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July 1, 2007

A Smoother Ride?

Forward talked with three players in the metals supply chain to understand what factors influence their supply decisions and how those factors have slowed implementation of more current concepts.

One day in early April, machine shop operator Mark Lindemulder learned that one of his customers, a manufacturer of agricultural equipment, had canceled an order that required 1,400 pounds of 10-inch round, hot-rolled steel bar. Lindemulder had ordered the bar stock from Earle M. Jorgensen Company’s metals service center in Schaumburg, Illinois. By the time he called his EMJ sales representative to cancel, the metal already had been shipped.

“I could call EMJ, and they would take it back,” says Lindemulder, president of Tibor Machine Products in Chicago Ridge, Illinois. “But I feel the order will materialize again. [It did, by mid May.] Meanwhile, I have to sit on the inventory.”

This kind of unpredictability is at the heart of the supply chain problem for the metals industry. In other industries, such as retailing, accurate demand forecasts are now considered normal and necessary. Every product carries a standardized bar code—from grills and filing cabinets, down to toothbrushes and nail polish.

In the metals industry, of course, there are few demand forecasts available. There are no standardized bar-code systems that extend universally from producers to distributors, from fabrication to end-use customer. And there are comparatively few fungible products. A coil of hot-rolled steel—essentially the irreducible basic steel product you can buy—can vary in metallurgical content, size, surface quality, strength, formability and other factors from the next one down the production line.

None of this is news to companies in the metals supply chain. What is less apparent, however, is the extent to which these factors, and the mindset and culture of the industry, work against almost any attempt to improve supply and logistics issues.

To take the current temperature of the industry, Forward talked in depth with three players in the metals supply chain to understand what factors influence their supply decisions and how those factors have slowed implementation of more current supply concepts. Not that the players—Niagara LaSalle Corp., the Hammond, Indiana-based supplier; EMJ; and Tibor—are unsophisticated. In particular, EMJ’s Schaumburg service center is state-of-the-art in many respects. Niagara LaSalle and even to some extent small companies like Tibor fully understand the value of demand forecasts and other ways to improve inventory turns, reduce supply chain costs and add efficiency.

Yet each is a captive of a supply system that finds modernization particularly difficult. The majority of the business flowing through EMJ is ordered within days, often within 24 hours of its expected use. That means EMJ holds most of its inventory on speculation. Niagara LaSalle produces much of its products on the basis of educated guesswork. It’s a business in which most of the time, the players don’t know their likely needs.

“We don’t have visibility into true demand,” says David Sinclair, vice president, information technology, Niagara LaSalle. “I don’t think you can get it, and I wouldn’t know what to do with it.”

In this environment, there is little patience for theories that could possibly create a more efficient network. Buying and selling metal effectively remains an art involving the quest for the best price and keeping options open.

“There is no magic,” says Frank Travetto, EMJ’s vice president, merchandising, based in Schaumburg. In fact, he says, looked at properly, “there is no supply chain,” in the sense of a continuous, reliable, uninterrupted flow of material from producers to and through intermediate stops to end users.

At EMJ, supply chain economics is a game of being competitive for the most in-demand grades of bar and tube—just as a supermarket makes sure it’s competitive on gallons of popular 2% milk. Monthly shipments of a generic grade of 2-inch round bar shipped from the Schaumburg facility can swing wildly from a low of 3,893 pounds in June 2006 to a high of 23,092 pounds in April 2007. “What happened the month I sold 23,000 pounds? Perhaps we were a nickel per hundredweight lower [than the competition],” Travetto says.

With 80% of the business ordered off the shelf, there’s little opportunity to forecast or share information. “The remaining 20% give you a forecast so you never run out, so they never run out,” Travetto says. Yet, he notes, “there is rarely any real obligation to take any [metal].”

A ROLLER COASTER RIDE

Ordering, therefore, is always an educated guess, based on historic patterns, analysis of publicly available economic data and a bit of “Kentucky windage,” says Tibor’s Lindemulder.

This causes inefficiency and sometimes extreme inventory cyclicality. Service centers historically overbuy in rising markets to avoid stock outages. In a softening market, they often have too much product on hand, then cut prices to reduce the surplus. Buying and selling metal is always something of a roller coaster ride.

