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Center of the action: metals distributors outlook

Keywords: Tags  Reliance Steel & Aluminum, David Hannah, Klein Steel Services, John Batiste, A.M. Castle & Co., Scott Dolan, Metals Service Center Institute, Bob Weidner Esmark

Today’s uncertain business environment is posing challenges up and down the supply chain, and metal service centers are no exception. To meet these challenges, distributors are positioning themselves to be an even more valuable part of the metals supply chain.

“The biggest challenge for the service center industry has been the slow growth of the U.S. economy,” said Bill Hickey, president of Chicago-based Lapham-Hickey Steel Corp., noting that gross domestic product growth of below 2 percent has put tremendous downward pressure on prices, which in turn has eroded service center margins.

Demand for service center products hasn’t been as strong as many distributors would have liked, said David Hannah, chairman and chief executive officer of Reliance Steel & Aluminum Co., Los Angeles. “We all expected that demand would pop up in January, which it did to some degree, but given that it came off such a low number in December it wasn’t as much as we expected. Also, usually the early momentum carries us through May, but it hasn’t done that, but rather held pretty steady since the first pop in January.”

In fact, demand has started to soften in recent months, according to John Batiste, president and chief executive officer of Klein Steel Service Inc., Rochester, N.Y. On average, metal service center revenues are down about 5 percent year on year, with inventory levels down approximately 15 percent, he said. “We are still dealing with the recession of 2009 as the U.S. manufacturing sector is not yet well.”

The recent softening of demand in many--but not all--end-use markets has resulted in short lead times at many domestic mills. While that could be a positive for service centers, as it enables them to keep their inventories lean, the weak market could make it appealing for customers to go directly to the mills rather than service centers, said Scott Dolan, president and chief executive officer of Franklin Park, Ill.-based A.M. Castle & Co. But he said he hasn’t seen much of that due to the value service centers offer to both customers and suppliers, especially in higher-demand markets.

The painfully slow economic growth has clearly cut into service centers’ profit margins and could affect their ability to create wealth for themselves and others in the metals supply channel, Hickey said.

While there hasn’t been a slew of financial restructurings, Hickey said that some companies have been exiting certain product lines, ceasing to offer some services and even closing plants because there isn’t enough of a financial return to justify the expense, and keeping those functions going is risky given the current “abnormally low” growth rate.

Many service center industry players have attributed the situation at least partially to what they say is a lack of governmental leadership, especially when it comes to trade issues. “The United States has no trade policy,” Hickey said, because it allows just about anyone in the world to ship products to the United States even if those products were directly or indirectly subsidized by their governments. Batiste estimated that between 65 and 70 percent of the global steel industry is owned by governmental agencies.

“Trade policy is about fair and free trade,” said Bob Weidner, president and chief executive officer of the Metals Service Center Institute (MSCI), and the U.S. government needs to ensure its trading partners comply with bilateral and multilateral trade agreements. He said the United States generally has lived up to its trade commitments, “but unfortunately from time to time countries, or blocs of countries, pick and choose what components of the agreements they like and don’t always follow all of them. If those trade agreements result in others getting access to our market, they need to allow us to gain access to their markets.”

“We’ll horse around for years with the World Trade Organization to see if we can get something resolved, but by that time the industries in the United States that were harmed could be gone,” Hickey said.

The same could be said of the trade complaint process, said Jeff Simons, vice president of marketing and business development at O’Neal Industries Inc., Birmingham, Ala. Not only is it long and drawn out, “but you have to be dead to prove that you are sick,” he said.

Thomas Modrowski, chief executive officer of Chicago-based Esmark Steel Group, a unit of Esmark Inc., said that currency manipulation has had the worst impact on the domestic industry. Hannah agreed, saying that “dumped material from countries that are manipulating their currency does not hurt just the service center industry, but our suppliers as well. It isn’t good for any of us. There are rules out there. We need to make sure they are enforced.”

“It’s all about ensuring that the playing field is level and that certain countries, including some that aren’t friendly to the United States, don’t use us as a dumping ground for their low-priced, sometimes poorer-quality, steel,” Batiste said.

