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Service Centers Can Add Value Through Smarter Purchasing: Fehr

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When service center operators talk about adding value, they are usually referring to the processing of metal on their shop floor. Yet there are ways for service centers to add value to each transaction long before that, during the purchasing process, says Gary Fehr, a longtime service center executive who spoke at CRU’s North American Steel Conference in Chicago last month. The consultant and former executive for Ryerson discussed how buyers for service centers can better use their purchasing power to capture value for their organizations.

Most buyers go into negotiations looking for four factors: best price, best delivery, best quality and best customer service. That is the wrong approach, Fehr insists. Instead, they should consider the general economic climate and specific conditions in each market. Once they have ascertained what suppliers are generally offering, they can make an informed judgment on what they can likely negotiate.

To determine what the purchasing department should be negotiating for requires an understanding of the service center’s basic operational strategies, Fehr explains. For example, a company that is cash flush may choose to negotiate for discounted early-payment terms, while a cash-strapped company is better off negotiating for extended terms.

“It doesn’t make a lot of sense to get an attractive discount rate if the company will never use it,” he notes. “Getting a concession on a program that doesn’t support an internal strategy is worthless.”

Likewise, a company’s philosophy on carrying inventory should factor into the negotiating strategy. If a service center is comfortable keeping large tonnages on the floor, the buyer may want to negotiate for bigger quantity discounts. In contrast, if the service center prizes inventory turns yet also promises customers quick deliveries, buyers should look for suppliers with short lead-time or consignment programs or lower mill minimums.

“You can’t negotiate in isolation. You’re often wasting your time negotiating for something that has no value for your organization, or in some cases is counterproductive to the core strategies,” Fehr says. “Purchasing needs to understand exactly what every department’s needs are as far as a material buy.”

Of course, price remains an integral part of every negotiation. But as with other elements, the pricing option also should reflect the company’s strategies. A risk-averse distributor may look to hedge, while a risk taker may hope to benefit from the price trend. “If you don’t mind price movement, but want to limit the frequency or timing, then maybe index-based pricing can provide you with a kind of predictability,” Fehr says.

Unfortunately, he argues, many negotiations stop at price and don’t include other variables. Many service centers are missing out on opportunities readily offered by the mills. For example, assistance in training personnel, technical support, product literature with the service center’s logo, mill stock programs, extended claim periods and product performance guarantees may be available simply by asking. “If any of these might create value for your organization, and you’re not asking for them, you’re not using the full advantage of your purchasing leverage and not maximizing your negotiations,” Fehr says.

But the purchasing agent can’t be expected to maximize the negotiation process alone. Fehr has identified several steps that a service center should take to accomplish what he calls “a strategic supplier selection process.”

It starts with choosing the product categories for which the process makes sense. Not every item a service center carries is a good fit. It should only be applied to those products that represent a significant percentage of a buy and where numerous potential suppliers are available.

From there, service centers should form product teams, bringing together representatives from various departments, plus a member of senior management. “The teams’ first step is to identify negotiable issues. What’s critical? What should you negotiate for and your targeted end result? The team has to thoroughly understand the operational strategies to do that,” Fehr notes.

Based on those decisions, Fehr recommends creating a questionnaire to solicit feedback from mills on the specific areas the service center has identified as important. One of Fehr’s clients uses a 65-question form to vet out potential suppliers. Once the responses have been tabulated, the most desirable candidates can be called in for negotiations. The result of those negotiations becomes a working document, a memorandum of understanding between the service centers and its preferred supplier that provides accountability going forward.

“It does require you to manage the process for the length of the agreement,” Fehr says. “You want to place as many tons as possible with those suppliers you’ve identified as creating value for your organization.”

The entire process takes 3-4 months, he estimates.
Rather than being scared off, most mills welcome the opportunity to participate, particularly during periods of slower demand. “In many cases what you’re looking for doesn’t change the price, it doesn’t change their commercial strategy. It may create no costs for them at all. And at a time of market weakness, you’re committing to specific tons from that supplier.”

Dey: Steel Lags Other Industries in Adding Value
Like service centers, steel producers also have a long history of leaving dollars behind, says Saikat Dey, CEO of Severstal North America, who also spoke at the CRU conference. He told attendees to draw inspiration and knowledge from companies outside the steel industry to create more value inside it.
He cited a study from Value Line that tracked the Economic Value Added by various commodity industries from 2006-11. While the chemical and petroleum industries were able to add 6.5 percent more value to their products annually, the steel industry was in the “fifth quartile,” generating negative 0.2 percent over that time period. “Even if it operated at an average EVA level (3.6 percent) like other capital-intensive commodity industries, it would have unlocked $15 billion in value that was left on the table,” Dey says.

Part of the steel industry’s problem is its reliance on generating most of its value during the up cycles. Since 2003, more than 60 percent of the value within the industry was created during the 30 months that were part of upturns. The situation was even more dramatic among the integrated producers, which generated more than 100 percent of their value during those 30 months. “Integrated mills only create value during spikes. For the rest of the period they lose money,” he says.

Steel producers tend to put too much focus on the area of the business that often creates the least amount of value—the operating rate. While operational efficiency certainly is important, it’s not the end of the story. “One big scrap deal or one big pig iron deal is enough to overcome the gains or losses in operations,” Dey notes.

His own company is a textbook example. No amount of operational excellence could overcome the “colossal mistake” that was Severstal’s acquisition of the now-defunct RG Steel, a $3 billion purchase that was sold 18 months later for a fraction of that total. The purchase of those assets was consistent with the industry’s tendency to spend lavishly during flush times, then shut off the tap entirely when the market softens.
“If you only have $1 to spend, spend $1 every year. Don’t spend $4 every four years, because that’s what everyone else is doing. Good assets are always available, especially at the bottom of the cycle,” Dey adds.

Steelmakers should be more like ExxonMobil, he says, which has expertly navigated the wild swings in petroleum prices by sticking to its core strategy of steady investment, resulting in a much higher return on capital employed.

There are three archetypes that generate value: non-conformers, shapers and timers, Dey says. Non-conformers, such as ExxonMobil, can make money regardless of the cycle by taking a disciplined approach to investment and maintaining a consistently strong balance sheet. Shapers are those companies that command such a big market share they can shape the price cycle through capacity and market leadership. Timers are those that believe they can beat the rest of the market by riding the waves up and down.

Timing the market may work for a short time, but it is not a sustainable strategy for long-term health, Dey says. “At some point you have to move on and try something else.”