Ann Arbor Area BUSINESS MONTHLY magazine brings the reader the latest business news and information important to the businesspeople in Washtenaw County. Each month articles cover real estate, legal, Internet, employee concerns and the climate of business in the greater Ann Arbor area. There is news about company employees and feature articles on local businesses. We cover business news from Ann Arbor, Chelsea, Dexter, Manchester, Milan, Saline, Whitmore Lake, and Ypsilanti.
High Gas Prices Prompt
New Business Strategies
By Mark Ziemba
It doesn't take a rocket scientist to know that the increase in the price of gasoline is painful to the pocketbook, and not just the consumer's. Businesses are suffering too, especially those that depend heavily on gasoline to conduct operations.
From 2007 to 2008 the average price for regular gas jumped by nearly 37 percent, and for diesel gas by 51 percent, according to the U.S. Department of Energy's Energy Information Administration. The government can explain this, and several area businesses share how pain at the pump is changing the way they operate.
The High Gas Price Story "The story behind gasoline prices is crude oil," says Energy Information Administration Senior Economist Tancred Lidderdale.
That's because crude oil currently makes up 75 percent of the price of regular gas, and 64 percent of the price of diesel gas. The price per barrel of West Texas Intermediate crude oil this June was nearly twice what it was last June. A high growth in demand has stressed supply, driving up the price of crude oil.
Surprisingly, U.S. consumption is not the biggest factor in demand. Lidderdale says that American gas consumption this year is expected to decline from the previous year, the first time since 1992 that this has happened. In response to high gas prices, Americans are opting for smaller, more fuel-efficient cars, and sales of large, gas-guzzling SUVs are declining.
"What's really driving crude oil consumption is not the United States," says Lidderdale, "it's the emerging economies: China, India and the Middle East."
These areas have huge populations and growing economies, which together create significant demand. With nearly 20 percent of the world's population -- 1.3 billion -- China has over four times the U.S. population. India is nearly on par with China at 1.1 billion people. Both China and India have robust gross domestic product growth approaching 10 percent, while U.S. GDP growth is only about 2 percent.
Several issues are affecting supply, which comes from Organization of the Petroleum Exporting Countries (OPEC) and non-OPEC sources. Although OPEC production has actually increased, non-OPEC production declined faster than expected, says Lidderdale. The largest OPEC oil producer, in fact the world's largest net exporter of oil, Saudi Arabia maintains such heavy production that its oil surplus is significantly diminished. All this has created a very tight market, says Lidderdale. "A characteristic of this tight market is that prices are very volatile," he says, prices which are easily affected when conflicts or hurricanes cause supply disruptions.
There is a silver lining to this threatening cloud of high gas prices, however. Lidderdale says that consumers respond to rising prices by decreasing demand and producers respond by increasing supply, which eases price inflation.
Lidderdale points out that after the high gas prices following the OPEC oil embargo of 1973 - 1974 and the 1978 - 1979 Islamic Revolution of Iran, American gas consumption declined as more people began to purchase fuel-efficient cars. He adds that production also increased with development of the Alaskan and North Sea oil fields. This combination resulted in the inexpensive gas prices enjoyed throughout the 1990s.
Lidderdale observes that consumers and producers are now responding similarly. Decreasing U.S. consumption has kept the price of U.S. gas from going even higher than it has, he says, so conserving gas has made a difference. Despite less-than-expected recent production from non-OPEC nations, he adds that new oil fields are also starting production in the Gulf of Mexico, Brazil and Russia, which will boost supply.
According to the government, gas prices aren't as bad as they might seem when you account for inflation. Although regular gas prices have hit all-time highs this year, according to the EIA's May 2008 pamphlet, "A Primer on Gasoline Prices," 2007 average annual gas prices are actually similar to inflation-adjusted prices seen in the early 1980s.
"Energy is going to continue to be expensive," says Lidderdale, but the EIA remains cautiously optimistic that by late 2009 "we see gasoline going back under $4 a gallon." He adds, however, "In this market, any forecast is highly uncertain."
