Not All Lubricants Are Created Equal But who’s counting?

Compoundings Magazine
February, 2002
By Thomas F. Glenn, Petroleum Trends International, Inc

Although manufacturing economics have always been a key factor in separating the leaders from the laggards in the lubricants business, understanding and managing manufacturing economics will become even more important in defining success and failure as we move foreword. This will be due in part to more intense competition and a softening in lubricant demand in the US market. Low costs producers are expected to have a significant competitive advantage in the changing market ahead. In fact, much of the merger and acquisition activity taking place in the lubricants business over the last five years is driven by interest in reducing costs.

Lubricant manufacturer typically assess manufacturing economics by looking at raw material cost over volume. Unfortunately, due to time constraints and complexity, this is often done on an aggregate basis and can result in a significant distortion of true cost at the product level. This distortion can then damage profitability when a manufacturer seeks to improve manufacturing costs by driving up incremental volume. More is not always better. In fact more volume can mean less profit when the incremental volume comes from a product who’s costs are high and/or hidden and not appropriately allocated. Damage to profits can be even greater when the increase in volume comes from products that not only have high unallocated manufacturing costs, but are also tied to high costs in such other business activity as sales and marketing, technical service, liability, and others.

LESS CAN MEAN MORE…

Most majors and independent lubricant manufacturers typically maintain product slates comprised of both high and low volume products. The manufacturing cost structures for these products can range widely. Some of the high volume products are comparatively easy to manufacture. Hydraulic fluids, for example, are typically blended either in-line or in large bulk tanks. Additives typically represent less than 1% of the finished product volume and net additive treat costs are comparatively low. Assuring blends are on spec is also comparatively easy in that the number of parameters to test for and the degree of sophistication required by the laboratory to assess blend quality is relatively low. In addition, much of the hydraulic fluid sold requires relatively straightforward transactions with little to no technical services component. In fact, in some applications, hydraulic fluids are considered to be nearly undifferentiated commodity products.

The importance of understanding true manufacturing costs at a product level becomes very clear when one contrast and compares the costs to manufacturer hydraulic fluids with that of making grease and other lower volume lubricants. Traditional grease making for example is a much more labor-intensive manufacturing process than that required to make hydraulic fluids and many other lubricants. It also consumes considerable more energy on a unit basis, and frequently requires the guiding hand of a professional experienced in the grease making.

So even if ones accounting system does allocate cost of the raw materials at a product level and calculates manufacturing costs at the same, does it consider labor, energy, and other product specific activities? Does it assess the impact the manufacturing costs for one product have on another? For example, is a consultant or a chemist needed to assist in customizing, fine-tuning and develop formulations for a specific product? Are a $125,000 inductively coupled plasma (ICP) spectrometer and its monthly appetite for energy and argon needed to assure blends meet military specification for a government contract? Are batches ever turned into “slop or flush” oil because they have more than 10 ppm of zinc? Does a Mil-H-5606 hydraulic fluid ever require a seemingly endless filtration process to bring the particle count to an acceptable level? Are you forced to use PAO to make synthetics rather than Group III because you don’t have the tankage to inventory both? Are you using Group II for all products because you need it for the small quantity of passenger car motor oil you sell to a local chain of quick lubes?

Granted, the use of PAO may be an important point of differentiation when selling lubricants in challenging locations and vocations. The spectrometer can also be used to test other products for quality assurance and maybe even turned into a profit center. And maybe you have never missed the mark when blending challenging products. But, unless all direct and indirect costs to make a specific product are accounted for and the impact they have on other products in the slate are assessed, one can fall into the trap where selling more volume does not yield the desired results of higher profits. In fact, it may result in effectively taking money from margin rich products to keep margin poor products limping along.

In today’s increasingly competitive lubricants market where manufacturing costs will increasingly define winners and losers, assessing manufacturing costs will require a look beyond simply the raw materials making up the costs of goods sold. In the process of assessing the true economics to produce each product in ones portfolio, some will find that less can actually mean more.


Copyright © Petroleum Trends International, Inc. 2002