November 1, 2006

Distribution, Euro Style

Producers find owning their own service centers puts them close to customers and protects their market share.

Speculation that the U.S. steel industry could once again integrate producers and service centers has sparked renewed interest in the European model.

The European market is two-thirds controlled by mill-owned distributors who say the system works well in part because it puts them close to customers and enables them to forecast demand better and protect market share.

The high degree of concentration in the European market doesn’t necessarily mean that customers are better served. Captive distribution arms either operate in lockstep with their mill parent—a strategy almost certain to alienate many customers—or they strive for operational independence, which negates many of the benefits that the Europeans say they now enjoy. What’s more, captive service centers must compete for capital with other corporate divisions in an environment where production and sale of the company’s own products holds sway.

Still, European steel producers are convinced that the advantages of controlling their own distribution networks far outweigh any downside, and some have invested or are gearing up to further invest in their service centers.

Steel giant Mittal Steel Group, headquartered in Rotterdam, said that one of the reasons it sought to merge with Luxembourg’s Arcelor SA was the company’s well-developed distribution network. In clearing the deal, the European Commission, the European Union’s executive body, noted that the merged company wouldn’t hold a dominant position since Mittal has little presence in steel distribution. Finnish steel producer Outokumpu has stepped up its investment in distribution networks, while London-based Corus Group plc also has indicated that it will continue to invest funds into its own.

Independent service centers control only one-third of the metal distributed in Europe, or 60 million metric tons a year. While their market share is steady, their ranks are thinning, says Jurgen Nusser, vice president of Eurometal, a federation of European steel, tube and metal distributors. Most—with the exception of Germany’s Kloeckner & Co—are small and operate regionally, very much like their North American counterparts.



The European model is the result of history and strategy. For the past 40 years or so, European steel producers have operated their own centers to increase profits and ensure a steady supply of steel to their customers.

Service centers weren’t as important decades ago, when the steel industries of most European countries were dominated by state-owned companies that commanded high domestic market shares and close links with large national manufacturers, such as car companies and shipbuilders.

But as steel mills either closed or reduced processing to concentrate on bulk production, independent distributors played a critical role for such jobs as slitting and cutting to length, as was the case in the United States.

By the late 1980s, mills realized that their strong market shares were threatened by independent service centers free to buy from any competitor. Furthermore, international trade in steel was expanding quickly, and service centers were an ideal vehicle for importers to penetrate markets, as they do now. Consequently, steel mills started to acquire independent service centers for defensive reasons—not only to protect market share, but also to participate in profits generated from the sale of imported products and fees charged for value-added processing services.

For example, distribution is profitable for Corus Group plc of London, U.K. The company’s distribution and building systems division last year posted an operating profit of $79.2 million on sales of $5.4 billion and EBITDA margin of 2%. Corus has captured the attention of India’s Tata Steel Ltd., which last month acknowledged it is considering an offer for the Anglo-Dutch steelmaker.

Whether service centers should be independent or owned by mills doesn’t seem to be a concern among several steel buyers surveyed, who declined to be quoted but say purchasing decisions are driven by price and convenience rather than ownership.


The close customer relationship that results from tighter control of distribution is one reason European mills choose to invest rather than divest.

Aad van der Velden, a former executive director at Dutch steel firm Koninklijke Hoogovens—and subsequently Corus, the merger of British Steel plc with Hoogovens in 1999—says by controlling production and distribution, steel mills have a more accurate indication of the different steel grades needed by end users, the amounts needed and the deadlines.

“They can explore opportunities to cross-sell other downstream services, such as cutting and stockholding,” he says. “This enables European mills to cater more readily to smaller customers or more niche, specific product needs.”

Van der Velden also says that the European model allows more opportunities for mills to make money from downstream operations, such as cutting, slitting and holding inventory. “By owning their own distribution centers, European mills can more easily cope and exploit opportunities to produce a wider variety of steel grades and products to suit particular individual customers or markets,” he says.

For example, Hoogovens in the mid-1990s had lengthy discussions with French car manufacturer Renault during the engineering of its Mégane car (launched in 1995) about what specific steel grades the automotive group needed for each part of the vehicle. “We were commissioned to produce every component that had a steel requirement for the cars, even if the requirements were very specialized and niche. Because the order was so large, it meant that the contract—which was given to the service center rather than the mill—was profitable,” he says.

Philippe Darmayan, executive vice president in charge of Arcelor Steel Solutions and Services, interviewed before Arcelor’s merger with Mittal Steel Co. was completed, agreed that by owning its own distribution centers, Arcelor was able to develop closer relationships with all types of customers, including smaller manufacturers.

