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Supply Chains of Steel

By Rajesh Ray and Abihshek Kaul | July/August 2013 | 23 | 4

The metals industry is one of the oldest in human history. In several countries, industrial growth is measured by the growth in metals. And, while most traditional supply chain concepts also apply to metals, there are some notable differences.Mastering 10 important lessons from the metals industry

The metals industry is one of the oldest in human history. Even today, in several countries, industrial growth is measured by the growth in metals, demonstrating the significance. While most traditional supply chain concepts also apply to metals, there are some notable differences. In the following 10 areas, we explore some of these differences and include examples and real-life case studies to illustrate the concepts. Each section concludes with a takeaway that can be applied by supply chain practitioners across all industries. 

1. Vertical integration matters more than virtual integration.
In most modern systems, the wisdom is it’s better to do what you do best and own a very limited asset. Nearly everything is outsourced but the brand and distribution process—a virtual integration with supply chain partners. However, in the metals industry, vertical integration still is an important supply chain strategy. The primary example comes from Henry’s Ford’s Model T system, where every part of the manufacturing process was owned by the company. Nowadays, a steel company might own coal and iron ore mines, and an aluminum manufacturer might have its own bauxite mines. These types of companies are known as integrated producers. Having this level of integration historically has paid dividends for metals companies in terms of cost control and availability of key raw materials. 

Takeaway: The concept of vertical integration can be extended to other industries that depend heavily on one or two key raw materials. Examples include thermal power, with a key ingredient of coal; cement, which needs dolomite; and petrochemical, requiring a lot of oil. On the other hand, vertical integration is not an option for industries such as automotive and consumer goods. It’s important to have a good understanding of your industry’s structure: One size does not necessarily fit all.

2. Proximity to raw materials outweighs proximity to customer. 
Historically, steel companies placed themselves at the origin of their raw materials, primarily iron ore. However, through globalization, production locations have dispersed. The reasons for this include the introduction of low-cost competitors into the free market and increased specialization among steel companies to serve niche markets. However, access to raw materials remains a key factor in investment decisions.

South Korea-based POSCO, one of the world’s largest steel manufacturers, planned to set up a 12 million-ton facility in Paradip, India—a $12 billion investment. India was chosen as the raw material source due to its high-quality iron reserves. The plan was to produce primary steel in India, where the raw materials are cheaper, and transport the semi-finished product to facilities in Korea—a process known as split integration. The initiative would help POSCO compete more effectively with its biggest rivals in the Southeast Asian market, although the project has stalled due to local protests. 

Takeaway: The cost of inbound and outbound transportation plays an important role in location. All factors need to be analyzed in detail before committing to investment. This is especially important for industries where transport expenses are a significant percentage of the costs of material, such as metals, mining, cement, and heavy engineering. 

3. Producing against demand does not always make sense.
Producing only what is needed by the customer or the next workstation is the fundamental philosophy of Just-in-Time production that revolutionized the manufacturing world in the 1980s. However, in the metals industry, the upstream supply chain is a part of the continuous process. For example, in the steel industry, iron ore is formed into different shapes, sizes, and grades of steel and sent for further processing via different finishing routes. This is referred to as a V-shaped bill of material, where raw material diverges to multiple end products. To lower inventory and energy costs, continuous and discrete production must be planned simultaneously and all alternate finishing routes loaded. 

Takeaway: While managing operations with low inventory is an indicator of supply chain efficiency, the benefits must be balanced against setup costs. In certain cases, it may make sense to create additional inventory up to a point if shutdown and restarting a particular operation are prohibitively expensive. This is particularly the case for process industries, including petrochemicals and metals. 

4. Both raw materials and finished products are commodities.
Managing products as commodities at both the input (coal, ore) and output (finished metals) ends poses a challenge for the metals supply chain. This situation is familiar to industries such as tobacco, which puts tremendous effort in branding to differentiate its end products. In the automotive industry, some inputs are commodity (metal, plastic, leather) and some are branded (tires, batteries), but end products are mostly differentiated. 

