causes that have contributed significantly to materials price increases. The three contributors are (1) scarcity of certain raw materials, (2) limited supply and capacity to produce certain materials, and (3) rising energy costs. Each of these factors will be discussed separately below.

We will not discuss the impacts of these factors on the separate classification of materials (subcontracted items, raw material, and purchased parts). Most of our examples of how

these factors affect prices do apply most directly to raw materials. However, it is also appropriate to attribute these factors to price increases in purchased parts and subcontracted items. Furthermore, raw materials are, of course, important inputs in these items. Increases in the costs of raw materials are thus rolled into the higher prices charged by vendors and subcontractors.

Within this discussion, as examples of the effects of the three factors on prices, we will point out causes for price increases of specific input factors, such as titanium sponge or aluminum sheet. (Appendix C contains historical charts of price increases in the United States of specific material inputs, as measured by the BLS, and a discussion of the relationship between our findings and the BLS data.)

B.1 Scarcity of Materials

Much of the increase in the prices of material components can be attributed to a basic scarcity of certain necessary raw materials. Materials such as cobalt and titanium have no substitutes in existing systems (although some degree of substitution can be effected in the design of new systems). Therefore, if the prices rise, either because of an increase in demand or simply because of monopolistic prices charged by suppliers, contractors are unable to substitute other, less costly, materials.

In the case of titanium sponge, surging demand from the commercial and foreign military aerospace markets has caused domestic contractors to turn to high-priced foreign suppliers. price increase of 76 percent was reflected in the July Producer Price Index (PPI 10220156) and we were informed that contractors have been paying steadily rising prices since early spring,

1980. In the short-term, it is expected that the price level of titanium sponge will stabilize; however, the recent price increases have not yet been fully reflected in the price index for titanium mill shapes.

A

Although cobalt is not required in great quantites for aerospace applications, it is nevertheless a significant input in engines and has no currently available effective substitutes. Zaire, the major source of world production, raised prices sharply during 1978, from approximately $6.00 per pound to $25.00. Prices have stabilized at this level and are expected to remain at the current level over the short term.

B.2 Limited Capacity

For several types of material components of defense systems, such as aluminum sheet, titanium shapes, and electronic parts and components, price increases have apparently been caused by limited processing capacity. The recent increase in demand in the military and commercial aviation markets is reported to be straining operating capacity for aluminum extrusions, aluminum sheet and plate, and titanium. Many major producers of these components are said to be operating at 100% of capacity. supply of certain semiconductors has also been constrained by capacity as demand has increased from aircraft and other markets such as consumer products and computer hardware.

The

The capacity to supply components such as aluminum sheet and castings has not increased for several reasons. Producers of military quality material, cautious of encountering another situation of suddenly diminished demand and resulting overcapacity such as they experienced upon termination of the B-1 bomber program, have been reluctant to increase capacity in the face of uncertain demand. The fact that aerospace special alloys account for less than ten percent of their market also inhibits expansion. The associated return on investment is alleged to be inadequate to encourage the massive capital investment necessary to expand this specialized capacity. In addition, some smaller suppliers, such as casting shops, are reported to have been forced to shut down when faced with continuing inflation and the increased costs of compliance with EPA and OSHA requirements.

The problem of limited capacity compounds the problem of

price increases because alternative suppliers often are not

available. Contractors may face situations of "take-it-or-leaveEven if several suppliers do exist, limited re

it" prices.

sources and long lead times mean that contractors must tie in early to long-lead contracts, often with prices to be those in effect at time of delivery. If prices then increase, contractors are unable to switch to less costly suppliers.

The problems of limited capacity have thus forced component prices up sharply. Contractors are reporting increases of 30 to 35 percent for such items as specialty alloys, aluminum sheet and plate, and castings and forgings. These reported price jumps are not, however, reflected adequately by the appropriate Producer The discrepancies seem to be

Price Indexes. (See Appendix C.)

due to the fact that many of the aerospace inputs reflect higher quality requirements than the other items included within the indices.

The capacity problem for certain items may be easing. Some major aluminum producers have announced plans for the expansion of sheet, plate, and forging capacity. The major producers in the titanium sponge and mill products industry are also reported to be investing in expansion programs. With expanded capacities, the current rate of price increase may partially abate.

B.3 Energy Costs

Rising energy costs have sharply affected some of the major material components. Most raw material and processing operations are extremely energy intensive. In 1976 the cost of energy

amounted to 25-30 percent of total production costs of aluminum, and by 1980 this percentage had risen to 35 percent. Energy problems further affected the aluminum industry during the first two quarters of 1980 as the Bonneville Power Administration in the State of Washington cut back its supply of power to the aluminum processors located there, thus forcing several production lines to be shut down.

Nickel is another material with significant energy costs. For each ten percent increase in the price of fuel oil, the price of nickel can be expected to go up by about 74 per pound. The jump in energy prices in 1979 is clearly reflected by the PPI for nickel, cathode sheets, which rose 71 percent between March 1979 and March 1980.

C. Direct Labor

Direct labor costs account for approximately 10% of the composite unit billing prices of the systems covered by our review.*

An additional, unspecifiable amount of labor is included in direct material costs (subcontractor/vendor labor costs are considerable in the manufacture of some labor-intensive specialized components and subassemblies) and in indirect costs. These labor costs are not included in our category weighting.