Darmayan says Arcelor, which operated 200 centers in 30 countries, sold almost 25% of its 2005 steel production of 46 million metric tons through its own service center network, and another quarter through independents. He says Arcelor had planned to expand its distribution business and invest throughout Europe and other markets. The company was expanding its distribution network in Germany and Eastern Europe and recently invested in a greenfield distribution center in Slovakia.

If mills are not able to produce all the steel grades required by their distribution service centers, they simply buy them from another mill. Darmayan says Arcelor’s approach to its service center network was flexible. “If a rival steel producer is producing more steel grades at better quality, at cheaper prices and closer to our customers, then there is no argument—we will definitely buy steel from that mill to supply to our customers,” he said in June.

Nusser of Eurometal says mill-owned distributors sell approximately 120 million metric tons of steel per year, accounting for two-thirds of the steel sold through distributors, sourcing mostly from parent mills but also from rival mills and imports. Independents source from European mills and imports.

Eurometal research shows that there are about 3,000 independent distribution centers in Europe, although only around 20 of them have a cross-border presence. Eurometal says just four companies control two-thirds of the steel distribution volume in Europe: mill-tied distributors ThyssenKrupp AG, Arcelor and Corus, and independent distributor Kloeckner & Co.

While no thorough research has been conducted, Nusser estimates that the number of independent distributors has decreased year-on-year for more than a decade. “The majority are very small and only operate in local, regional markets,” he says. “There are very few that have any kind of significant market share.”




Not every European company trumpets integration. Gisbert Rühl, chief financial officer at distributor Kloeckner in Duisburg, Germany, which recently went public, doesn’t see the advantages of European mills consolidating production and distribution. “It takes up significant financial power,” he says. “It is much more important for the mills to integrate upstream into iron ore than downstream into distribution.”

Kloeckner is the largest independent steel distributor in Europe and employs almost 10,000 people at 280 locations in 10 countries. Kloeckner controls about 11% of the market, roughly the same as Corus, but lags Arcelor with around 25% of the market and Thyssen with 20%, estimates from Moody’s Investor Service in Frankfurt, show. Last year, the company reported sales of $6.1 billion.
Rühl says the iron ore value chain from production to distribution is too long. Distribution in other industries is, in most cases, independent, and no mill produces all the steel a distributor sells. The distribution arm of ThyssenKrupp, for instance, sells a maximum 20% of captive steel, he estimates. A Thyssen spokesperson declined comment.

“Besides, steel producers need independent distributors because they can’t cover all regions,” Rühl says, adding that a mill-tied distributor also must buy from other mills because no mill covers the entire range of steel. “We think that European steel producers will move to the U.S. model for these reasons,” he says.

Some producers are looking to sell. Linz, Austria-based VoestAlpine AG is considering a sale of its distribution centers, confirmed spokesman Gerhard Kürner. He says the steel producer is looking for a strategic partner, but doesn’t rule out an outright sale of some of its service centers.

But Eurometal’s Nusser says this doesn’t signal a shift. “We are definitely not moving toward the U.S. model of steel production and distribution. Europe’s largest mills are preparing to invest more funds in their distribution service centers to exploit further market opportunities and grow their market shares,” he says.

For example, steelmaker Outokumpu in April 2004 completed a $10 million processing and distribution center in Sheffield, England. The plant supplies stainless and non-stainless products in the U.K. and Ireland from Outokumpu plants in Finland, Sweden and the company’s three facilities in Sheffield.

The Sheffield site, which replaced a facility in the West Midlands, has invested more than $4 million in processing, polishing and packing equipment, such as the capability to slit stainless-steel coil to close tolerances. Sheffield operates two shifts per day, five days per week, and is a third larger than the old facility.


While the European model seemingly has been successful for mills there, could the U.S. model work as well? An executive from Outokumpu, who declined to be named, says U.S. mills divested their distribution arms to cut costs because their service centers were not being run profitably. “That made sense,” he says. “But mills do not need to divest if the centers work and are efficient and profitable. Why sell? U.S. mills shouldn’t be afraid of changing the way that they operate, as long as these changes serve to improve their bottom line.”

Despite increased competition and consolidation in the steel industry, Duncan Pell, director of commercial coordination for Corus, does not believe European steel producers will divest their centers.

“Steel mills see their own service centers as increasingly important in securing routes to market and giving visibility of supply chain efficiency and customer relationships,” he says. “A well-run service center can be a highly profitable activity in its own right, so the mills win on every count.”