This is a follow-up post covering China’s steel industry
Compared to the rest of the world, China’s steel industry is dreadfully fragmented, the top four mills took just 23.9% of the market compared to 60% in the European Union and 80% in Japan, S Korea and the USA. China’s steel industry suffers from this fragmentation in many ways.Ã‚Â Here are just a few examples of the problems they have identified in a report by www.steelhome.cn/en:
- A fragmented structure means mills tend to invest blindly in market segments without the opportunity to coordinate with other producers. Consequently the market suffers from over investment in some sectors and occasionally under investment in others. Investment can be wasteful and sub optimized
- In addition when the market is in contraction or even when production exceeds consumption a small number of large mills are better able to react to over supply by cutting production and maintaining a market balance. US mills are doing this very capably at the moment and although none of them like operating at 60-70% capacity they know it is better to make a margin on ever reduced ton of steel than to make a loss on full production
- The larger the mill group the easier it is to access funding and technology. Larger producers tend to be able to borrow more cheaply and to invest more often in the latest technology making them more competitive in the longer term
- Although market collusion is against the law and there are strict rules against the formation of cartels, the reality is if a few large producers dominate a market it is easier for them to act in tandem even if they are not actually talking to each other. This reduces competitive pressures and allows a more orderly marketplace at least for the producers
So if all or even some of the above holds true why haven’t China’s steel producers formed into larger firms by mergers and acquisitions as they have done in OECD markets? Well broadly the reasons fall into two challenges the Chinese market faces. The first is the strength of regional or local governments that consider their state steel plants to be local champions. Local governments derive many benefits from their local producers and would not want to lose that income to a neighboring state. Apart from a six month period after the start of the financial crisis, Chinese mills have been making a lot of money. When enterprises are strongly profitable there is less incentive to sell out to a competitor, nor are enough of the shares of enough of the small to medium mills on stock exchanges where a hostile takeover is a viable options. Consequentially shareholders prefer to hold onto their assets and continue to take their profits a sharp downturn may change that thinking, an eventuality some think we will see in the early part of this decade.