Area businesses that rely heavily on gasoline have adopted an assortment of strategies to address the pressure of high gas prices.
Domino's Emphasizes Value, Explores Fleet Vehicles
With drivers who cover over 40 million miles a month in the United States at over 5,000 national stores, Ann Arbor international pizza delivery company Domino's has mainly approached high gas prices by reminding its customers that delivery saves them gas, money and time.
"What we've really done in response to rising fuel costs is focus on how pizza delivery can be a greater value to our customers," says Domino's Vice President of Communications Tim McIntyre. "You don't have to use your own gasoline," says McIntyre. He adds that "having a full meal delivered at home is probably one of the best bargains you can get." On top of that, "you have an extra half hour in your day where you're not in the kitchen making dinner."
Domino's relies mostly on the vehicles of its delivery drivers, whom the company reimburses on a per-delivery basis to cover fuel and maintenance costs. McIntyre says that the reimbursement has moved up with gas prices.
Domino's also began testing the use of economical, fuel-efficient fleet vehicles in its Las Vegas, Nevada, stores in July. This eliminates driver reimbursement and increases delivery fuel efficiency.
The roughly two dozen Toyota Yaris vehicles are also fully branded with Domino's advertising, which adds marketing value for the company. "They're rolling billboards," says McIntyre.
Big George's Adds Value, Streamlines Processes
Recognizing that customers are spending more on gas and are more pressed for time than ever before, Ann Arbor appliance and outdoor living store Big George's adds value to the customer experience and cuts business expenses by increasing efficiency.
Vice President Mark Bishar says that industry studies show that customers typically only stop at two appliance stores before making their decision, so service and convenience are more important than ever. He says that Big George's has polished the skills of its sales associates, and emphasized service with its Internet phone sales staff. The staff encourages phone customers to stay at home and take installation measurements rather than driving to the store. That way, Bishar says, "they may not have to burn any fuel."
Big George's is also training its delivery staff to perform appliance installations, which saves the customer and the store both time and money. Bishar acknowledges that Big George's has had to raise delivery fees to respond to high fuel prices, but points out that Big George's delivery fees are still less than its competitors.
Improving efficiency has helped Big George's cut costs in response to high gas prices, too. Software has helped the company implement bar coding, which has drastically cut inventory count time. "We used to shut down the whole company," says Bishar, while employees counted all day. Now, he says, employees can count inventory quickly, before they even open in the morning. "They have the whole showroom counted by 10."
Bishar says that Big George's has looked into alternative vehicles, but diesel fuel is still more cost-effective for delivery trucks carrying heavy loads.
Bishar sees high gas prices as a challenge. "It's costing us money," he says, but "it's making us improve." He views this challenge as a motivation for businesses, consumers and government to explore conservation and energy-efficient solutions for the future.
AATA Invests in Futures Market, Hybrid Busses
Using an average of 50,000 gallons of diesel fuel per month in 72 busses, the Ann Arbor Transportation Authority is severely affected by fuel price increases. Each 10-cent per gallon price increase in diesel fuel adds a cost of $5,000. Additionally, high gas prices have flattened the AATA's income from state gas tax revenue, says AATA Controller Phil Webb. People are buying less gas, meaning less money for mass transit. So the AATA is aggressively fighting fuel prices by minimizing the volatile market's risk with oil contracts on the futures market, and investing in more hybrid busses.
The AATA's futures market strategy is to buy contracts for heating oil, a traded commodity which correlates closely with the price of diesel fuel because of its similar chemical composition. It purchases these heating oil contracts at current market prices to sell them at a later date. Since fuel prices are generally going up, the investment realizes profit to offset the cost of current diesel fuel purchases. If diesel fuel prices were to go down, the cost of purchasing cheaper diesel fuel would offset losses from the futures heating oil investment.
"For the whole year we've saved 72 cents per gallon," says Webb. That amounts to a savings of about $36,000 a month, or about $432,000 a year. "We feel like geniuses!"