Meanwhile, with the structure of some end-use markets changing rapidly, a number of metal service centers have found themselves in a poor strategic position, according to Christopher Plummer, managing director of Metal Strategies Inc., West Chester, Pa., resulting in them having to scramble to either diversify, expand their geographical reach or add new capabilities.

“One of the things that has made the service center industry a great industry for over 100 years is that as the world changes, as business models change and as industry dynamics change, service centers, being phenomenal entrepreneurs, have adapted accordingly,” Weidner said. That can be seen in the evolution of MSCI’s name from the American Steel Warehouse Association when the trade group was formed in 1936 to the Steel Service Center Institute in 1951, adding the term “service center” into the metal industry’s vocabulary as companies began to not just warehouse and break down bulk steel, but also provide some service in the form of basic processing. “Now just about any service center, whether it is large or small, provides value-added services,” Weidner said.

Hannah said that today’s service centers like to do as much processing and first-stage fabrication as possible. “When you can do more for your customer, it brings the two of you closer together and hopefully strengthens your relationship,” he said. Hannah acknowledged, however, that companies have different levels of comfort with the kinds of value-added services they are willing to provide.

“At Klein Steel we have worked very hard to help our customers cut their costs by providing value-added services that reduce their cycle times, and therefore the time it takes them to get their products to their customers,” Batiste said. That includes getting into the business of component manufacturing, making “kits” for original equipment manufacturers (OEMs).

Batiste said in order for Klein Steel to make kits--parts that are cut to the right shape with all the holes drilled and tapped and beveled to the customer’s specifications, then bundled together so all the customer needs to do is assemble them into a finished product--the company had to invest in very sophisticated, highly automated machinery, including water-jet cutters, lasers, high-definition plasma cutters, automatic sawing machines, milling machines and vertical lathes. He said that Klein Steel also uses an automated storage and retrieval system to speed up the process of getting the kits made, packaged and sent to customers.

Providing customers with kits, however, isn’t for all service centers. Dolan said that Castle is leery of going too far downstream, as it does not want to compete with its machine shop and fabricator customers. “We do have some targeted accounts or agreements, such as that with the U.K.’s BAE Systems on the Joint Strike Fighter, where we do some first-stage machining.”

Castle is not alone. Hannah said service centers that tend to sell to larger OEMs might be more inclined to provide kits, but companies that sell a lot of metal to subcontractors or fabricators, as Reliance does, is less likely to do so. “That still leaves us a lot of room to do processing, even advanced processing,” he said. “Doing first-stage processing is also a big help for some of our OEM customers, but we just don’t want to go too far downstream.”

Simons pointed out that as more service centers get into providing complex solutions for OEMs, it will create a greater competitive parity, making it harder for companies to scratch out a living. “Also, the newcomers to this don’t have as good of an idea of the cost of fabricating kits and tend to undervalue their work. That has dropped pricing levels for everyone.”

That might be just a temporary downside, however. “It is a continuing evolution, with certain service centers being very innovative and looking to make the process more efficient throughout the system,” Hickey said.

The service center industry also is feeling strong demographic influences, Weidner said, with an estimated 76 million to 78 million baby boomers expected to retire over the next 10 to 15 years. “As companies go through this transition it will put pressure on service centers to possibly rethink their business models due to the generational differences between the baby boomers now running the companies, especially privately owned small to medium-sized service centers, and their children--the echo boomers, or millennials,” he said. “This is likely to play out in a variety of ways. Many are tied to technological advances, given that the baby boomers and their children look at technology through two very different lenses. But it is also related to succession issues, and ultimately industry consolidation.”

Modrowski said one reason for this is that the service center industry is just not a sexy business. “I don’t think that in many cases the next generation wants to work in this business,” he said.

The issue of consolidation goes beyond succession. “Coming from the much more consolidated airline industry, I was very surprised at how fragmented the metal service center industry is,” Dolan said.

While industry consolidation has been a theme for years, and could accelerate going forward as the economy improves, Sean Hoover, U.S. metals leader for PricewaterhouseCoopers LLP, said that he doesn’t believe the industry is actually much more consolidated than it was 20 years ago.

