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Steel: Long way to go

Nov 21, 2003

Industry consolidation has a number of advantages associated with it and more so, it is especially helpful for the larger companies. Among the important advantages, economies of scale, which could be a factor of combining of operations, better strength to achieve globalisation of business with improved and larger number of products, cost rationalisation owing to better bargaining power with suppliers on account of increased volumes, etc are the major ones. In this article, we try to throw some light on the steel industry with respect to consolidation.

The global steel industry continues to be highly fragmented in nature. This can also be re-affirmed by the fact that the top 5 steel producing companies control only about 16-17% of the world production, whereas the top 10 control under 19% (see chart above). As a result of this fragmentation, steel companies are unable to achieve higher operating margins (due to lower realisations), which hover around an average of 8%-10%. In relative terms, other industries like aluminium, copper and cement enjoy better operating margins that could be anything about 15%-18% for aluminium and copper while the average for the cement industry would be about 20%-23%. However, in these industries, the fact that the top 5 companies control around 45-50% of the world market plays an important role for the reasons mentioned above.

This is because when the majors of any industry have a significant control over their market, they are in a relatively stronger position, vis-a-vis a fragmented industry, in squeezing out margins from their suppliers owing to their bargaining power. Further, it also helps reduce volatility in prices as significant under cutting can be avoided, which is a behaviour generally witnessed in fragmented industries. Thus, consolidation could be a positive for the industry from this point of view.

Now considering the global steel industry with this respect, while the consolidated production of the top 5 companies over the last 3 years has improved from 15% to 17% that of the top 10 has fallen substantially. The reason for the increase in contribution by the top 5 could be attributed to the efforts and rise of the UK-based LNM Group owned by steel tycoon Lakshmi.N.Mittal. The LNM Group has improved its ranking from 4th at the end of 2000 to 2nd in 2002 owing to its strategy of expansion through acquisitions. As a result, the group's steel production shot up from about 20 m tonnes to almost 35 m tonnes making it the second largest steel producer in the world. However, its efforts alone are not enough for the industry, which continues to have an excess capacity to the tune of nearly 100 m tonnes.

Now, considering the top 5 countries' contribution to world steel production, China, Japan and the US continue to lead the production table. If we look at the 'Top 5 countries' chart above, it can be seen that the compared to 52% in 2000, 54% of the world's output is now contributed by the top 5. The credit for this goes entirely to China, which has been the sole factor responsible for driving up steel production and consumption. Just to put things in perspective, while world production actually fell in 2001 (according to the International Iron and Steel Institute), China's production increased by 19%. Even in 2002, of the 50 m tonnes incremental world steel production, 30 m tonnes was contributed by China alone, whose production again increased 20%. Simultaneously, the country's consumption has also been displaying a strong upward trend in wake of the huge infrastructure spending undertaken by the country, whose GDP continues to grow at 8%+. Now, considering the top 5 countries' contribution to world steel production, China, Japan and the US continue to lead the production table. If we look at the 'Top 5 countries' chart above, it can be seen that the compared to 52% in 2000, 54% of the world's output is now contributed by the top 5. The credit for this goes entirely to China, which has been the sole factor responsible for driving up steel production and consumption. Just to put things in perspective, while world production actually fell in 2001 (according to the International Iron and Steel Institute), China's production increased by 19%. Even in 2002, of the 50 m tonnes incremental world steel production, 30 m tonnes was contributed by China alone, whose production again increased 20%. Simultaneously, the country's consumption has also been displaying a strong upward trend in wake of the huge infrastructure spending undertaken by the country, whose GDP continues to grow at 8%+.

To conclude, acts like global consolidation and alliances tend to benefit the industry as a whole. The mega consolidation in Europe between 3 steel companies, Arbed/Aceralia/Usinor, in February 2001 brought into being the world's largest steel producer, Arcelor, with a capacity of about 55 MT. Another consolidation took place in Japan wherein NKK (16 MT) merged with Kawasaki Steel (13 MT) to form the world's second largest carbon steel producers. While there have been these positive signs in recent times, there is still a long way to go on a global scale. This is because, in the Indian perspective, though Sail and Tisco together control over 40% of the domestic capacity and production, lack of pricing power, owing to their relatively smaller size, forces the Indian steel industry to follow the internal pricing trends closely.

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