On the front cover of a recent issue of Automotive News, I saw something that struck me. It was a feature article containing an interesting interview with Scott Kunselman, Senior Vice President of Purchasing and Supplier Quality at Chrysler Group. Kunselman was quoted as saying, "If I can build another car, am I willing to pay a couple of pennies more for a part? Absolutely." Very interesting...

I was a buyer once, 30-plus years ago, and still remember that the overwhelming daily concerns dealt with delivery and quality. Sure, pricing was always a factor, but it did not drive the daily concerns that affected the operations of the manufacturing plants.  When I read this quote, I was reminded about the business priority to maintain production and support surges in demand.

My first observation surrounded the issue of capacity dynamics within the iron castings market. Here's what we know: about one million tons were removed from the North American Iron Casting market during the Great Recession of 2008 and 2009. To provide some context to that number, one million tons could produce 150 million brake rotors or 100 million differential carriers. That's a lot of tonnage out of the market. And, based on industry demand and supply numbers from such services as Stratecast and Knight Wendling, there is not enough capacity in place today to support forecasted volumes.

Here's what's being said: the Automotive News article spoke of increased North American capacity or "Factory frenzy" by the Japanese OEM's—in the automotive market, but also by the commercial truck, construction, and agricultural OEM's, implying that demand is increasing, again, and more iron foundry capacity will be needed.In addition to what we read in our industry publications, we hear first-hand about the possible scenario that market dynamics will come to the rescue and add capacity.

Certainly some foundries have added capacity, including Waupaca. We restarted our Etowah, Tennessee, facility in October 2011, which put back about 200,000 tons into the market. We have heard that MTI is adding new equipment, as has Cifunsa in Mexico. But even with this announced new capacity, the demand is still likely to exceed supply, based on present knowledge of the iron foundry industry's capacity growth plans.Waupaca's customers understand this capacity dynamic, and have for more than 2 years, because of our collaborative relationships. We have encouraged people throughout the industry to have strategic meetings with their foundry partners to thoroughly discuss this capacity situation, working to bolster new investments from both sides of the equation.

Building a "green-field" plant is not a quick fix—as the Automotive News article identified, relative to capital-intensive industries like tires. In many ways, iron castings follow the same scenario. A new plant generally takes one year to design, one year to build, and another two to three years to operate at full capacity, especially at an efficient level. This means we're talking about a 4-to-5 year start-up. So our industry should start discussing this challenge very quickly.

This type of planning and investment is not only needed in North America, but in all regions of the world—if the major industries reach forecasted growth, whether in China, India, Europe, or South America.Thinking about the capacity dynamic almost always brings us back to pricing. In the late 1980's and 1990's, extending to the early 2000 years, iron foundries, like many manufacturers, fought fiercely with each other over pricing, driving market pricing down. This was coupled with the OEM demands for year-over-year price reductions, further driving margins down.

The largest foundry in the North America market in 2000 was Intermet, and they no longer exist today.The Automotive News article mentioned that in high, capital-intensive industries like foundries, companies must be strongly profitable to encourage their investors to make the tough decision to build a new foundry at a cost of more than $100 million—depending on the number of molding lines and core equipment. The roadblock of investment size is compounded by the length of time required (4 to 5 years) to bring a new plant to efficient operation, as noted previously.

There has been much already said and written about the differences in investment decision-making by strategic owners of companies, and private equity firms. Waupaca Foundry knows these ownership environments, given our prior ownership by a strategic owner, ThyssenKrupp, and today's ownership by a private-equity company, KPS Capital Partners.

A company must earn an attractive profit and generate strong cash flows to encourage any investor today to make sizable capital investments, whether a current plant expansion, greenfield, or acquisition. While the article cites an improvement of operating profit before interest and taxes, the article did not elaborate whether current margins are sufficient to encourage an owner to make necessary capital growth investments.  The Automotive News article referred to a recent Roland Berger study for the first six months of 2012 of the 50 publicly traded suppliers in North America.

While the article cites an improvement of operating profit before interest and taxes to 6% (from 5% a year earlier), the article did not elaborate on the idea that whether a 6% EBIT number is an attractive performance indicator to encourage an owner to make sizeable capital growth investments, especially in capital intensive industries. It's not easy to discuss openly the margins and cash flow needed to provide the attractive environment for significant capacity growth. But, it needs to happen.

As a real example of these discussions, some OEM purchasing managers have recently acknowledged to me that iron foundries could get better margins in other industries, and most understood that in order to secure foundry capacity, the OEM needed to address necessary pricing issues. This type of strategic discussion about capacity and the required investments should span a 1-to-2-year period, but also include a 10-year outlook or longer.In summary, the capacity situation is a real, immediate concern within the iron foundry market.

The challenge is to have honest, open dialogue about various industry volume scenarios, commitments of volume and related capacity on both sides, and open pricing issues that could prove a roadblock to capital growth commitments. The current situation can only be remedied with meaningful discussions and commitments.