But clearly there is a need. Hannah noted that even with all the companies that Reliance has acquired over the years--including its recent acquisition of Metals USA Holding Corp., which closed in April--it still only has about a 6-percent share of the overall market, leaving thousands of service centers, most of them small and privately owned.

He said that even though Reliance hasn’t closed many physical locations, despite all the companies that it has acquired over the years, it doesn’t mean there hasn’t been consolidation. “And I think that consolidation has been good for the industry, bringing more discipline to the industry both in terms of management and pricing. As our customers get bigger and our suppliers get bigger our industry is often caught in the middle, but further consolidation can help with that.”

That said, Hannah acknowledged that there continues to be a place for small, privately owned and operated service centers. In fact, Batiste said they could have certain advantages. “While the big guys have the advantage of certain economies of scale, being large could also be a disadvantage. They tend to make decisions slower and, in my opinion, don’t necessarily offer the same things that we do to help our customers to cut their costs,” he said. “The advantage that we have as an independent, private company is our independence. We set our own policy. We can make longer-term decisions. We are not focused on the 90-day horizon that publicly traded companies are, and in many ways that gives us more flexibility and freedom.”

Dolan noted that different companies take different approaches when integrating companies they have acquired, from maintaining a “don’t touch” stance to fully integrating it into the parent company. He said that a lot depends on the business niche and whether the acquired company brings something new to the organization or is complementary to what the parent company already does.

There is always a risk when melding different corporate cultures, Modrowski said, noting that Esmark had a lot of experience with integrating “one-offs,” or one-location family owned operations, in its first go-around in rolling up the service center industry before being acquired by Russia’s OAO Severstal in 2008.

Modrowski said that in Esmark’s first go-around it kept the companies it acquired independent. “This time we are keeping things more centralized,” he said, which not only has helped the company avoid some of those corporate culture issues but also has allowed it to be more efficient both from an operational and a technological standpoint.

Hannah acknowledged that with its many acquisitions Reliance has many information technology systems. “Many of the companies are still on the legacy systems they had when we acquired them,” he said, maintaining that isn’t a problem as long as those systems have the proper controls, run efficiently and have a means to provide necessary information to Reliance’s corporate office.

“While we are fortunate to have a more modern system, which we implemented about four years ago, we haven’t done as good a job as we should utilizing all the capabilities of our enterprise resource program,” Dolan said, including some of the inventory management and operational aspects of the package.

One problem, Simons said, is that service centers are generating more data than ever before. “We are suffering from some paralysis of analysis,” he said, although many companies are implementing sophisticated analytical solutions, given how business information has become a hot-button issue. There is a need for companies to overlay an analytic business tool that can take all the information for different legacy systems and put it into understandable reporting packages.

Cyber security is another issue, and one that the whole supply chain needs to tackle together, Dolan said. “While what we do might not be perceived as a threat, we have some information about our customers and certain end markets that could be targeted. Because of that there is a need for a comprehensive strategy to protect not only our industry but our customers.”

“We are also having to try to adjust to technology in terms of mobility,” Simons said, noting that the use of tablets and smartphones allows the outside sales force to access more information in real time in front of customers than ever before.

No matter what form it takes, all of this technology is geared toward one common denominator, Weidner said. “That is how service centers can be more efficient, more productive and more communicative, and how companies can operate their businesses better and achieve greater shareholder value.”

One thing service centers need to do going forward, Plummer said, is to look at how their markets, even the more attractive ones, are changing, and how they can position themselves to take advantage of that change.

“I think the future is very positive for our industry,” Hannah said. “We are doing better today than we were a few years ago and we have been providing an increasingly important and valuable function for both our suppliers and our customers.” He said there will continue to be opportunities, with both mills and OEM customers looking for service centers to do more for them.

“Service centers have been around for a long time and they are a very important part of the supply chain as they provide value-added services that could solve problems for their customers,” Dolan said. “But as processing gets more sophisticated and complex, we have to be careful not to compete with our customers.”

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