Steel industry anything but status quo: Next generation of distributors set to lead wave of change

TPJ - THE TUBE & PIPE JOURNAL® MARCH 2000

July 12, 2001

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As the market demands change, the steel distribution industry will take up the gauntlet and change with the times. Contrary to some speculation, the steel manufacturing industry is neither going away nor reluctant to embrace the innovations necessary to survive.

 

The other day, I received one of those greeting cards that plays a tune when opened. That card contains more computer power than existed in the world in 1950. When avoiding her studies, my daughter entertains herself with a hand-held Nintendo® Game Boy®, which contains more computing power than was used in any of the Apollo space missions.

A few years ago, when Boeing acquired McDonnell Douglas, the Federal Trade Commission's (FTC's) apparent apathy was striking. However, time has proven that the FTC's laissez-faire posture was not temporary—just one year ago, global mergers and acquisitions surpassed the $2 trillion threshold for a single year for the first time.

On Sept. 11, 1998, the first day that the Kenneth Starr report was made available to the public, more Americans logged onto the Internet than bought newspapers. E-commerce quickly is approaching $1 trillion of an $8 trillion gross domestic product (GDP), mainly in business-to-consumer transactions. The market has not even scratched the surface of business-to-business opportunities.

While all of this occurs at the speed of light, suppliers in the so-called rusty, dusty steel industry supposedly wake up each morning intent on selling steel—the same steel, the same way—to the same type of people as it did a century ago. A Nov. 15, 1999, Wall Street Journal article contended, in essence, that no demand exists for steel executives outside the steel industry. Translation: They have no marketable skills.

With perhaps 85 percent of the U.S. GDP coming from the service and information sectors and only 15 percent from the industrial sector, is it any wonder that the negative stereotype of the steel industry is so prevalent? However, a dynamic industry is steel, indeed. If the measurement criterion is innovation, the U.S. steel industry holds its own.

Some History

To understand today, we first must peek at the past. Historically, the U.S. economy was agriculturally based. The U.S. was, in effect, a nation of farmers. Americans worked each day simply to sustain life. There was no such discretionary income component in economic models of the day because there was no discretionary income to speak of.

As the country entered the 19th century, 90 percent of the population was involved in farming. A century later, the Industrial Revolution was in full swing. Employees migrated from the farms to the factories, and the industrial-based economy was born. The very innovations of the industrial sector enabled the farm to become more automated, less labor-intensive, and more productive. Today, just 3 percent of the population is involved in farming, and it has become negligible as an employment base.

Manufacturing a Thing of the Past? Never

Today, we find ourselves in the midst of yet another revolution—the service/information revolution.

The pundits would have you believe that, as an employment base, factories will go the way of the American farm. They cite, of course, the fact that 85 percent of economic activity is coming from the nonindustrial sector of the economy. However, an observer must step back and consider this trend more objectively.

A nation must have an industrial sector. If you follow the economic stream, you must ask who is consuming the services, who is purchasing the computers, hiring the consultants, utilizing the bankers and lawyers, etc. A nation must produce things. It is the producers of the society who consume the services.

Figure 1:
A greater interdependence exists today between the industrial sector and the information sector of the economy than existed between agriculture and industry at the turn of the last century.

Therefore, a mutual dependence exists between the industrial and service/information sectors that did not exist between the agricultural and industrial sectors (see Figure 1). Today's service/information sector needs its industrial counterpart to consume its services and information. The industrial sector, in turn, needs services and information to render it more productive and competitive on a global scale. Hence, the beauty of America's market-based economy is that a true symbiotic relationship exists, rendering the U.S. the most powerful nation in the world.

Steel Industry Improvements

In the late 1960s, the steel industry employed 600,000 people; today, it employs fewer than 200,000 people. The papers and professors are quick to point this out as evidence of the steel industry's demise. Truth told, with two-thirds less labor, the nation is producing more steel.

The reason is the industry's willingness to explore, create, develop, and incorporate innovative technology. It has gone from 12 labor-hours per ton in open-hearth furnaces to basic oxygen furnaces that are coupled with continuous casting. The industry also has developed electric arc furnaces and mini mills, which originally were perceived to pose little threat to traditional mills because of their limited size range and chemistries.

Today, in the more efficient mills, a ton of steel can be produced in 45 labor-minutes. In addition, 50 percent of the steel types—chemistries, coatings, etc.—produced today did not even exist 10 years ago.

The U.S. is now world-class-competitive. The size ranges of products and chemistries have grown exponentially. The joint ventures between integrated and mini mills are exciting. Electric arc furnaces now are being charged with scrap metal rather than strategic minerals. Although there always will be a need for some virgin material and components, the steel industry now can boast that it has the most recyclable product on earth. It did not come without effort or cost—a $60 billion investment in aggregate by the steel industry."

To spoof a once-popular advertisement, "This is not your father's steel industry.

Distribution: Yesterday and Today

Of late, distribution perhaps is best characterized by alarming consolidation. This consolidation is typical, predictable, and understandable as players in a mature industry, which is undergoing a fundamental metamorphosis, seek ways to further solidify their niches or grow bigger in a quest for economies of scale.

