Consultants advise leaders in all U.S. industries to study China’s agenda, leadership and business practices to better compete against the growing global giant.

By Dan Markham,
Senior Editor

Sidebars and Tables:

• Chinese Overcapacity Cause for Sleeplessness
• Reliance Follows Customers Into China
  

Metals executives competing in the global economy will probably never need to become fluent in Mandarin. But advocates and analysts are certain that all industry leaders need to study Chinese.

“The fundamental challenge (to all North American steel industry leaders) is understanding China’s economic strategy, and then addressing this strategy in an effective way. All of the specific China trade issues should be viewed within this context,” says Andrew G. Sharkey, president and chief executive officer of the American Iron and Steel Institute.

Sharkey describes China’s strategy as an aggressive expansion of its fixed asset base designed in part to grow its steel-making capacity. Additionally, he says, China is interested in controlling raw materials, such as coking coal, oil and other inputs.

The AISI is among several U.S. organizations supporting legislative action to address concerns about China’s steel policies. Those actions include convincing China to float its currency, applying countervailing duties to subsidized Chinese imports, and establishing a new Security and Prosperity Partnership work group charged with developing a better understanding of China’s economic strategy.

China’s currency has been one of the most talked-about topics among analysts and executives in every industry, particularly in the final days of 2005.

In a November report, U.S. Treasury Secretary John W. Snow said the Chinese government remains too slow in developing a market-based exchange rate, but he stopped short of calling China a currency manipulator. Earlier this year, to mollify critics, the Chinese government made a small, 2 percent adjustment in the value of the yuan and said it will allow market forces to influence its currency within a limited range.

Organizations, such as the China Currency Coalition, an affiliation of North American manufacturers and labor groups, were quick to criticize the administration for its weak stance. “It is incredibly frustrating, given that it appears the administration recognizes China does in fact manipulate its currency. Yet they continue to issue warnings rather than take action,” says China Currency Coalition spokesman David A. Hartquist.

Critics got support for their case in December when the government released figures showing a $69 billion U.S. trade deficit in October, including a $20 billion deficit with China. By the time end-of-year figures are in, the trade deficit with China is expected to top $200 billion.

Sharkey hopes these numbers will lead to some action in Washington. “My sense is if the administration is not successful within a reasonable period of time, in terms of getting the Chinese currency to revalue, then congressional action is almost certain,” he says.

One analyst says the North American steel industry should be careful what it wishes for. If China’s currency is revalued, says Chuck Bradford of Bradford Research in New York, it will reduce the costs of the imported oil and other raw materials that China needs to make steel. “Their consumption would increase and our prices would go up. It’s not to our benefit,” he says.

Despite being constrained by raw material supply, analysts believe China’s long-term goal is to become a global exporter of steel. China was a net importer of steel in 2005 despite an acknowledged excess capacity estimated at nearly 100 million tons.

Sharkey is uncertain whether China will become a major steel exporter in the years to come, though he is confident the global market has already experienced a significant change. “The one thing we do know is China won’t be a huge importer, as they were historically,” he says.

While China’s imports of raw steel outpaced exports last year, its export of finished steel products into the United States grew by almost 40 percent.

“A lot of this excess capacity finds its way over here in the way of steel-containing products,” Sharkey says. “That’s the big worry to the service center side of the business, as they sell to a lot of [domestic] manufacturers who make products made out of steel. We see some finished products coming into the North American region at or below the cost of the raw material.”

“China is a concern for me, not so much on shipping cheap steel into the United States, but in supporting Chinese manufacturers shipping in cheap finished products,” says Bud Siegel, president of Mississauga, Ontario-based Russel Metals. Exporting more finished steel parts is a way for the Chinese to circumvent U.S. trade actions on steel imports, he adds. “If China’s going to be a concern on steel, that’s the vehicle they will use.”

Know thine enemy
Even analysts who see opportunities for North American suppliers and service centers in China agree that studying the country is imperative for long-term success.

“It is absolutely vital for every business executive in almost every multinational industry to pay attention to what China’s leadership is doing,” says Michael Colopy of International Commerce Consultants.

“What’s important is to look at the agenda of the Chinese leadership and deduce from that what China’s needs and demands are going to be,” says Colopy, a foreign policy analyst with a 25-year specialty in China.

Colopy says the Chinese leadership that came into power in 2003-04 has a greater emphasis on “strengthening its grip on that very large segment of the country that is in the countryside. That has immediate implications for patterns of state-sponsored construction. It has implications for where centers of commerce and industry will be encouraged to take form. It’s a different agenda from the prior leadership.”

Monitoring this agenda, and where it will lead, provides North American companies the opportunity to make inroads into China. And making inroads, according to consultant Bill Barron, is imperative.

“For every company, if you don’t do anything, (China) is a threat. The key is to do something,” says Barron of KDC & Associates Ltd.

Barron says opportunities exist inside China for North American companies. Entrance can be gained simply by following an existing customer over. That is the strategy Los Angeles-based Reliance Steel & Aluminum Co. is pursuing through its joint venture Reliance Pan Pacific Pte. Ltd. (see opposite page).

