Makers should aim for cost-competitiveness

IN FOCUS/ IRON & STEEL

The steel industry is on a roll now and steel producers expect the good times to last through 2005, but serious players would do well to focus on the core issue of becoming globally cost-competitive taking advantage of the current boom phase.

"It is important for players to be cost competitive so as to be in a position to withstand all phases of the steel cycles", credit rating agency ICRA Ltd warned in a recent review of the sector.

ICRA identified the sources of cost competitiveness.

The list includes large installed capacity for the economies of scale, high degree of labour productivity, efficient operational and process cost control measures and sound working capital management.

Icra said, "As steel is a relatively low margin, capital intensive business with severe steel cycles, it is important to have a conservative capital structure so as to be in a position to service debt in time".

Stabilising demand was suggested as a way ahead for steel producers.

"Tie-ups with bulk consumers (such as automobile original equipment manufacturers) mitigates demand risk and accordingly ensures product offtake and high level of capacity utilisation", said ICRA.

However, as steel industry pundits point out, such long-term contracts entail sacrifices in the form of price discounts for assured supply contracts.

Besides, such commitments will prevent any steel producers from offloading more volumes in the spot market when prices rise, thereby capping gains when the market booms.

It is also important to have an integrated operation, preferably with captive coal and iron ore mines.

This insulates producers from volatility in the prices of these raw materials and intermediate products.

Steel is a commodity business with significant volatility in prices and is also a relatively low margin business.

"Integration into downstream value added steel production enhances the margins and profitability", said ICRA.

Higher realisations and margins are associated with flat products, especially cold rolled (CR) products.

Accordingly, manufacturers are shifting towards value added flat products and modifying their product mix though 60 per cent of steel demand in India continues to be for long steel products used in infrastructure, construction and housing sectors.

Branding has started playing an important role in the steel business as branding enhances customer acceptance and loyalty and allows steel companies to charge a premium on the branded product which is partially insulated from price fluctuations.

High freight costs associated with product movement makes it important for manufacturing units to be located close to the consumption centres.

Because of proximity to raw material sources are the pre-liberalisation industrial policy of the government, major integrated steel producers Tisco and SAIL are located in eastern India, at significant distances from the major consumption centres in west and south India.

Thus, producers like Ispat Industries and Essar steel, in the west and Jindal Vijaynagar in the south have freight cost advantages over integrated players like Tisco and SAIL.

Also, increasing freight costs in the face of declining import duties put Tisco and SAIL at a major disadvantage against low-cost imports in western Indian markets.

Apart from distances, poor quality of road infrastructure in the country also results in time delays and enhances the delivery costs of the finished products.

Thus, in view of these concerns, the golden quadrilateral and the other road projects initiated by the government, appear to be steps in the right direction.