Commodity prices vary based on demand and supply, and some commodities follow standard boom-and-bust cycles. Recently, for example, coal prices hit the roof, and every steelmaker felt the sting. Problems arise when the company has to supply finished goods against a contract. While many contracts have a price variation clause to combat this effect, it often is difficult to pass on increased prices of raw materials to high-volume customers, and thus higher input costs eat into profits.

Some metal companies own captive mines to have better control of inputs. However, building capacities or owning mines during boom periods may result in problems during downturns, when buying from the outside is the cheaper option. Additionally, some metals companies derive part of their earnings from financial instruments in order to hedge against price fluctuations. 

Takeaway: Managing a commodity-based supply chain is a specialized skill, requiring expert knowledge in certain tools and concepts, including contract management, commodity pricing, futures, and hedging. Careful navigation through boom-and-bust cycles is crucial to the health and survival of the organization. 

5. There is a near-infinite number of end product options. 
While every organization wants to provide more options to their customers, this can lead to product and stockkeeping unit (SKU) proliferation. Pharmaceuticals, retail, and consumer goods may carry the highest number of SKUs, but the issue is also significant in the metals industry. In steel manufacturing, a product can be classified into one of hundreds of grades; rolled into almost any combination of width, thickness, and length; finished to any number of specifications, such as 60-micron coating or blue in color; and, finally, cut and shaped to any customer specification. 
For the steel supply chain, most planning is performed across three horizons: 
  1. Sales and operations planning. The forecast is made for a horizon of two years at the aggregated planning level and agreed-upon supply to ensure a product mix that maximizes contribution per hour on resources. 
  2. Master planning. This is part of order-based planning across the entire production network, including upstream, rolling, and finishing, and generally at three months ahead. This ensures campaign formations, managed inventory levels, running of resources, productivity, and order commitment. 
  3. Detailed planning. This piece-based line scheduling, done for the short-term horizon within the next couple of shifts, keeps the rework and production realities synchronized. 
Takeaway: Managing a huge number of end products requires a focused supply chain strategy. One technique is to build around a supply chain decoupling point, also known as an order penetration point. This can enable a company to produce intermediate inventory to forecast and then commit orders for priority customers from this intermediate inventory and finish to order.

6. Consolidation is the rule, not the exception.
Jack Welch, former CEO of General Electric, said that if you are not among the top few companies in your area, it’s only a matter of time before you’re taken over. While many other industries see consolidation at some point of their life cycles, it is practically the norm in the metals industry. 

The world’s biggest steelmakers are continuously investing to buy smaller competitors to gain market share. Notable examples include Kawasaki and NKK of Japan forming JFE Steel, Thyssen and Krupp of Germany merging into Thyssen-Krupp, British Steel and the Netherlands’ Royal Hoogovens becoming Corus, and three major European steelmakers consolidating into Arcelor. 
However, nothing compares to how Lakshmi Mittal built his steel empire, aggressively acquiring poorly performing steel plants in 14 countries across the globe and turning them into money-making ventures. In October 2004, his company, Mittal Steel, acquired the International Steel Group for $4.5 billion to become the largest steel producer in the world. He then made the largest-ever steel acquisition in 2006 when he took over Arcelor for $33 billion, becoming ArcelorMittal. 

Takeaway: Mergers and acquisitions can alter the landscape in terms of new factories, distribution centers, and stocking points. They may require shifts in effective supply chain strategies; the questioning of flows, such as which factories should supply which distribution centers or customers; revisiting stocking norms across the network; and even complete supply chain redesigns. 

7. There are many supply chain trade-offs to consider.
Business-to-business commerce (B2B) versus business-to-consumer sales (B2C). The original equipment manufacturer model is the traditional B2B enterprise. This requires long lead times and buying decisions that are based on quality, price, delivery schedules, and terms. Meanwhile, B2C (best represented by retail) requires a healthy dealer distribution network, stocking and storing materials, managing channel partner margins, and promotions. Metals companies usually operate with both kinds of customers and must consider on which customer to focus in order to optimize profits. 

Spot versus contract. Most metals companies prefer to secure the bulk of raw materials from their own sources or through long-term contracts with key suppliers to protect against price fluctuations. However, they also may meet some of their requirements through spot auctions, which can be cheaper in some circumstances. How much to source and from where are important financial decisions.

