12/21/2011 — Steel prices have fluctuated wildly since the downturn of 2008 and no link in the supply chain has suffered more as a result than distributors. That’s why the organizers of last month’s CRU North American Steel Conference in Chicago summoned three service center operators to share their views on the best way to manage steel distribution through the ups and downs of the market.
Panelists John Sunderman, president of Owen Industries, Omaha, Neb.; Jeremy Flack, founder of newly formed Flack Steel, Cleveland; and Mike Taylor, president of Minneapolis-based Cargill Industries, delivered different perspectives on how steel distributors should cope with price volatility.
To Sunderman, handling the inherent volatility starts with proper inventory management. And that, he said, “starts with the customer.” Such an approach is founded on intensive communications with customers to get the most complete picture of their demand expectations. It begins with picking the right customers in the first place.
“We find a certain type of customer who will give us good inventory turns. They tend to be some of the most demanding customers, those who demand high-quality, on-time products. It places us in a position, once we reach that expectation, that we’re in with that customer for a long time,” Sunderman said.
The next step is to incorporate standardized tools into the operation. His company is ISO certified, but also has met the difficult nuclear accreditation standard NQA1. Though demanding, achieving such a designation requires inventory management techniques that pay off in the long run.
“It has made us a much better company, having to set up some fairly rigorous tracking mechanisms. To do nuclear work, you have to have 100 percent material traceability,” he said. “The byproduct of that is we know where our inventory is more than any company we compete with at any given time. If you ever lose that traceability, you cannot use it on a project and the material becomes scrap.” Other tools used by Owen Industries include SAP software and a comprehensive nomenclature system that ensures every product throughout its divisions and branches has the same name.
The third step is to prioritize inventory management throughout the company, he continued. Incentive programs based on inventory turns, an emphasis on profitability and other controls ensure that all employees are dedicated to the task of getting the maximum benefit out of the material.
The company also employs a variable purchasing strategy that spreads the risk. Its mix of buys typically includes about 30 percent based on index agreements with the mills, 30 percent spot market, 20 percent purchased through mutually inclusive index agreements with customers and mills, 5 percent purchased through customer programs featuring specific pricing, and 15 percent through other warehouses.
“We never used to buy from our competitors. Now we buy from them all the time, and they buy from us,” Sunderman said.Jeremy Flack, president and founder of Flack Steel, offered an entirely different approach to managing through volatility. Flack encourages his customers to look for inflection points in the steel market and make educated buys based on that information.
He points to four tenets that help determine where the price of steel is headed. It starts with the relationship between the cost to make the product and the price at which the material is being offered.
“If the price for steel is way over the cost to make steel, this is where we look for a potential peak to be setting itself up in the market,” he said. “The reverse is what we’re looking at today. If cost and price are converging, the floor is setting up, and you can feel comfortable getting into the market so you don’t get left behind on the way up.”
Another industry trend worth following, Flack said, is the state of imports and exports, and specifically the export floor. Customers need to consider what price mills could move tons out of the market to shore up their order books.
Third, he urges buyers to look at “money chasing value.” He noted: “When I saw the hot-band price go $260 to $270 above China’s, that was a really good indicator our market was going to crash.”
Finally, he said, there’s a difference between apparent demand and real demand. “If you spend a lot of time with apparent demand above real demand, you’re set up for a fall. If apparent demand is less than real demand, you’re set up for a market to rally.
“This is how we look for inflection points in our company. We try to smooth out our buys so we don’t get caught on either side,” he added.On the other hand, Flack advises against paying too much attention to the past. “History does not seem to be a good indicator of future steel prices.”
Besides being one of the nation’s largest service center companies, Cargill is also involved in numerous other businesses, including financial services. That combination is one reason Cargill is comfortable using a price risk tool that many others eschew—dealing in derivatives, said Taylor, the third panelist.
There are limited options for a company that wants to lock in its steel pricing for the longer-term—a fixed-price contract with the mill, a floating-priced contract attached to an index or hedging.
As for the first option, he asked, “How many people have one of those?” Mills can’t guarantee a fixed price because their input costs are so volatile.
Forward contracts indexed to some variable work well in theory, he said, but not always in the real world. If the price drops sharply, buyers are reluctant to accept material on contract when they could buy it on the spot market for less. “That’s not a criticism, that’s a reality of the market,” Taylor said.
That leaves hedging, which is a tool each member of the supply chain should consider, Taylor said. The premise behind hedging is not to make money, but to remove risk. “The way we look at it, if we look forward and see a time when we’re not certain we want to open ourselves to risk and margin, these are times we put varying degrees of hedging into our inventory,” he said.