Do you know your true costs?

Published in October, 2006


There are many great positive aspects to working with natural stone as anyone within the industry will readily testify. Trying to enumerate them one by one would need a book, perhaps, an encyclopaedia, and that is not the purpose of this article. However, there is also another aspect about the natural stone industry, all over the world, which has nothing to do with a particular type of stone or supplier, but which also makes it truly unique- the almost suicidal and uncontrollable destructive tendency to give low prices even when not necessary.

Lower and lower prices may be a defining characteristic of a market economy in a globalised world with ferocious competition. The constantly increasing competition ensures that sellers are always under pressure to lower their costs and make their operations more efficient. Orders have to be won, for quarries, factories and workshops cannot be kept idle. The fixed costs are simply too high. It happens in all kinds of industries with all kinds of products and services, almost all the time. The economic rationale is the same everywhere.

But what sense does it make for the stone industry to reduce prices when the market is buoyant, when there are so many buyers all over the world frustrated about lack of supplies?

What are stone companies afraid of?

Lower prices would also be understandable in the case of passing on to clients the benefits of improved efficiencies in the production process and all the other operations. This is normal. In the stone industry companies are always installing new, modern machinery which allows them to lower per unit costs or offer a superior product.

But what explanation can there be when a company is consistently dispatching hundreds of containers every month, having problems in meeting delivery schedules, working at peak capacity, yet reducing its prices to clients to levels so low that the company has a permanent liquidity crisis and is losing money?

The answer to this question is not so obvious; in cases such as these it is obviously not a question of excessive competition, or lack of demand, or the Chinese (in fact, in many segments of stone industry, China is actually a big market, not a competitor). But one can make some educated guesses.

The most likely explanation is that many people in the stone industry simply do not know their true costs of operation. To be sure they may know the cost of energy, the cost of cutting by diamond wire or disk, the salaries they pay, the financial costs, even the depreciation of machinery (There are people who doubt if even this is true).

But there are also other costs in the stone business, not so obvious, but they do show up when one finally closes the accounts for the year or starts examining in depth why the company seems to making no money, even when, in theory, everything is looking so wonderful. What are these costs?

In every business, unless you are handed cash or a bank transfer is made in your favour before delivering the goods, or you are given iron clad guarantees of payment, there is a certain risk of non-payment. The risk may be low or high, actual non-payment by buyers may be little or high, depending on many criteria, but there is, as everyone knows, in the real business world, a certain amount of non-payment. Well, do all the stone companies when calculating their prices for blocks or slabs or whatever, take this into account? Have they tried to put a number, an amount, which quantifies this risk of non-payment into a cost? The answer, almost certainly, would be no.

The stone industry may consist of relatively small companies the world over, but one of its defining characteristics is a very high component of international trade. Perhaps as much as 50 % of the stone is finally installed in a country different to where it was extracted. We live today in an environment of exchange rate volatility, with periods when this volatility is extremely high, deviations of 1% a day in currencies being frequent, of 5-10% in a three month period becoming common.

When the stone industry exporters start giving extended and highly flexible payment terms to their buyers so as to obtain orders, they are also taking on huge risks of making losses if the exchange rate movement takes place against them. The price one gave in US dollars may have been a good one at a certain exchange rate, but when the money actually arrives and is converted into the local currency 120 or even 180 days later, the company may find it has actually lost money in the transaction. Ask the Brazilians who depend so heavily on the US market. The question once again is - are the companies aware of the exchange risk when quoting prices, do their prices incorporate clauses allowing for price revision if an exchange rate moves beyond a certain level? Are the companies even aware that giving extended payment terms without guarantees in international trade may constitute a huge risk for their company? One cannot assume, as many companies especially in the developing world do, that if they receive money later, because their country’s currency will become more weak against the Dollar or the Euro, their profits will be even higher. (That assumption was actually valid till only recently and may have been the reason why many exporters were relaxed about receiving money late). Trying to predict the exchange rate movement, by the way, is something for the specialists, and even they get it wrong very often.

There are other costs which most stone companies simply are not able or willing to take into account when trying to give the lowest possible price under pressure from a possible buyer. There are breakages in stone, in every phase of the operation. Many times a buyer uses this as an excuse when trying to negotiate a bigger discount before paying, but the fact is breakages do take place. Are you, therefore, taking into account, that there will be certain losses every year because of breakages, and incorporating this into your costs?

And what about those excuses from the buyer for extracting further discounts even when the prices and payment terms have already been negotiated – that the stone supplied was defective, it was broken at the edges, there were too many veins, or too few veins, the colour was not what he had asked for, etc.? Of course, in 90% of the cases, they are only excuses, and the unscrupulous buyer is only trying to take advantage of the hard pressed seller. The well managed companies know exactly who is who and know how to deal with these situations. But there many who sellers who simply do not know how to resist this kind of pressure. And the question, once again, is – have you taken into account this discount you are always giving when you are giving a price to this kind of buyer?

At the end of the day, the question of giving unprofitable prices boils down to the quality of management of a company. There are too many new, inexperienced people in the stone industry (logical, since it is a growing industry in many parts of the world), but who also think it is an industry where there are easy profits to be made. It takes them time before they learn this is a complex, difficult industry where only the most committed and serious people ultimately triumph. Giving low, unprofitable prices may be an easy way of obtaining new clients, but it is a complete disaster if not rectified soon enough. And one of the basic elements of the learning experience should be-know your true costs, if you really want to survive in this business.