May 1, 2006

Blurring The Lines

As service centers add more value to the metal they handle, the traditional distinctions between distributors and fabricators are becoming less clear. The question is, are service centers well-suited to be true manufacturing sites?

At Chicago Tube & Iron’s new 400,000-square-foot service center in Romeoville, Illinois, a worker bends and welds carbon and stainless steel pipe that will be used as brake lines for rail cars at Union Tank Car Co. At a nearby station, an operator enters numerical codes for a laser that will cut 6-inch-diameter holes on carbon tubing, which will serve as the base on Deere & Co tractors.

The push toward fabrication has taken Chicago Tube a long way from its service center roots. Early stage processing now represents about half of the company’s $200 million in revenue. That share is up from 20% of sales in 2000 and 5% in 1990.

“The economy is not going to allow you to profit from breaking bundles,” says Donald R. McNeeley, Chicago Tube president and chief operating officer.

Chicago Tube isn’t alone. Service centers increasingly look to add more value to the metal they handle and, in the process, blur the traditional lines between distributors and fabricators. And it’s not just mid-sized companies like Chicago Tube. Smaller shops, such as Rolling Meadows, Illinois-based The Steel Supply Co., and larger players, such as Chicago’s Ryerson Inc., have followed similar paths.

Driving the trend is the push by original equipment manufacturers to concentrate on assembly and outsource the early stage fabrication to companies that can do it more efficiently and deliver the parts on a just-in-time schedule.

“If you’re a Caterpillar, you’ll see this as an opportunity to reduce the amount of processing done in-house,” says Tony Taccone, partner at Pittsburgh steel consultant First River.

For service centers, first-stage fabrication offers a chance to differentiate themselves. Adding value commands a higher price and boosts the profit margin. Eliminating a step in the supply chain adds to efficiency and reduces costs. Service centers enjoy a lower-cost structure in that they aren’t burdened with the legacy costs that dog older manufacturers.

Yet to a large extent, service centers are only scratching the surface, and it’s unclear whether they are ready to step into manufacturing with a capital M. If first-stage manufacturing has become a service center staple, can second-stage assemblies ever be in the future?

“In the spectrum of complexity, they are still doing the simple chores,” says Robert McCutcheon, partner for U.S. metals at PricewaterhouseCoopers in Pittsburgh. Service centers are mostly reacting to customers, not thinking of ways to supply more complex future needs. They usually lack research and development and engineering capability—functions that are better funded at the OEM and producer levels.

“At the end of the day, if you truly want to take on a manufacturing culture, you have to develop your own technology,” McCutcheon says.

In that realm is a steep learning curve and a lot of pitfalls. Managers either must find skilled machinists or retrain their own employees. Employees must learn the culture and language of manufacturing, without losing the principles of the distribution business.

Industry consultant Michael E. Workman, a College Station, Texas-based distribution industry consultant and former professor at Texas A&M University, says that the amount of contract manufacturing can expand quickly, overtake distribution in revenue terms and become the tail that wags the dog. That’s a common scenario that service centers must learn to navigate.

There is an inherent risk in setting up an assembly operation for a single customer—it’s preferable to produce less specific parts for more users if possible, he says.

There’s also a chance that manufacturers will continually increase their demands, asking that service centers invest in more expensive equipment. Meanwhile, the service centers may be so focused on winning the business that they don’t price it to earn an adequate profit.

“Pricing can go out window, and that can make you vulnerable if you don’t have the right metrics,” Workman says.


The trend could threaten smaller fabricators, who do the same welding, cutting and machining that service centers now perform. Distributors are quick to assert, however, that they don’t want to compete directly with their own customers. For example, they may perform jobs that fabricators lack the machinery to handle.

“We try to bring more business than take away,” says James M. Delaney, president of the customer solutions team at Ryerson. “The customer makes the call.”

In other cases, the fabricator handles specialized work that a service center is unlikely to touch. For example, Southern New Jersey Steel Co., of Vineland, New Jersey, forms stairs, railings and columns from structural steel and doesn’t see service centers as competition, says President Hugh McCaffrey. In fact, distributors can help by delivering different items cut to length and in sequence, which helps his company operate more efficiently and, ultimately, land more business.

But the trend has the potential to eat into the sales of small fabricators who don’t have the capital to invest in equipment—a laser can cost more than $1 million. And service centers hold a cost advantage in that they’re buying large quantities of metal.

“If you’re purely a fabricator and sell to OEMs, you would see [service center] investment as an encroachment and direct competition,” Taccone says. Much depends on the product line and whether there’s a lot of competition in a particular geographic area.

At Chicago Tube, McNeeley says the service center doesn’t compete directly with fabricators, who represent 25% of his customers. Instead, the company works directly with its OEM customers to determine where the holes are and identify where Chicago Tube can do the job more cost-effectively and manage the inventory.

“Few can do laser cutting; it’s a specialized niche,” says Chicago Tube General Manager Bruce Butterfield.

