Module
Executive Summary
With the changing demand across the emerging economies, the centres of activity in the steel production market are shifting away from the traditional markets in North America and Europe towards Southeast and Central Asia, Africa, and Latin America. Established players are facing increasingly stringent competition from technology-constrained players in the emergent market, coupled with fast growing markets in those countries, which they can capitalise on. This report includes an internal assessment of Severstal, one of the world’s largest steel producers, followed by a five forces analysis of the steel industry. The second section of the paper comprises a description of important forces that will drive the industry, including the rise of the emergent markets, tighter regulatory pressure, increasing industry demand, strong government involvement, and greater consolidation.
Introduction
The global steel industry stagnated following the 2007 recession and the Eurozone debt crisis, but has maintained encouragingly positive growth in demand. Severstal faces a rapidly changing industry, constant consolidation and fragmentation cycles, and while the global demand is expected to grow, it has remained flat over the past few years. Similarly, the company struggles against intense industry rivalry, increasing buyer power, pricing pressures, and the rapid industry growth in the emerging markets. As such, it is critical that the company plays to its strengths, by investing in the emerging economies (through mergers and acquisitions), and ensuring its organisational culture is conducive to this strategy.
SWOT Analysis
Strengths
There has been a sustained positive growth in the global steel demand and Severstal has posted positive healthy net profits over the difficult economic period, having recorded upwards of $2.2 billion in net profits in 2011. A weak US dollar reduces the foreign exchange risk for Severstal and other Russia/Chinese steel manufacturers. Further, Severstal’s excellent relationship with the Kremlin offers it access to the government’s financing, which is critical in the face of the credit dry up following the banking crisis since 2007. Other important strengths enjoyed by the company include a portfolio of relatively successful acquisitions, strong financial performance, and acceptably high market power enjoyed by steel producers.
Weaknesses
The global demand for steel has been falling over the past decade and has recently stagnated. The demand in 2012-2013 was the similar to 2010’s demand because of the difficulties arising from the Eurozone debt crisis, China’s slow down, the global economic crisis and the resultant lack of credit to finance operations in the emerging markets (that maintained positive growth). Prices collapsed by 60% since the 2008 recession. The business confidence has collapsed as a consequence, and companies including Severstal struggled financially due to the weak demand. The difficult times make it difficult to finance (or even justify) new investments, besides creating a problem of a possible glut in the market because many producers have maintained their output levels. However, the rapid price fall may be due to the industry overheating just before the 2007 collapse and should not be used as an indicator of a collapse in the industry.
Opportunities
With the emergence of China, India, and South American markets, coupled with the lack of efficient steel producers in these markets (particularly China) offers opportunities for Severstal to competitively enter/expand operations in these countries. In 2011, China was the largest steel consumer, in part because of the booming construction industry and the overall healthy economic growth, and this trend is expected to keep up for the near future. Even most importantly, the 5% growth expected due to growth in the global construction, automotive and other steel-demanding industries by 2021 promises a boost for the demand. Further, while Chinese production has been rising by 15% every year, the efficiency gaps suffered by the country’s producers offer established global players like Severstal an advantage.
Threats
The industry is not only characterised by intense competition, but the strategic positions in the market by some of Severstal’s competitors puts them at an advantage in the industry. For instance, Hebei’s position in the Chinese (as well as the global) market puts it an advantage given the promise that China holds, as well as the fact that buyers want producers close by, which puts companies that already have plants in the emergent markets in a great position. Further, the intense competition in the industry, in part because of the emergence of new players in the emerging markets such as South Korea and China, can only increase the cost of competition as well as the profit margins.
Five Forces Analysis
Buyer/Supplier Power
Increasing vertical integration in the industry, as perhaps best evidenced by Tata Steel’s acquisition of Corus has increased the reduced the suppliers’ as well as buyers’ market power, even though the price inflation appears to be unabated. Customers are pushing for structural changes that will bring plants closer to their own plans, particularly in the emerging markets. The importance of supply chains in the industry can never be gainsaid, and therefore suppliers retain fairly high bargaining position.
Industry Rivalry
The steel industry appears to increasingly concentrated, with the largest firm, Arcelor Mittal, producing more than twice the amount of crude steel than its nearest competitor, and the top 30 firms (including Severstal) produce a substantial proportion of the global output. High industry concentration pushes the industry towards oligopolistic competitive practices including collusion, deeper consolidation, and other forms of non-price competition.
Threat of substitutes
Steel’s properties and its importance in the construction and manufacturing industries means that it has few direct substitutes, but firms need to expand their research and development spending to ensure this remains the case. The emergence of materials such as fibreglass may one day compete directly with steel, particularly in car manufacturing if their costs can become competitive.