In the most recent iteration, inventories of steel products at service centers during the 10-month period ending December 2006 swung from a low of 2.5 months of demand in March 2006—a month of seasonally brisk demand—to a supply adequate for 4.7 months in December—the slowest sales period of the year. December stocks reached an all-time high of 16.5 million tons, MSCI’s monthly Metals Activity Report shows.

Underlying these gyrations is a mindset to buy at the best price by playing suppliers and foreign and domestic producers against one other. Although this factor in purchasing has abated somewhat because of North American producer consolidation, it has not completely gone away, especially during periods of significant overseas supply. Metals purchasing resembles something of a bazaar, with bargaining and a big element of gamesmanship.

So could something closer to the hyper-efficient retail model work in metals? Yes, says Panos Kouvelis, director of the Boeing Center on Technology, Information and Manufacturing, and Emerson Distinguished Professor of operations and manufacturing management at the Olin School of Business at Washington University in St. Louis.

Following the Wal-Mart model, an OEM might award the steel bar business to a single service center supplier, expecting to lower costs and enabling that supplier to meet production requirements with less inventory because of better estimates of how much metal was needed. “If [a business can] run with less inventory, that makes it more responsive and cost-effective,” he says.

However, there are enormous differences between the retail and industrial networks. Metals remains highly fragmented—there are thousands of small users booking small orders, and even the largest OEMs buy lots of different grades in different sizes. No metals users have emerged that have the scale, clout or incentive to change time-honored practices. And no overriding incentives have been presented—at least not yet.

Impetus for a shift toward a more efficient system might come from large OEMs under immense pressure from global competition to reduce costs. Caterpillar Inc. Vice President of Global Purchasing Dan Murphy recently threw down the gauntlet when he said the giant equipment maker must learn to run its business with one-half of the inbound raw and finished inventory. “We must find ways to massively reduce inventory, or we won’t be able to grow,” he told a steel industry conference in March. A Caterpillar spokeswoman said the company wouldn’t comment further.

Even an end user like Peoria, Illinois-based CAT can’t tame the supply chain, however. Unlike domestic and foreign automakers, which buy huge tonnages of flat-rolled steel, equipment operators like CAT and Deere & Co. buy a variety of shapes, sizes and grades, says Sinclair of Niagara LaSalle.

“They can’t give us the tonnages we would need,” he says. “They don’t buy enough of any one thing.” Moreover, much of this tonnage comes to the Niagara mill through EMJ and its many competitors. So Niagara determined it is better to sell through the metal distribution channel and avoid concessions on price that are part and parcel of an exclusivity agreement.

“If EMJ doesn’t have [the business], someone else does,” Sinclair adds.

CAN’T SEE DOWN THE ROAD

There is some sharing of demand forecasts for orders that involve long lead times. Tibor, for example, receives detailed projections from its OEM customers that require less common alloys that, in turn, require long lead times at the mills. These projections are then shared with EMJ for planning purposes.

OEM customers provide full-year forecasts of the materials they will need and when they’ll need them, says Lindemulder, who joined Tibor 28 years ago after leaving high school. These long-term forecasts turn out to be fairly accurate over the course of a year, but the due dates and quantities change weekly. “The five- to 10-day window gets nerve-wracking,” he says.

Several times a month, orders are canceled or postponed. Those changes represent only a small percentage of the approximately 100,000 pounds of metal Tibor receives each month from EMJ (which, in turn, represents 40% of the metal shipped to Tibor by four suppliers), and can be costly and time-consuming.

Orders with long lead times represent just 8% to 10% of EMJ Schaumburg’s total, says District Manager Paul S. Ioriatti. And they are 20% or less at Niagara LaSalle. Beyond these OEM-provided forecasts, the picture is murky.

One market, such as appliances, may be up, while another, such as housing, may be down, Sinclair says. “You need the whole economy [to ascertain an accurate snapshot of demand], and that’s so diverse.”

Effective supply chains require a level of trust, but information-sharing historically has been absent in metals. EMJ has had problems with various OEM customers at different times not disclosing plans to source a part offshore. Those customers ordered through the domestic pipeline until they were confident about the quality of foreign parts, then abruptly cut off domestic purchases.