Darwin's theory of evolution says the fittest survive. However, Darwin did not define fittest as the strongest, but rather those of a species that could most readily adapt to a changing environment.

In the same way, some distributors, such as Metals USA, have grown through a classic roll-up strategy in an attempt to capture appealing synergies. Others, such as Reliance Steel & Aluminum and its companies, acquire organizations, add them to the portfolio, and allow each to maintain its independence. Still others—such as O'Neal Steel, Inc., Tubular Steel, Inc., and Chicago Tube & Iron Co.—have elected to maintain their independence and grow by adding new locations, equipment, and capabilities.

Distribution is in the middle of its very own metamorphosis. To understand this, we must consider the historic channel of distribution in the steel industry (see Figure 2). Some salespeople are compensated by salary, others by salary plus commission, while others draw straight commission. Denominators in these calculations can run from a percentage of the gross margins to a percentage of sales growth to a percentage of sales revenue.

Figure 2:
Traditionally, sales has played a part in every step of the steel supply chain.

When all is said and done, sales compensation typically makes up approximately 2 percent of the sale price. In the model shown in Figure 2, 16 percent of the cost in the channel is related to sales salaries and commissions.

As the industry has moved from a domestic to a global economy, competition has increased exponentially, which in turn has compressed profits.

To preserve profits, or simply to survive, the channel some time back began to incorporate technological links. Some customers began to view sales calls from salespeople as an interruption in their day. A good percentage of businesses entered into annual contracts with a firm, negotiated price and predetermined, scheduled material releases. This eliminated the social sales role and, along with it, its cost.

Make no mistake—sales personnel are still in the channel, making calls. However, there are fewer of them, and those who remain have substance. They can discuss nonmetallic inclusions and other metallurgical problems. They can put forth economic models of cost-of-possession. They can make articulate presentations to steel-buying committees. This is a far cry from Joe calling on Larry with a slap on the back, a two-martini lunch, and a handful of scratch pads. This fundamental change has removed cost from the channel.

Distribucation: The Next Generation

Right now, the U.S. is continuing the longest economic expansion in its modern history. Some contend that, as a global economy, recessions are a thing of the past and that explaining them to the next generation will require history books. Not so. There still will be economic slowdowns and even recessions. However, because of the diversified, global economic base, recessions will not be as frequent, as deep, or as long, but they will occur.

With the eventual economic slowdown in mind, we will once again revisit the channel of distribution in search of the next generation of efficiency.

Today's advanced marketplace is so sophisticated that it will not allow a business to profit from simple bundle-breaking, in which the channel uses someone to buy products in a bundle and resell them one piece at a time. Gross margins on traditional off-the-shelf/out-of-stock business are eroding. At the same time, operational expenses are increasing as customers demand more.

Incorporating these trends into a traditional business, a three-year pro forma suggests that a fundamental change is in order. That change is additional value-added services. The distributors of the next decade will process at least 50 percent of what they sell.

One common value-added service among distributors is contract cutting. Distributors are reluctant to outsource services for fear of losing control over delivery and quality. Contract cutting orders involve, in some cases, millions of cut pieces at tolerances measured in thousandths of an inch. End finishing specification, customized packaging, and just-in-time delivery serve to differentiate these products from commodities. In the future, you will see service centers drilling, welding, painting, powder coating, and performing other value-added tasks.


Figure 3:
The steel distribution chain of the future likely will include a new animal—the distribucator.

The problem, of course, is that this trend will, in part, put service centers in competition with their fabrication customers. Therefore, the next trend for the distribution channel will be a morphing of distribution and fabrication—a distribucator, if you will (see Figure 3).

In fact, the channel of distribution in the next decade should bring not only the progressive merging of distribution and fabrication, but also the recyclability of steel produced in electric arc furnaces. This state-of-the-art channel may look like the one illustrated in Figure 4. Some service centers are incorporating these fabrication capabilities within their divisions, while others are taking the extra step and establishing their own segregated value-added centers.

Does this mean the demise of fabricators? To the generic, run-of-the-mill fabricators that lack a specialty, the answer may be yes. For those that offer expertise in a specialty niche and high-quality products, no. Just as with distributors, there simply will be fewer of them.

Figure 4:
The future steel distribution chain may, in fact, look more like a regenerating circle than a linear chain.

To paraphrase General George S. Patton, "My job is not to die for my company. It is to let some other poor sap die for his." The market is a battlefield that claims casualties every year. However, honest, ethical, well-earned profit is available for those that are enterprising.

Today, the world is spending $1 billion per day on scientific research. One-half of the scientists who ever lived are still alive today. Medical knowledge at the beginning of the century was one-tenth of what we enjoy today. Our standard of living has quadrupled in the past 40 years and is expected to do so again over the next 40 years. We are, no doubt, living in the most glorious time in the history of mankind, and it is the steel industry that built the infrastructure for it.

To borrow from another notable American, J.P. Morgan, "Any man who is fool enough to short the future of this great industry will go broke in the process."



Donald R. McNeeley

Ph.D.

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