Threat of new entrants
The high capital requirements and high industry concentration reduce the likely of new entrants and/or a marked change in the global steel industry due to new players, other in the form of consolidation and fragmentation. According to Sainidis (n.d.), acquisitions and mergers are a preferred expansion and targeting strategy because organic expansion is expensive.
Industry Trends
Consolidation
Investment in new manufacturing plants in the emerging markets is costly, and therefore, foreign direct investments into these markets are likely to take the shape of mergers and acquisitions. This will allow large market players to gain a foothold in promising markets. The acquisition of Corus by Tata Steel illustrates the popularity of this strategy for major players to consolidate their positions in the most lucrative markets, while at once ensuring that production efficiencies are achieved where applicable. Vertical integration permits increased investments in service and quality, which add to the competitiveness of the firms involved, while at once rendering it more difficult for firms that fail to consolidate. Further, increased product differentiation offers higher monetary returns for firms because of the possibility of premium pricing.
Emerging Markets
Over the past four decades, the industry has already shown a shift and the importance of the Chinese market on the global industry can never be overstated. It is evident from the case study that while the global demand for steel has been rising, the importance of different markets is changing. Particularly, Russia and the CIS, as well as EU27 markets are shrinking. This is important when coupled with the trend towards greater vertical integration and the need by buyers for steel plants to be based close to the buyer facilities as well as perhaps most importantly, the fact that Severstal’s Russian roots may be a disadvantage. The shrinking of the Russian and CIS markets should be a challenge, but since the company has thrived over the past three decades with a rapid decline of this market, it should not be a strategically difficult experience. Similarly, the continuing importance of the South American, EU27 and Eastern European, NAFTA and other traditional markets should not cause too many upheavals in the industry as well as in Severstal. However, the nature of these trends should worry Severstal, given the rapid expansion in demand in China, Asia and Oceania, South America and Africa.
Strong Role of Governments
Unlike the traditional markets where government roles in the steel markets is restricted to regulation and macroeconomics, the emerging markets will ensure stronger roles for governments in such countries. In China, Russia, India and Brazil for instance, the privatisation of steel-owned facilities led to an increased inflow of foreign direct investment. While this is a necessarily positive development, governments in the emerging economies play an uncomfortable role for firms in strategically important industries. The political risks of doing business are higher in the emerging markets, particularly in Russia and China. While Severstal has excellent relationships with the Russian government, the Russian government’s appetite for expropriation of assets as a political tool must not be understated. The Kremlin’s treatment of oligarchs opposed to the government, particularly in the oil industry reveals the difficult political environment that Severstal must struggle with, as well as the importance of maintaining excellent relations with the government. Similar political risks are more emphasized in the developing countries (worsened by weak institutional safeguards) compared to the steel industry’s more traditional markets. As such, it is critical that Severstal manages these risks both by maintaining excellent relations with governments (not a reliable strategy) as well as using mergers and local expertise, both to reduce and avoid risk.
Environmental Regulations
While the political risk in the traditional markets is lower for the industry, Severstal and other firms face increasingly tight environmental regulations, as a consequence of which the cost of energy, emissions tax, and other operational aspects may rise. Governments across Europe, North America and elsewhere across the world are growing increasingly enthusiastic about environmental protection, particularly with respect to climate change. The industry was already facing pricing pressures, asset concentration, and gaps in the product mix prior to the 2007 global economic crisis, besides rapid changes.
Increasing Demand
The expansion in the global demand for steel should be expected, despite the stagnation over the past few years. It is evident, given the fact that the year-on-year demand has been increasing since 1990 and the lull following the global economic crisis and the Eurozone debt crisis should end with the recovery of the Eurozone and the global economies from the difficult economic times. This trend is equally backed up by the fact that the global demand for steel has been on the upward trend since the 1950s. Effectively, Severstal’s strategy of making international and domestic acquisitions is extremely critical to ensuring the company targets potentially lucrative markets in the merging markets and consolidates its position in the traditional markets (Sainidis, n.d.). However, to ensure that such disparate acquisitions succeed, the company focus more on its culture and corporate governance, else it would be difficult to create and leverage the synergies that arise from these acquisitions.
Conclusion
The internal analysis of Severstal points to a hugely successful and large company, which does however, faces immense industry competition, a fast-changing market and rising political risks. Given the stagnation and shrinking of the steel industry’s markets in North America and Europe, investing in the growing emerging markets is extremely important for Severstal. However, the company is unlikely to grow to the size of Arcelor Mittal given the high costs of putting up plants. As such, mergers and acquisitions in the emerging countries (particularly since steel producers in the emerging markets lack for technology) is a critical strategy that would ensure Severstal sees of the strategic difficulties facing it (Sainidis, n.d.).
Bibliography
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Sainidis, E. Severstal and the Global Steel Industry. Northumbria University, Newcastle Business School. Newcastle: Northumbria University.
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