The High Cost of Doing Business

Michael Fickes

Recently, the peoria disposal co. (PDC) in Peoria, Ill., acquired a small hauler. Among the new customers that came with the acquisition were residents and businesses of a small municipality in Illinois. In light of the surging industry costs of recent years, PDC has instituted annual price increases for all customers. However, following the acquisition, PDC's accountants discovered that none of the residential or commercial customers in the small town had seen their trash disposal fees rise for seven years.

“When we talked to the customers and told them we were going to raise prices, people laughed,” says Matt Coulter, vice president of Coulter Cos., the parent firm of PDC. “They said, ‘Where the heck have you been? We've been expecting prices to go up for years now. Are you making any money in your business?’”

As haulers continue to deal with the rising costs of fuel, truck bodies, engines and other materials, firms are now aggressively seeking to recover their expenses and manage costs. For instance, waste companies are no longer basing price hikes on Consumer Price Index (CPI) increases, which they say do not accurately predict the amount they need to charge their customers.

Haulers also are instituting fuel surcharges and strengthening maintenance programs to get more years out of trucks and other equipment. They are applying technological solutions to routing and driver management, and to business decisions. And to attack rising health insurance and worker's compensation costs, haulers are starting programs to address employee wellness and safety.

Compacted Margins

The prices charged by the waste industry have been out of sync with rising costs since 2000, says Tod Holmes, chief financial officer with Fort Lauderdale, Fla.-based Republic Services. Holmes says Republic's operating income in 2000 stood at 21 percent of its revenue before taxes. By 2006, Republic's profit margin had fallen to 16.9 percent of its revenue. “On a percentage basis, we have had a 20 percent decline in profit margin,” Holmes says.

Holmes attributes the decline to several factors, particularly fuel costs. “The cost of diesel fuel for our equipment doubled from 2003 to 2006, from 3 percent of revenue to 6 percent of our operating budget,” he says. “Fuel costs were flat for the first nine months or so of 2007. Then they jumped 20 percent.”

Also, most waste industry professionals agree that fuel prices are the number one cost problem that the industry currently faces. “Fuel accounts for 10 percent of our annual operating costs,” Coulter says. “It is the number one issue we have to deal with.”

Ben Harvey, senior vice president and co-owner of E. L. Harvey & Sons in Westboro, Mass., echoes similar sentiments. “Our biggest problem is energy costs to run our vehicles and our plants,” he says.

Other cost problems include the impact of higher oil costs on the prices of necessities like motor oil, plastic recycling containers and landfill liners, and the indirect fuel costs incurred when paying for waste to be hauled to distant landfills.

In addition, rising steel costs (see “The Steel Price Timeline” on p. 25) have raised the cost of steel containers, roll off trailers, and compactors, as well as truck bodies, truck chasses and other equipment.

Also hitting haulers in their wallets is new engine emission technology, which has added as much as $10,000 to the price of 2007 truck engines. Another round of cost hikes will accompany new emissions restrictions scheduled to take effect in 2010.

And finally, health care costs also have been rising. “Our health care premiums are up 13 percent this year,” Holmes says. “We have seen double digit increases in health care costs every year since 2000.

Innovative Management

There was a time when haulers increased their customers' prices by following the CPI. But CPI no longer relates to the cost structure of a waste hauler. Take the cost of fuel, for instance. According to Bob Gregory, CEO of Austin, Texas-based Texas Disposal Systems, fuel accounts for 4.3 percent of the CPI — and the fuel that CPI tracks is gasoline, not diesel.

“But, diesel makes up 9 percent of our overall costs,” Gregory says. “The same is true of health insurance costs. Health insurance represents 0.386 percent of CPI, but it is just under 2 percent of our budget.”

CPI simply doesn't work anymore, and haulers are searching for innovative ways to monitor and manage costs. Texas Disposal calculates its own index for municipal accounts by blending CPI with a diesel fuel index. “We weigh CPI at 85 percent and the fuel index at 15 percent,” Gregory says. “This has helped us deal with fuel costs related to municipal customers.”

Meanwhile, The Coulter Cos. have adapted Motorola's trademarked Six Sigma program to help manage quality and costs in the waste business. The program offers a step-by-step management approach to eliminating defects in processes.

