Just as with any other manufactured products, the economics of pencil manufacturing are driven by a number of factors.
These cost drivers include:
- cost of raw materials (wood, graphite, clay, brass or aluminum for ferrules, lacquer components, etc.)
- cost of parts or other finished components used to assemble the pencil
- cost of transportation and handling of various materials used and of the finished product to the factory
- cost of labor and benefits for the factory workers employees
- cost of energy
- cost of supplies used to maintain equipment
- cost of government regulations (taxes, duties, compliance to safety, labor or environmental rules)
- cost of capital (money used to buy equipment, to purchase and maintain inventories of raw materials, parts, supplies and finished product)
- cost of management
Pencil companies make a number of important decisions regarding these costs as part of their business. Some of the most important decisions include:
- the quality of product they wish to produce will impact which raw materials and component parts they will purchase
- alternative suppliers for raw materials
- whether to make internally or buy externally different component parts like slats, leads, ferrules and erasers or even semi-finished pencils from other pencil manufacturers (NOTE: Read about the famous essay I, Pencil to learn more about the important economic principal of specialization of production and how free market pricing system leads to best organization and allocation of resources into firms in an industry)
- where to locate their pencil factories which is driven by relative difference in costs between cities, states or countries for labor and materials, transportation costs for incoming materials as well as to the customer, regulatory and energy cost as well as duties and taxes
- the quantity of product to produce drives the level of investment required in the factory and inventories as well as can effect the cost per unit produced due to economies of scale.
The pencil manufacturer strives to minimize the cost of producing the pencils at the desired quality level and quantity of production and to sell all these pencils for more than the cost in order to achieve a profit.
All of these decisions are made within the framework of the marketplace and the competition the pencil maker faces for business from the other producers. The level of competition can have a big impact on the profit in an industry or segment of the pencil market. Each company tries to focus on what competitive advantage it has versus other pencil makers and what it can do better than others. This is why different companies specialize only in certain markets or product ranges to try to set themselves apart.
These days, typical yellow writing pencils and children’s coloring pencils are generally considered to be a commodity. That is, one product from one producer is more or less considered by the customer to be as good as another, just like corn from one farm is more or less the same as corn from another farm. When this occurs the price often becomes the key purchase factor for the pencils. Then it is more difficult to make a profit without a strong brand name or other point of difference in terms of product feature or performance.
A key factor that effects the competition is the increasing level of international trade. As more markets have opened up to more producers from more countries around the world the pencil industry like many others has globalized. Many poorer countries such as China, Indonesia and India have dramatically increased pencils production and export because of a general cost advantage in materials, labor and reduced regulatory environments.