It is no more a surprise that the steel industry is going through a rough patch, driven primarily by skewed demand-supply ratio. Steel experts predict a continuous slow growth and lack of demand in the near future, owing to slow economic progress in major nations. Thereby, adding further pressure for the survival of most of the existing players.
To add to industry woes, Chinese steelmakers (accounting for 50% of total steel production) are maintaining their output at a decent pace. China's production grew by 4% CAGR from 2012 to 2015, while global production merely escalated by 2% during the same period. It has been noted that in February 2016, China announced plans to shut 100 million to 150 million tonnes of crude steel capacity in the next five years. However, with the current capacity of 1.13 billion tonnes, reduction of 100 million tonnes, that too, over the period of next 5 years would not give much relief to the global industry.
Global overcapacity coupled with declining steel prices have landed steelmakers in financial and operational trouble. Amidst this misery, the only respite some companies have currently, is declining raw material prices which has essentially provided some relief from the incessant narrowing margins. But, this is a breather only for companies which are dependent on third party supplies for raw materials. On the contrary, vertically integrated firms have already reached their lowest possible cost numbers, driven by in-house raw material supplies. Hence, the fall in the rate of raw material is not impacting their margins considerably (barring any marginal gains of operational cost reductions that may be brought about).
Therefore, in a way, these integrated players are stuck in a situation where they have no control on their output price and also, cannot do much about their input prices. Thereby, faced with continuous declining margins.
The remedy at this juncture is that companies need to venture into different areas where they are less vulnerable to price volatility. Companies, like AK Steel have already entered this arena - "Specialized Steel products". The above chart clearly explains that companies that have incorporated higher margin products in their portfolio have been able to improve their profits in last 3 years versus integrated players.
From a long-term perspective, backward integration is undoubtedly a valuable strategic move to ensure raw material supplies and weather the impact of price volatility. However, it seems, to rely completely on this is probably not the best decision. Instead, companies should consider adding high-margin specialized products to their portfolio. Driven by relatively lower competition, specialized steel market offers altogether a different area to innovate, new markets to cater and lastly, of course higher margins. But, this diversification may not offer a substantial size of production and demand loss, that some of the steel majors have been encountering.