Coulter says they began using the Six Sigma program to reduce fuel costs in early December. “Fuel makes up about 10 percent of our annual costs,” he says. “We spend $6 million per year on fuel.” The project will attempt to reduce those numbers. Tactics include passing on fuel costs through surcharges.

Also, building more transfer stations within a service area to reduce the number of trips to the landfill by collection vehicles is being evaluated by PDC. The new transfer stations would fill pup trailers — two 48-foot trailers linked together — with waste to minimize trips from the transfer stations to the landfill. PDC also is making more frequent use of routing software, while installing larger fuel tanks at operating facilities to increase savings from buying in bulk.

E. L. Harvey also buys in bulk to lower the fuel costs and to stabilize surcharges. “Buying large blocks of fuel enables us to keep the surcharges from yo-yo-ing up and down,” Harvey says. “We're also buying the most efficient trucks.”

The firm handles few residential accounts. Almost all of its customers are on the commercial side, and 90 percent of that business is roll-off. The company has installed a global positioning system (GPS) to track trucks and permit more fuel-efficient dispatching.

To combat the rising cost of steel, the company is exploring rebuilding programs for trucks, yard equipment and steel containers. “The idea is to take old motors, transmissions and rear ends, and put them on new chasses,” Harvey says. “Caterpillar has a program that puts rebuilt equipment into a shell for 50 percent to 75 percent of the original cost of equipment.”

In the area of health care costs, Republic Services monitors available plans on the market and looks for discounts. “We have been able to mitigate some of these cost hikes,” Holmes says. “For example, we changed to Blue Cross and Blue Shield and increased our discount from 42 percent to 48 percent. We passed some of these savings along to employees by holding down the price hikes on their shares of premiums.”

The company also has applied a number of technological solutions to control costs and improve revenues. For example, in the Houston market, Republic operates three transfer stations and two landfills. In addition, Allied Waste and Waste Management operate disposal sites in the region. “We use a [software] modeling tool called Disposal Optimization to determine the most cost-efficient disposal site,” Holmes says. “It holds down disposal costs and truck running time for disposal.”

The company also employs up-to-date routing and maintenance technologies to control costs. While Holmes says he wouldn't think of operating without these kinds of tools, he acknowledges that their combined impact is small.

“If inflation runs between 2.5 percent and 3 percent, we might be about to offset .5 percent to 1.5 percent of those costs,” he says. “So costs continue to rise. That means you have to get back to pricing. We need to get higher prices from customers to pay for rising equipment and operating costs.”

On the revenue side, Republic Services uses Return On Investment software to evaluate cost structures of operating locations and to price new customers. “We can also look at existing customers with this tool,” Holmes says. “This has become part of our overall strategy — to ensure that customers are paying a fair share of these costs.”

What's Next?

While some observers have noted that cost increases may be self-correcting, analysts that have studied the numbers warn against easing up on efforts to manage rising costs. “In the first half of 2007, the rate of cost increases moderated slightly when compared with increases of the previous year,” writes Kenneth D. Simonson, chief economist with the Associated General Contractors of America in Arlington, Va., in a mid-November analysis of building costs.

“That raised an expectation in the industry that cost increases may be coming to an end,” Simonson adds. “The latest data indicates this not to be the case.”

Simonson writes that October surveys of manufacturing and non-manufacturing purchasing executives found that prices for diesel fuel and hot-rolled steel are continuing to rise. He also notes that the Energy Information Administration projects that the cost of diesel fuel will rise 8.1 percent in 2008.

Continually rising prices may be an unavoidable part of the waste industry's environment for the foreseeable future. If so, they may inject a new form of competition into the industry: Who will be able to manage costs well enough to sustain service quality without driving customers to haulers offering lower prices?

Michael Fickes is a Westminster, Md.-based contributing writer.

THE STEEL PRICE TIMELINE

At the beginning of the War in Iraq in March of 2003, steel prices shot up past $100 per ton. By January 2004, a ton of heavy melt steel averaged $161.62. Wild price swings characterized 2004, which ended with the price hovering around $250 per ton.

Prices plunged through early and mid-2005, falling as low as $125 per ton in July. But by December of that year, a rally had pushed prices back up to $250. Prices hovered or fell for most of 2006 and then came back up in 2007, ending November at $265 per ton. Since Sept. 11, the price of steel has more than tripled.