The danger, of course, is that a service center such as EMJ gets stuck with inventory of a unique item that can’t be sold to another OEM. In May, the service center was saddled with a “significant amount” of a proprietary grade and size of steel tubing sold through a machine shop and earmarked for an automotive user, Ioriatti says. The OEM, whom Ioriatti declined to identify, didn’t feel legally obligated to take the product. EMJ was likely to discount the product and sell it for a lesser application, or worse, only recover scrap value.

“They should keep us posted,” Ioriatti says, “with an open and honest exchange of information.”

Could EMJ pitch a special partnership, perhaps with an OEM, to pre-empt business from going offshore? “We try to add value every day,” Ioriatti says. But sometimes, a large manufacturer is able to buy a machined part for less than the cost of the raw material. “At times, it can’t be done,” he says.

A LONG PATH 

Transportation is another discipline that could be more efficient. Do mills and service centers, in their quest to shave nickels and dimes off rates for shipping metal, lose sight of larger opportunities for
cost savings?

Many service centers bid one truck run at a time and use as many as 30 different carriers—all in the interest of landing the lowest price per mile. But that can create chaos on a loading dock and add expenses in terms of paperwork alone, says Jim Baber, vice president of TKX Logistics, a subsidiary of ThyssenKrupp Material NA, in Maumee, Ohio, which offers combined transportation, logistics and warehouse services. If a carrier has to find his own load back from a run, or drive an empty truck to another pick-up point, he is likely to charge a higher rate.

If shippers can form partnerships with carriers and commit to certain tonnages, carriers will guarantee prices, Baber says. A service center, for example, could help the carrier with his round trips, maybe even arranging inbound shipments from a mill so the carrier doesn’t have to scramble to find a load for the return.

Brian Yamaguchi, manager of transportation and logistics for EMJ who manages for-hire trucking, acknowledges there are inefficiencies. And while there are benefits to using third-party logistics companies, service centers can lose the autonomy to select the carrier that offers the best service at the best price. EMJ once used a third-party logistics company designated by the corporate office, but Yamaguchi says that company wasn’t always responsive to local concerns and customer service suffered.

EMJ may lose some visibility and control by not designating one manager over all loads, but the goal is to ensure good service over time, even if at times it pays a premium. Centralized coordination of all inbound and outbound shipments theoretically might improve efficiency, but that level of control is rare, expensive to achieve and in practice often just doesn’t work.

“Your job is to keep as many options as possible,” Yamaguchi says. “I need to have enough people quoting against each other—that’s one of the main ways to have leverage. We have to get the metal [to our customer] at a rate so we make money.”

However, he does suggest that the sourcing of trucking increasingly is nuanced and based on relationships. For example, understanding the location of trucking company hubs can enable a shipper to make intelligent decisions.

“If you can locate a carrier with terminals in the region to which you are shipping, it may be easier for that trucker to take a load,” he says.

Dan Taylor, vice president for sales and marketing at Tulsa, Oklahoma-based Melton Truck Lines Inc., one of EMJ’s largest carriers, says shippers probably could reduce the number of carriers they use in the interest of efficiency. But he says a large carrier like Melton is often in a better position than most shippers to match inbound and outbound loads because it has large numbers of trucks serving many customers in big markets like Chicago and Dallas.

“We may have 25 to 40 trucks going into Chicago on any given day, and based on our customer load history within the area, I know we can get a load [out] for every truck we send in,” Taylor says.

ROOM FOR IMPROVEMENT

It may take a turn in the economy to compel changes in the metals supply chain. Sales and earnings have been strong, but the pressures of globalization are mounting. With growing competition from overseas, more companies may see advantages in sharing better information to minimize the highs and lows in inventory swings. It may take driving financial necessity or a major player with the power to transform the industry before significant change happens. “You need a big player to say, ‘I’m going to streamline it,’” Kouvelis says.

Executives along the metals supply chain say there is room for improvement, but the changes they see are incremental rather than sweeping: better forecasts from the OEMs, shorter lead times at the mills. (Although not too good and too short, Travetto says, or more producers will work directly with large end users and cut out service centers.)

But more importantly, executives at EMJ don’t expect the steel industry to embrace a model closer to Wal-Mart because demand for steel is variable and changes rapidly, as compared to the more predictable consumption of consumer goods.

“The same guy eats a Snickers bar every day at 2:30,” Travetto says. “Steel is never like a Snickers bar.”