The current performance of steel companies across the world shows that they have much in common. They have all been hit hard by the demand crunch, with the vast majority sinking into a sea of red. A global cyclical downswing is very clear. The worry, however, is that the global steel industry is heading for larger trouble than what has so far been presumed.

According to estimates by International Iron & Steel Institute (IISI), crude steel production in 1998 was down by only 2.3 per cent compared to 1997. And 1997 was a record production year of 799 million tonnes.

Accordingto Dr AS Firoz, Chief Economist, Joint Plant Committee (JPC), the fluctuating growth rates shown by developed countries after the 1973 oil crises were offset by sustained demand for steel in the developing world. The Asian financial crises changed that scenario completely. Traders panicked and liquidated the excess inventory they had booked in anticipation of higher prices. This caused a sharper price drop than warranted. The panic also resulted in a disproportionate fall in steel raw material prices--such as scrap, pig iron, DRI, coal and coke. The global recession also brought down ocean rates, which increased the ability of some manufacturers to reduce prices further.

Analysts estimate that for most steel products the price drop has been as much as 50 per cent. This has shattered the steel industry worldwide.

The word on everyone's lips these days is restructuring. But most steel companies in developing countries had undertaken massive privatisation programmes between 1992-96. That doesn't seem to havehelped them much. New private players who had entered the steel business in a big way find their capital costs far too exorbitant, bringing down their chances of survival sharply. The only conclusion that emerges is that developed countries have benefited at the expense of developing countries. Let's see how.

PRIVATISATION: The privatisation process has varied from country to country, but the need was the same. The rationale was that government was not able to meet the continuing losses. The methods varied. In the Czech Republic the process of privatisation was through the buyout method with a guaranteed option for the management to gain further control if they met certain set criteria. In Italy, the declaration of bankruptcy saw the privatisation of Dalmine (an Italy-based seamless tube manufacturer). The stake of the company was picked by the Technit group (promoters of one of the bigger steel plants in Argentina and Mexico.) The mounting losses of two of the biggest state-run steel firms inBrazil, namely CVRD (the world's biggest iron ore firm) and CST (Brazil's fourth largest company) left the government with no option but to go for a privatisation programme. CVRD was taken over by CSN, the largest private sector steel producer in Brazil, through a bidding process.

The second biggest privatisation process in the Brazilian steel sector involved CST. The government adopted a novel method in this process. Banks converted their debt into equity and then sold it to a competitor of the company, Acesita.

COST REDUCTION: Interestingly, after privatisation, all these companies focused on cost reduction to directly improve the bottomline rather than put up new plants to increase topline sales.

A similar trend was also witnessed in India. The public sector giant SAIL is a case in the point. The company's entire focus was on decreasing costs by going for more automation and use of less energy per tonne of steel production.

According to the Indian Iron & Steel review, this exercise resultedin savings worth Rs 525 crore in the three quarters of 1998-99 compared to Rs 429 crore achieved in the corresponding period of the previous year for SAIL. This cost cutting exercise was over and above cost savings of Rs 730 crore by the company last year.

The company has, till date, spent 90 per cent of the Rs 12,000 crore earmarked for modernisation. Since the internal accruals fell, the company was forced to undertake a modernisation programme through loans. This raised the interest cost for SAIL from five per cent of total production cost to more than 16 per cent.

Further, the modernisation exercise is far from complete and estimates for the revival of IISCO (a subsidiary of SAIL) and the pending modernisation programme of SAIL vary from Rs 5,000-6000 crore more.

In fact, critics have been unanimous that the Rs 12,000 crore spent on the modernisation program for SAIL--that too on a piecemeal basis--could have been utilised for setting up new capacities with better plant layout. Even if themanagement would have scrapped the original plants, the net outcome would have resulted in higher sales and lower cost.

One worry is that many plants worldwide which followed a similar exercise have defaulted in interest payments and a few have actually gone under with the company shutting down the plant itself. In the Czech Republic, two of the biggest companies, Poldi Kladno and Tube Rolling Mill Co. Ltd, went bankrupt mainly due to the inability to pay interest taken on debts for mordernisation programmes.

The Latin American experience was slightly different, as earnings there are sensitive to the export market. Approximately 50 per cent of their output is exported and so they have to be cost competitive. Since their cost of production has been 10-15 per cent higher than their US neighbours, these companies went for extensive capex mainly funded by forex debt. The forex component of debt was upto 50 per cent of the total debt--which, in absolute terms, was as high as twice the net worth of thecompanies. Hence the recent devaluation of the currency by 30 per cent completely changed the financial viability of the companies. The devaluation raised local interest rates and increased the outgo for foreign debt repayments. The net result has been that the companies are in a far worse position than when they started the modernisation process.

Even operationally, the efficiency parameters show a lot of inherent weaknesses in such plants.

