis for each cost component, we can quantify the variability around the above averages. This level of insight provides operators within the wood supply chain—both on the supply and the consumption sides—with a greater level of certainty.

Typically, changes in the cost components are not as dramatic as the example above. However, regardless of the dynamics in a particular wood basket, the following hold true:

  • Supply and demand factors will drive prices up and down in the free market of fiber transactions.
  • In a market with increasing prices:
    • Additional money goes to the supplier in the short-term as margin, which translates into profit, extra payments on debt, etc. A supplier is the contract holder and may be a dealer, a landowner or a logger.
    • In the long-term, additional money goes towards stumpage due to free market forces where the contract holder will generally keep as much margin as possible.
  • In a market with decreasing prices, savings go towards the consumer and are generally regarded as additional profit for the consuming facility, both in the short- and long-term.
  • Forest2Market’s standard benchmarks report average pricing during a particular time frame. Depending on where the fiber market is in its free-market cycle, supplier pricing will vary around the average reported in the benchmark, sometimes significantly.
  • Forest2Market can quantify the variability around these averages, but looking forward to where the market is driving prices is a key element for interpreting the results.

Improving supply chain efficiencies is the single most effective method to boost profitability within the free market for fiber transactions. Supply and demand will always drive prices up or down. Optimizing supply chain efficiencies, however, will not only make the forest products industry more competitive within the free market, it will also make specific operations more profitable.

Learn more about Forest2Market's Suppy Chain Optimization Program.

 

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Topics: supply chain

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