Steel Industry’s Navigating
Its Own Bumpy Route 66

Editor’s note: Consultant Glenn Kidd, former director-market research and analysis at U.S. Steel, offered the following historical ­ perspective on the steel industry at the recent FMA Toll Processors Conference in Orlando, Fla. Kidd can be reached by e-mail at ­ gckidd@nauticom.net.

Route 66, known nostalgically as Main Street America, has oft been romanticized in story, song, TV and film. Last month, the nation’s Mother Road was even the subject of a steel market lecture.

Economist Glenn Kidd, who recently retired from a long career  at U.S. Steel, drew an apt analogy using the evolution of the nation’s interstate highways and the displacement of communities along old Route 66, comparing it to the evolution of the U.S. steel industry, which is similarly bypassing some players and leaving ghost towns where steel towns once thrived.

Bringing some historical context to the subject of steel industry consolidation, Kidd explained how in the middle of the last century construction of the interstate highway system transformed a patchwork of local and regional roads, which wound from community to community, into straight, multi-lane strips of concrete that expedited travel by eliminating stops and bypassing the commercial areas that had grown up along Route 66 and other thoroughfares.

“Route 66 went through every town. Entrepreneurs along the way made a living by providing travelers with food, shelter, gasoline and auto repairs. Main Street America became prosperous. It was a successful business model. But Eisen­ hower’s interstate highway system shook the Route 66 business model to its roots,” Kidd said.

Like the Route 66 model before the advent of the interstates, the steel industry business model of the past century was also highly successful. “We were very good at what we did,” Kidd said, noting that America’s steel industry contributed mightily to winning WWII. “The U.S. industry was the lowest cost producer of steel in the world for half of the 20th century.”

For at least a decade following the war, the U.S. industry had relatively little competition from the countries in Europe and the Far East that were devastated by the war. U.S. steelmakers got complacent, Kidd said. “The American business model is based on competition. Without competition, you get fat and lazy, and you lose some of your edge”

Hit by bitter labor disputes in the late 1950s, which were disruptive to society, steel executives gave in to government pressure and made generous concessions to steelworkers. “They made promises to the union that they really could not keep.”

A few years later, the Kennedy administration was seeking to spark the economy with tax cuts. Concerned about inflation, the government exerted pressure on the steel industry to hold the line on prices. The combination of labor concessions and price restrictions, along with renewed competition from recovering mills in Europe and elsewhere, forced the cash-strapped U.S. industry to curtail R&D, capital spending and necessary maintenance, setting them on the downward spiral that eventually led to the recent shakeout.

“There is a big difference between the American economic view of business and the rest of the world’s,” Kidd noted. “Here we believe that if government is on the side of the consumer, the economy will be best served. In the rest of the world, their formula is to protect business first, because business creates jobs, and people with jobs are happy voters.”

Thus foreign countries’ tax and trade laws are designed to support their domestic industries through national health care systems that cover workers’ medical costs, by promoting exports, helping to finance expansions and funding research and development. It’s no wonder U.S. steel producers complain of an uneven playing field, Kidd said.

Closer to home, the advent of the electric-furnace minimill in the 1970s and 1980s presented the traditional integrated steel producers with an entirely new competitive threat. Employing cheap electricity and scrap, and a partnership with labor based on productivity incentives, this new business model challenged the old-style integrated mills, which struggled to respond.

“Their answer wasn’t that sophisticated—and in my view wasn’t a success strategy—it was withdrawal,” said Kidd. Mills restructured to cut costs, spinning off high-cost operations and pulling out of low-margin markets like rebar. Their divestment of distribution and processing operations contributed to the growth of the independent service center industry as it is today.

Kidd expressed his respect for the early minimill pioneers, who not only took advantage of new melting and casting technology, but also brought new thinking and a new management style to a mature market. To their good fortune, the United States had both a 50-year backlog of scrap and electric utilities willing to offer cheap power rates to attract large users.

“Have you ever asked yourself why there isn’t a vigorous and competitive large-market-share minimill industry anywhere else on the earth? It’s because the environment where they set up this model to be a success was unique to the United States,” Kidd explained. “We’re the largest scrap producer in the world and we have a dynamic and competitive independent power system. You don’t see that anywhere else.”

By the 1980s and 1990s, there was a major imbalance in the market, with old-line integrated mills struggling against imports and a vigorous and expanding minimill industry, eventually leading to the bankruptcies and consolidations that have reshaped the competition.

Today, minimills are feeling the effects of another paradigm shift, this one partly of their own making. Scrap prices have reached new highs in the past two years, and the minimills’ cost structure is now fundamentally changed.

“The scrap market is no different than any other; when there is excess supply and little demand, prices are very cheap. When supply and demand come into balance, price becomes a factor,” Kidd noted. Last year the cost for a ton of scrap peaked around $250, far above the typical $70 to $80 level. Though it has come back down, it may never get back to $70. “The average scrap price is going to stay in those higher ranges because the market has a new paradigm. It will continue to vary, but will keep looking for new highs while future lows will not go as deep as before. We have finally returned to what economists call a state of equilibrium.”

As painful as the process has been, consolidation among steelmakers is fundamentally good for the industry and the economy, Kidd said. “Unfortunately, there are still a lot of assets in the wrong place with the wrong cost model, which just don’t have a future.” Though new mills are being built in other parts of the country, closer to the new concentrations of customers, the old mills will reluctantly but inevitably close—and employees and the surrounding communities will suffer. “Doesn’t that sound like Route 66 all over again?” Kidd asked.

The old steelmaking mentality—to run full out and produce the maximum tonnage regardless of demand—was financially ruinous and aggravated inventory cycles, Kidd continued. The new steelmaking mentality calls for “scalability,” allowing producers to respond quickly to declines in demand and cut back production.

“When demand falls off, you shouldn’t keep making steel. Excess production when people don’t want to buy just drives prices down. If you can’t sell it, don’t make it.”

While electric arc furnaces can be throttled up and down, integrated mills’ blast furnaces are steady-state machines designed to work best at a constant full output. But a company can take a blast furnace off line, noted Kidd. Thus the more furnaces a company controls, the more flexibility it has. “Consolidation accomplishes that. If a steel company used to have five furnaces but now has eight, it gives them the scalability. That allows a company to seek economic equilibrium, managing its business to match production with demand for its products during inevitable economic slowdowns.”

Though minimills can more easily adjust the output of their furnaces, the concept runs counter to their philosophy of paying workers based on productivity. “Cutting production could undermine their basic labor covenant. If management wants to throttle its furnaces back, it has to tell labor it needs to cut wages back. To sell that is a real communications challenge. So far I’ve heard lip service from the minimills, but I have not seen serious scalability at the minimills, because they are afraid of this issue,” Kidd said.

The service center industry is complicit in oversupplying the market and putting pressure on prices, Kidd noted, referring to the current large inventory overhang in the distribution channel. “Service centers have gone so far they have created inventory cycles that just don’t exist in other industries.”

Pointing to a chart showing the large first-quarter gap between supply and demand, he added, “This shows a real lack of professionalism. Inventory shouldn’t see such wild swings; it should be appropriate for business needs. This is speculation, which is very unfortunate because it aggravates the steel industry’s instability.”

So, can Steelville survive the bypass of the highway to its future? “Yes, I think it can,” Kidd concluded. “We are in the early stage of the process. Consolidation is the first step. There’s more to come. Meanwhile, competition will invite new entries with new ideas.”