CAPACITY ADDITIONS: The process of privatisation also saw a lot of private sector investment in the steel industry. Steel prices were freed in a lot of countries. In 1996, after the privatisation programme, the Brazilian government allowed the producers to charge an eight per cent higher price for domestic consumers. Earlier, governments in various parts of the world, including Korea, China and India, never allowed steel producers to set prices for domestic consumers.

The advent of new technologies allowed small players at lower investment costs to ventureinto the steel business. Most of them were provided finance on easy terms by equipment suppliers, but in the absence of risk-sharing by the suppliers, some of them were bound to be failures.

PROTECTIONISM: With the devaluation of currencies, the impact of the higher cost of funds could have been offset by developing countries. But America and the EU were quick to impose anti-dumping duties on imports from Brazil, Korea and Japan. For some products, even Indian producers were not spared. Ironically, one of the most important criteria for evaluating anti-dumping requests was whether imports of certain products from a country have been rising and if so by what percentage. The anti-dumping authorities did not try to check whether a company was actually selling its products cheaper internationally compared to local markets. The result was most of the steel companies in the third world sank deep into the red.

SURVIVAL STRATEGIES: So what are companies doing for survival? Broadly we can divide thestrategies followed by the companies into four different categories.

The first one is to move up the value chain for delivering high value-added products. In production terms this means producing thinner, stronger steel as well as a greater proportion of coated products, to add more value to production. The idea is that higher value addition would be able to offset high capital cost associated with expensive modernisation or greenfield plants put up earlier. Examples can be given of CSN in Brazil, Anganag and Chongqing in China, SAIL, Essar and Tisco in India.

The second visible trend is to scrap inefficient plants. By reducing the capacity overhang, this eases supply pressures and there is a likelihood of price rise which would offset the mistakes of the past.

In the third week of March, four major EAF players in South Korea--i.e. Dungkuk Steel, Inchon Iron and Steel, Korea Iron and Steel and Kangwon Industries--decided to band together under a common holding company in an attempt to reduce excesscapacity. The excess capacity (according to estimates, in the region of four million tonnes) would either be scrapped or sold to outsiders. The same decision has been taken by four major Japanese steel makers--NKK, Nippon Steel, Sumitomo and Hitachi. They have agreed to a production cut of 10 million tonnes and another 10 million tonnes of capacity would be phased out of the system in the next fiscal.

The third visible trend is the strategy followed to pick up scrapped plants at a bargain and then turn them around. Ispat International has become the world's largest EAF steel producer by picking up inexpensive steel assets at throwaway prices and then reworking the plant to make it operationally efficient. The company also derives a lot of incentives from the government which also has an effect on the cost structure of the final product. This strategy has so far paid rich dividends for Ispat International. But such companies are more the exception rather than the rule.

The fourth visible trend is try tolook inwards into the local market rather than exports or imports. This is clearly seen in the synergy between the strategies pursued by China and Japan. Construction activity has reached a saturation point in Japan. Accordingly, Japanese manufacturers are selling plants which are into long products (mostly used in the construction sector). Simultaneously China, which is in a different stage of economic development, has shown keen interest in picking up the Japanese plants.

WILL THE STRATEGIES PAY OFF?

At the end of day, the strategy to scrap inefficient plants to cut down losses might well clinch the deal for players in the Asian region. Basically there has been a realisation among Japanese and Korean producers that the technology of mini-mills is obsolete and a better idea would be to export these mini-mills at throwaway prices and build better plants for high-quality steel in your own country. The advantage would be that such technology can later be sold at a premium or one could exportsteel-making technology rather than steel, which is in any case facing severe non-tariff barriers.

Industry observers suggest that the strategy of going up the value chain is the riskiest of all options. The basic flaw in such projects is that the capital cost for installing equipment for cold-rolling and galvanising would rise. Since capital is very scarce in developing countries, the lure of low interest rates through equipment financiers is irresistible but the benefits could well be a mirage. The risk of currency devaluation and the possibility of all players entering into value-added products could destroy whatever extra margin the producers wished to generate through additional investment.

OTHER OPTIONS: Probably one option that not many companies are following is to develop new chains in distribution to reduce the inventory carrying cost by a physical reduction in inventory carried by the system. The only way that seems to be possible is if companies try to adopt the American method ofselling.

The distribution of steel in America is through Steel Service Centres and not through company-owned depots. The modus operandi is simple. When customers require a particular quality and quantity of steel, they place an order with a steel service centre. Once the service centres receive order they check with the plants about the availability of the required size and grade material. Now these service centres have their own slating and shearing machinery--which helps them finetune the length and other physical properties required by the customers. The beauty of the system is that companies do not have to carry inventory or plan to produce any items for stock. Most of the time they are busy producing standard grades for supply to the service centres.

The difficult task of separating the various grades, sizes and length as per customer requirement is done at service centres.

Once companies accept the indirect mode of selling, all they have to do is integrate their operational activities byincreasing yields and reducing costs of production.