Establishing roots in China, either directly or indirectly, can offer a big payoff, Barron says. “It’s such a growth market for just about anything. There are not many economies in the world that grow 9 to 10 percent every year. There are still a billion people that want to move up to the middle class,” he says.

Colopy agrees opportunities are plentiful, but not without a committed effort. “There are opportunities, particularly further inland, for suppliers of everything China needs, if companies are willing to do the spade work to establish the relationships.”

Chinese Overcapacity
Cause for Sleeplessness
The overcapacity of China’s steel industry—and the potential for the Asian giant to flood the market with cheap steel in 2006 and beyond—keeps steel executives awake at night all over the globe.

“China remains a wildcard in the steel industry,” Nucor Vice Chairman, President and CEO Daniel DiMicco told investors during a recent third-quarter conference call. “It’s a situation unique to China because of the massive amount of capacity they’ve built in that country. There is probably an excess of 100 million tons of very inefficient, antiquated steel production in China,” he said, which even the Chinese would like to see eliminated because of its very uneconomical use of raw materials.

In July 2005, China’s National Development and Reform Commission released a China Steel Industry Policy statement that offered suggestions for the development of the industry, which included rationalization of obsolete capacity. Mittal Steel President and CFO Aditya Mittal considers that a hopeful sign.

Speaking at the recent World Steel Dynamics/Metal Bulletin Steel Success Strategies Europe Conference in London, Mittal said the Chinese steel industry must consolidate in order for the global steel industry to become truly sustainable and create value over the longer term. “The Chinese government is definitely aware of the problems that fragmentation is bringing. They have said that by 2010 they would like the Top 10 producers to comprise 50 percent of total market share, rising to 70 percent by 2020. This would definitely help the sustainability of the industry, not just in China but globally,” he said.

To some observers, the China commission’s policy statement provided evidence that the Chinese government is actively subsidizing its industry in violation of global trade rules.

Andrew G. Starkey, president and CEO of AISI, called the policy “an extraordinary example of government intervention/non-market behavior.”
In response to the China Steel Policy, the NAFTA Steel Institute released a statement claiming, “the bottom line of this policy is that it ignores market-based principles and keeps the Chinese government in the steel business.”

It cites three recommendations within the report as evidence of the Chinese government’s open declaration of subsidization:

• “The state will provide tax support, interest subsidization support, scientific research funding support and other policy support to key steel projects constructed in reliance of new domestically developed installations.”
  
• “The state provides export credit support to encourage steel manufacturing and equipment manufacturing enterprises to export domestic superior technologies….”
  
• NAFTA also claims the policy states that with respect to new projects of ironmaking, steelmaking and steel rolling, the enterprise at issue need only provide “more than 40 percent” of necessary investment capital, opening the possibility the remainder would be supplied by government funds.
  

One analyst believes the Chinese government’s efforts to shutter the least efficient, most-polluting mills in advance of the 2008 Olympics has had minimal, if any, impact to date. Chuck Bradford of Bradford Research says the country has targeted the smallest mills, many which rely on antiquated technology, for closure. But the effort has had an unintended consequence, as many of those smaller mills have upped production in the meantime, he says.

“So far what I have seen has not worked. I don’t see any signs that production has been reduced,” Bradford says.

But consolidation is a worthy endeavor, Mittal believes, just as it was for the industries in North America and Europe. Consolidation there led to the unprecedented condition in which value was sustained in an oversupply environment by temporarily reducing production. The same is not true in China’s fragmented market, Mittal says.

“Unlike in North America, we have yet to see a price recovery in China, and this is because the Chinese companies are still very much production-focused.”

Reliance Follows Customers Into China
Reliance Steel & Aluminum Co. was one of the first North American service centers to establish a presence inside China this fall with the creation of a Far Eastern joint venture. Reliance and two associated Singapore companies combined to form Reliance Pan Pacific Pte. Ltd., with Reliance owning 70 percent of the enterprise. One of the venture’s first efforts will be the purchase of Everest Metals Co. Ltd., a small Chinese service center.

“For us, the attraction is we have customers here in the States that are building or planning to build facilities in the area in China where we have gone. In order to continue to support them with processing and metal, we thought it would be a good idea to follow them to China,” says David H. Hannah, president of Los Angeles-based Reliance.

Bill Barron, a consultant for KDC & Associates Ltd. of Barrington, Ill., supports such a strategy.

“If you are selling to an American company that’s building over there, you just follow them. They will buy from you over there because you’re a current supplier over here,” Barron says. “That’s how the electronics industry moved over there. If you were a component supplier to these companies, you were already qualified.”

The service center to be purchased by Reliance Pan Pacific fits that category. It’s not a full-line service center, Hannah says, but a specialty business that processes aluminum for the electronics industry.

Hannah’s company will provide its customer contacts and expertise to the existing Chinese facility in the area where his customers are relocating operations.

“We will continue to look for additional business opportunities over there. It’s not going to be a shotgun approach. It will be more of a rifle approach where we concentrate on the specialty products we have some knowledge of from our business here.”

Hannah is not certain if Reliance’s entrance into China will cause others to follow suit. “I’m not aware of anyone else that has established or is in the process of establishing companies over there,” Hannah says. “I would suspect if there’s opportunity, others would find it as well.”