Supply Chain Matters has been noting that increased material and commodity costs are one of the two most significant challenges facing supply chains in 2011. Definitive evidence of this challenge continues to come forth, specifically yesterday’s earnings announcement from Philips Electronics NV which posted a steep second-quarter loss attributed to weak demand and eroding product margins. Philips loss of $1.9 billion was primarily attributed to lower growth expectations in its healthcare and lighting divisions, and announced it will cut €500 million in costs over the next two years.

According to a report published in the Financial Times, margins in the lighting division halved, falling to 5.7 percent from 11.3 percent a year earlier. Phillips CEO Frans van Houten indicated that much higher prices for China sourced rare earth metals were the primary culprit of reduced margins in lighting. Rare earth metals are utilized in traditional neon lighting, and the WTO has urged China The cost of phosphorus has risen 10 times in the past two years, and price increases can only go so far in compensating for the increased inbound costs. The World Trade Organization (WTO) recently ruled against China for cutting exports of eight raw materials. Industry in the United States and Europe had expected the WTO’s ruling to spur China to increase export of rare earths, as the 2010 export was insufficient to meet world demand but China authorities have instead imposed production caps and export limits to limit production at 2010 levels.

The effect of increased supply costs is expected to somewhat moderate later this year but the damage to margins and pressure on sourcing teams are continuing.

Bob Ferrari