1. Experts and analysts routinely blame the struggles of the steel industry on overcapacity and import pressure
2. In the wake of flagging profitability, steelmakers focus once again on cost reductions while overlooking one crucial fact: They are leaving money on the table
3. The flawed conventional wisdom of the industry is trapping steel companies in a vicious cycle of unprofitable sales decisions
4. Decisions are often made based on obsolete financial information – True economic value is not considered
5. More is not necessarily better when it comes to volume – Fill the mill, but not at any price
6. Competing on price with imports is futile – Domestic steelmakers have the advantage in offering additional services over imports
7. It is time for steel companies to challenge conventional wisdom and rethink turnaround efforts by taking a closer look at commercial decision-making

Chicago, August 28, 2014

It is no secret that the steel industry has been struggling for some time. Analysts and industry experts alike constantly point to global overcapacity and the slow recovery from the recession. Meanwhile, with rising price spreads between domestic mills and imports, approaching two-year highs in some cases, steelmakers continue to sound the alarm about cheap imports. As a result, they scramble to cut costs with routine announcements of plant closures, layoffs, and asset sales. While these efforts help stop the bleeding, cost reduction measures do not provide a long-term solution to the modern challenges of the steel industry. In its new report, Challenging Conventional Wisdom in Steel, Roland Berger Strategy Consultants explores a different approach to addressing the problems plaguing domestic mills.

"The major threats – overcapacity, low price imports – are here to stay," says Thomas Wendt, a Partner in Roland Berger's North America practice. "It is now cheaper to transport a ton of steel halfway around the world by sea than it is to send it just a few hundred miles by ground. Competing on cost against just about every mill in the world that is by a port is a game that domestic mills won't win," explains Wendt. "They need to address the top line."

A vicious cycle

In following conventional wisdom, many steel companies have become trapped in a pattern of behavior that leads to worsening profitability. The typical diagnosis of the P&L concludes that sales contracts are profitable, but fixed costs are too high. Naturally, the response, in addition to cutting costs, is to increase sales volume. In the current environment of overcapacity and rising imports, filling the mill means dropping prices. However, the resulting price dilution has widespread effects, and more than offsets the benefit of the additional volume. This causes profitability to fall even further, beginning the cycle anew.

A gap in GAAP

When a mill is under pressure to perform financially, the natural reaction is to scrutinize every decision through the lens of the P&L. However, this can do more harm than good. "The P&L provides a distorted view of reality," explains Isaac Chan, a Senior Consultant at the firm. "When that view becomes the basis for your day-to-day decision-making, you will lose out in the long run." The reasons for this are complicated, but it all has to do with timing. The shipments contributing to the P&L today reflect decisions made months ago, so the price is not the real price, and the cost is not the real cost. Therefore decisions should be evaluated based on market conditions at the time the decision was made rather than the distorted view presented in the P&L. These are important details in an industry with volatile markets and razor thin margins.

More isn't always better

Because high capacity utilization helps spread the burden of fixed costs, conventional wisdom says to 'fill the mill.' But driving up volume has some severe side effects, particularly on price levels. The problem has been exacerbated by the low prices offered by imports in recent years, as obtaining order volume from an import buyer requires significant concessions. The resulting price dilution is often underestimated, and the push for higher volume leads further down the path toward the vicious cycle. The lesson learned is that with such aggressive import pricing, capacity utilization must be balanced even more carefully with price; the additional volume can be beneficial, but not at any price.

Play to your strengths

In the report, Roland Berger argues that tangible services such as warehousing and customized payment terms, and soft factors such as better communication and personal relationships, have real value that needs to be leveraged. These additional considerations have a real financial impact on both steelmakers and their customers.

"Steel is considered a commodity, but that doesn't mean it has to be sold like one," says Roland Berger's Kunal Shah, an expert in revenue management. "Many domestic mills have a misconception that they need to cut prices in order to compete effectively with imports. Instead, domestic mills must focus on adding value through means other than price to differentiate."

Breaking the cycle

The first step toward addressing these issues is to get a clear picture of what is going on. This means both internally along the sales decision-making process and externally through insight into the market dynamics that truly matter. Only once an understanding of these pieces is in place, and the leadership can distinguish between temporary upswings from the market and sustainable success, can the diagnosis begin. It is time for steel companies to rethink the conventional wisdom of the industry by taking a closer look at commercial decision-making. Otherwise, they are missing out on perhaps their greatest opportunity to increase profitability.