But managers at Chicago Tube admit it is a formidable challenge to move a traditional distribution company toward manufacturing, which required substantial retraining. Not all employees embraced the change, McNeeley says, but management can make the most of the inevitable attrition to upgrade the skill set of the workforce.


Chicago Tube’s roots are in fabrication. In the decades after its start in 1914, the company employed trained artisans who bent tubing that was sold to commercial boilermakers, who were largely based in the Midwest. But the boilermaking industry migrated south in the 1970s, and the company was faced with attrition of its customer base.

Butterfield recalls that in 1988 the company was unable to land a new job because it didn’t have welding capability, and he vowed, “I’m going to do something about this.” Chicago Tube started small as it hired a single welder and invested in a welding machine. The company subsequently received American Society of Mechanical Engineers certification to weld pressure parts for the power boiler industry. Three years later, the company received an additional certification to handle redesign for the utility industry. It now employs 15 welders.

At the same time, changing market conditions underscored the need for a shift. Steel was more of a global commodity, and Chicago Tube was facing competition from domestic competitors who had access to cheaper foreign steel.

“How could Chicago Tube meet the price that was demanded by Deere, its longtime customer?” McNeeley asks. “I would have to grow four-fold to buy enough foreign steel to compete with major national distributors. But how do you do that in a mature industry?”

Chicago Tube got its first referrals for international fabrication work through board members who had global contacts. One involved work on a nuclear power plant in Korea. The other was a Patriot missile support strut project in the Middle East, McNeeley says.

It also built on its niche in the power boiler industry by expanding bending equipment and adding welding expertise, Butterfield says.


But the biggest investment came in the past several years with laser cutters—one in 2004 and the other in 2005. The laser equipment has opened new doors. One of the first jobs involved cutting columns for .50-caliber machine-gun mounts manufactured by Nashville-based Sabre Defence Industries LLC for the makers of military vehicles. It was the start of the Iraq War, and the customer was under pressure to complete more mounts.

The specifications were tight to meet military requirements, Butterfield says, and there was concern about uniformity. Would all the cuts be identical? “They were up here inspecting part after part,” he recalls. “The 3,000th part was the same as the first.”


Of course, there always is the risk that an OEM customer will decide it has enough volume and buy its own equipment. Distributors like Chicago Tube hope customers won’t want to tie up the space and capital. They hope customers will see that service centers can use this type of equipment most efficiently and serve a number of OEM customers.

In the case of Union Tank Car, Chicago Tube had, in prior years, bid unsuccessfully to supply the steel it needed for its brake lines. But in 2004, it won new fabricating business through a happy confluence of events.

The market had improved, and the OEM wanted to adopt lean manufacturing. Chicago Tube already had the bending capability; it needed only to automate some welding processes to accelerate them.

“We started with approximately 20 parts a week,” Butterfield says. “As they grew, we grew.” Now Chicago Tube cranks out 60 each of brake line and product conveyance parts every week.

The outsourcing is part of Union Tank Car’s effort to accelerate its assembly process. It also has adopted an integrated manufacturing system that involves just-in-time deliveries and tight inventory control.

“Our relationship has allowed Union Tank Car to concentrate on what we do best: build railroad tank cars,” says Tom Cafferata, Kanban/VMI manager at East Chicago, Indiana-based Union Tank Car, a unit of the Marmon Group Inc. The system eliminated unnecessary repetitive paperwork and enabled the company to reduce and keep better tabs on the material on hand. Overproduction was greatly reduced as components were pulled into the production system on an as-needed basis.


Ryerson has offered fabrication for decades, but contracts out to a network of qualified subcontracting job shops for welding, machining and painting, Delaney says. It also supplies North American customers through its 50% joint venture in a sub-assembly and fabrication plant in Matamoros, Mexico.

Ryerson can cut or burn virtually any shape through flame, plasma and laser, but doesn’t own the equipment for other types of fabrication. “Our strategy is not to own every type of processing equipment needed to serve our customers,” Delaney says. “Our core competency is in managing the logistics of the supply chain, not in the [metal] forming itself.”

Fabrication is a critical element at The Steel Supply Company, a distributor with $20 million in sales that specializes in tubing and shafting used in hydraulic cylinders, water chilling units, furnaces and other heavy equipment.

For example, a computer numerical control (CNC) lathe produces a threaded, chrome-plated shaft for use in a hydraulic cylinder for forklift trucks by Iowa-based Shaver Manufacturing Co. An affiliate company of Steel Supply performs the plating.

Meanwhile, a CNC vertical milling machine cuts a key slot into a carbon bar that already has been ground to a close tolerance. The piece, after it is finished on a separate polishing machine of the company’s own design, will be shipped to Minneapolis-based McQuay International Corp., which produces chillers, air conditioners and ventilating equipment.

Machined products represent 25% of sales, says David Sheer, vice president and general manager. Adding value has enabled the company to expand its customer base and has added 5% to 10% profitability.

“Value-added is the future of service centers,” Sheer says.