Backed by robust volumes as well as realisations, steel Industry has registered a phenomenal growth across the world over the past few years. The situation in the domestic industry was no exception. In fact, it enjoyed a double digit growth rate backed by a robust growing economy. However, the current liquidity crisis seems to have created medium term hiccups. In this article, we have analyzed the domestic steel sector through Michael Porter's five force model so as to understand the competitiveness of the sector.
Barriers to entry: We believe that the barriers to entry are medium. Following are the factors that vindicate our view.
Capital Requirement: Steel industry is a capital intensive business. It is estimated that to set up 1 mtpa capacity of integrated steel plant, it requires between Rs 25 bn to Rs 30 bn depending upon the location of the plant and technology used.
Economies of scale: As far as the sector forces go, scale of operation does matter. Benefits of economies of scale are derived in the form of lower costs, R& D expenses and better bargaining power while sourcing raw materials. It may be noted that those steel companies, which are integrated, have their own mines for key raw materials such as iron ore and coal and this protects them for the potential threat for new entrants to a significant extent.
Government Policy: The government has a favorable policy for steel manufacturers. However, there are certain discrepancies involved in allocation of iron ore mines and land acquisitions. Furthermore, the regulatory clearances and other issues are some of the major problems for the new entrants.
Product differentiation: Steel has very low barriers in terms of product differentiation as it doesn't fall into the luxury or specialty goods and thus does not have any substantial price difference. However, certain companies like Tata Steel still enjoy a premium for their products because of its quality and its brand value created more than 100 years back.
Bargaining power of buyers: Unlike the FMCG or retail sectors, the buyers have a low bargaining power. However, the government may curb or put a ceiling on prices if it feels the need to do so. The steel companies either sell the steel directly to the user industries or through their own distribution networks. Some companies also do exports.
Bargaining power of suppliers: The bargaining power of suppliers is low for the fully integrated steel plants as they have their own mines of key raw material like iron ore coal for example Tata Steel. However, those who are non-integrated or semi integrated has to depend on suppliers. An example could be SAIL, which imports coking coal.
Competition: It is medium in the domestic steel industry as demand still exceeds the supply. India is a net importer of steel. However, a threat from dumping of cheaper products does exist.
Threat of substitutes: It is medium to low. Although usage of aluminum has been rising continuously in the automobile and consumer durables sectors, it still does not pose any significant threat to steel as the latter cannot be replaced completely and the cost differential is also very high.
Conclusion: After understanding all the above view points and the current global scenario, we believe that the domestic steel industry will likely to maintain its momentum in the long term. However, the growth may get affected in short run. Investors need to focus on companies that are integrated, have economies of scale and sell premium quality products
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