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GM's Catch-22

By Rich Smith
March 25, 2004
According to a report in Tuesday's Wall Street Journal, the growing crisis in the nation's steel market is threatening to pull the emergency brake on General Motors' (NYSE: GM) production lines.

U.S. steel users, from tiny construction companies like Williams Industries (Nasdaq: WMSI) to car-making behemoths like GM, Ford (NYSE: F), and DaimlerChrysler (NYSE: DCX) are all being affected by the global shortage in steel. The causes of the shortage range from the failure of U.S. steel makers to radically restructure their operations when they were protected by the Bush administration's steel import tariffs to the reduced buying power of the U.S. dollar to China's booming economy and insatiable demand for steel scrap.

But whatever the primary cause, steel prices are rising precipitously, more than doubling since last June. Now, steel is a cyclical industry, as are autos. Being a maker of autos and a user of steel, GM takes precautions to ensure a continuous supply of the much-needed steel for car building. Specifically, the company enters into long-term supply contracts with suppliers such as Steel Dynamics (Nasdaq: STLD) and Textron (NYSE: TXT) to ensure that GM will always be able to get the steel it needs, delivered "just in time," and at a predictable price.

That was the theory, anyway. As it turned out, however, GM is now alleging that Steel Dynamics and Textron both have reneged on their contracts and handed GM an ultimatum: Pay a surcharge on the steel you buy from us, in addition to the agreed-upon contractual price, or we will cut you off entirely.

Faced with those two choices, GM really had no choice -- it paid. But simultaneously, GM filed suit, demanding that the contractual prices be affirmed and that any surcharges GM pays be reimbursed to it.

To some extent, you have to sympathize with the plight of the steel manufacturers -- they are having to pay higher prices for iron ore and scrap steel themselves, and are only trying to break even by passing their costs on to the steel users. But that does not justify breaching their contracts with their customers.

A deal's a deal, guys.

Fool contributor Rich Smith owns shares in Williams Industries, but none in any of the other companies mentioned in this article.

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