The AATA has also transformed over one quarter of its fleet into hybrid gas and electric busses. By spring 2009, 38 percent of the fleet will be hybrids. The hybrid busses save money because "they get about 35 percent better mileage," says Webb.
Webb says that additional measures include eliminating the half-hour morning idling time when starting the busses and carrying on good engine maintenance to get the best gas mileage.
Golden Limousine Grows Internationally, Cuts Costs and Conserves Fuel
Ann Arbor's Golden Limousine operates in the global market, reduces operating costs and emphasizes fuel conservation to adapt to high fuel prices and Michigan's struggling economy.
Golden Limousine began to expand operations beyond Michigan in 2003, and today offers services in cities from New York to Chicago to Los Angeles, as well as internationally. This adds value for its customers, increases Golden Limousine's revenue and diversifies that revenue stream. Chairman and CEO Sean Duval says that the company arranges work through its own network of trusted affiliate chauffeurs to provide expanded service. Local clients benefit by being able to arrange even their international transportation needs through a familiar, trusted limousine company, he says. Golden Limousine benefits from setting up a job without much overhead. Its affiliates benefit by receiving work without marketing costs.
The rapidly rising cost of fuel creates significant expense in the limousine business, which requires large, luxury vehicles, so Golden Limousine cuts costs to adjust. It is transferring ownership of the majority of its sedans to its own chauffeurs, but maintaining ownership of a diverse spread of a small number of vehicles, from sedans to stretch limousines to highway motor coaches. The move cuts its monthly fuel cost to $17,000, but because of rising gas prices it only amounts to about a 15 percent reduction from its previous monthly fuel cost.
Golden Limousine also conserves fuel as much as possible. It asks chauffeurs to shut off the engines when possible, which can be difficult when it's important maintain a cool temperature for the customer in the summer and a warm temperature in the winter. It also encourages its chauffeurs to drop the highway speed of its motor coaches.
Duval has had to increase his fuel surcharge from 5 to 12 percent, as well.
The pressure of high fuel prices concerns Duval, who wants to see Michigan's economy bounce back. "It's just a tax on everybody," he says. It slows the growth of business, too. "You can't do as much," he says. "Instead of spending money on bonuses and awards and upgrades in your business, you're spending it on fuel."
Reliable Delivery Stalls Base Price Increases
Based in Romulus and operating in Grand Rapids and Flint, Reliable Delivery's 250-vehicle fleet covers 1.5 million miles per month. Although it applies a floating gas surcharge that changes weekly with the price of gasoline, for the past three years it has kept increases on its base rate at bay.
"The customer is the one bearing the brunt of the price, which is not good for our business," says Operations Manager Craig Holland.
Reliable Delivery still feels the pressure of high gas prices, though. "It's frustrating," says Holland.
Holland says that double-digit growth in its business has required Reliable Delivery to invest in more staff, so it's difficult to find places to cut back. "We've had to watch our costs very closely."
Con-way Freight Decreases Truck Speeds to Conserve Fuel
Consuming over 8 million gallons of diesel fuel a month, Ann Arbor's Con-way Freight is dropping truck speeds from 65 to 62 miles per hour to conserve fuel. Con-way predicts this will cut fuel consumption by 3.2 percent and save them over 250,000 gallons per month. It's also adding auto shut-off controls to cut idling and using more effective vehicle lubricants to increase gas mileage.
July Hinted at Relief, but Gas Prices Remain High
Gasoline prices have pushed businesses that rely on gasoline to change their strategy in order to move forward. Fuel prices are primarily driven by the price of crude oil, which is likely to remain high and volatile. The month of July was a clear example: the price of U.S. benchmark West Texas Intermediate crude oil hit a record-high nearly $146 a barrel by the end of the second week, and then dropped by 11 percent to just under $130 a barrel before the end of the third week. Perhaps minor relief is on the way in the near future, but businesses that rely on gasoline should expect to maintain conservation and cost-cutting strategies.