Direct versus multi-mode transport. The metals industry suffers high transportation costs for both raw materials and finished goods. For coal, a major input, the transportation can cost more than the material itself. For finished goods, companies can use various transport modes, such as ship, rail, and truck; whereas, on a per-unit cost basis one mode may be cheaper, the total effective cost must be calculated before making a decision.

Takeaway: Similar trade-offs can be seen in many other industries. For instance, automotive components suppliers must decide how to allocate between original equipment manufacturing, which provides volume, or the replacement market, which provides profit. Likewise, a mixture of long-term contracts and opportunistic buying is employed in many industries; the challenge is to find the balance that minimizes risk and maximizes profit. 

8. Sustainability concerns are changing manufacturing processes. 
The metals industry began examining its energy consumption and carbon footprint long before green became a supply chain buzzword. The primary driver was to keep down operating costs; concern for the environment was a secondary priority. The measures undertaken by the industry were deep, requiring much in the way of technology innovation, engineering excellence, and facility layout and design. 

One way that the steel industry continues to lower energy costs is through the use of integrated steel plants. These facilities contain every operating unit needed to produce steel, including a power plant, blast furnace, and hot rolling mill, to name just a few. Benefits of integrated plants include the ability to reuse heat or energy generated in one unit in others and a more efficient internal use of metal, scrap, and waste.

Takeaway: As a strategy, green business is reshaping tomorrow’s supply chains. No longer a “nice to have,” sustainability is a core business function that is changing the way products and manufacturing processes are designed. Smart supply chain practitioners will keep their eyes and ears open and continuously evaluate emerging technologies in this area. 
Pressure to keep down costs must be carefully managed.

9. Pressure to keep down costs must be carefully managed.
Each operating unit in a metals facility is tasked with reducing costs and increasing yield. However, this can lead to conflict among business functions and inventory pileups. To manage these conflicting constraints, integrated steel plants employ a central coordination department known as production planning and control. This group is responsible for the flow of production across individual units, work-in-process inventory buildup, and adherence to order commitment date. In terms of production flow, the production planning and control department provides guidance on when, what, and how much to produce in the short term, given the various constraints of the upstream units.

Takeaway: Managing conflicting constraints among different steps of the manufacturing process requires integrated planning and coordination—a complex task if operations are performed in different operating units of the same facility. Investment in integrated information systems such as enterprise resources planning or advanced planning, scheduling, and optimization solutions can make a real difference. 

10. Yard management and logistics require innovative solutions.
The metals supply chain has unique challenges in the areas of storage and transportation. As a finished product can weigh anywhere between 1 and 25 tons, stacking rules tend to vary depending on the item. Packing efficiency likewise tends to be low. Unfortunately, radio frequency identification, bar coding, and other solutions used in many industries are difficult to implement in metals due to various limitations.

Simple policies such as storing materials based on customers, standard sizes, stacking height, or various other rules become greatly important for ensuring smooth operations. One leading steel company reorganized its logistics structure by setting up a single point person for sales coordination and logistics and yard management, thereby ensuring goods are stored and dispatched based on sales priority. 

Takeaway: The final lesson is that traditional warehousing concepts can be applied to large yards or anywhere material has to be stacked, stored, and tracked. Industries such as mining and automotive also require careful yard management and logistics. Warehouse management demands a diverse skill set that can be extended to many other areas of the supply chain. 
Rajesh Ray is senior managing consultant and product lead at IBM Global Business Services. He may be contacted at rajesray@in.ibm.com

Abhishek Kaul is global metals SME at IBM Global Business Services. He may be contacted at abhishek.kaul@in.ibm.com

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  1. Vishwanath Sastry September 02, 2015, 07:18 AM
    Very well explained about in and out of steel supply chain business;Especially the takeaway points after each concepts. Thanks for posting this. A must read for all supply chain practitioners.
  2. Alie Wube Dametew June 20, 2016, 09:02 AM
    The  expression and Case is interested and I have got alot, thanks for your contribution for people , I ADVISE  PROFESIONALES SEE AND USE IT.


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