Nucor Case Analysis Essay Sample
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Nucor Case Analysis Essay Sample
The U.S. steel industry is comprised of three distinct groupings of companies – integrated steelmakers, minimills, and specialty steelmakers. The main difference between them is the stark divide in capacity as well as what they actually manufacture. Integrated firms can produce 107 million tons of steel through reduction of iron ore, and minimills have a capacity of 21 million tons, and these businesses utilize a scrap melting process. Specialty mills have a capacity of 5 million tons, and for the purpose of this analysis, the focus will remain between the first two types of firms.
Integrated firms dominated the industry until the 1960s. This segment was dominated by powerhouse companies such as U.S. Steel and Bethlehem Steel, which mainly competed in the flat sheet segment, which accounted for nearly half of U.S. shipments in 1986. The buying criteria for customers of these firms revolved around price, quality, and dependability (both structure and strength). Integrated firms’ mills were located primarily in the upper-Midwest and Pennsylvania, and prided themselves on staying ahead of the curve in technological prowess, at least through the 1950s. A subsequent decline in performance was actually caused by a failure to keep up technologically, as well as low price and high quality imports. These developments paved the way for the development of minimills. Minimills used electric furnaces to melt scrap into steel, took advantage of improvements in casting technologies, and were thus able to reduce the capital cost per ton of capacity.
Minimills, by pursuing regional strategies of being located within 200-300 miles of their target markets, were able to reduce operational costs through inexpensive electricity, as well as less expensive labor. Also, because of a narrower product line (which decreased the amount of time spent on manufacturing), minimills began to steal market share from integrated firms. Because of increasing prowess in the manufacturing of low-end bars, wire rods, and small structural shapes, minimills claimed sole manufacturing power over those products; however, they were still shut out of flat-rolled products, which were the specialty of integrated firms.
The Nucor that existed in 1986 came from a Ken Iverson’s (CEO) $6 million gamble on the building of a minimill in Darlington, South Carolina in the late 1960s. After Iverson was handed the reigns, he focused much of the company’s then diverse efforts on the manufacturing of steel components. By 1986, Nucor solely competed in steel, and Iverson was named “Best CEO in the Steel Industry.” Iverson was a firm believer in the least levels of management possible to conduct business. Thus, Nucor maintained five levels of hierarchy, whereas most competitors has around twelve; it also empowered its lower level employees by decentralizing all decisions besides major capital expenditures, hiring/firing, and plant organization.
In addition, Nucor also implemented well-paying performance incentives, as well as made many efforts to get rid of noticeable differences in status amongst its employees. For blue-collar workers, Nucor was an enviable environment in which to work; employee turnover ranged from 1-5%/year (compared to 5-10%/year in the industry as a whole). The organizational structure and performance-based incentives provided Nucor with an advantage over its competition by reducing unnecessary levels of management, reducing employee turnover, and encouraging employee performance.
Nucor had a strong history of adopting the latest technology in the steel market and rather than have a separate R&D division, the company used the launch of new plants and new items from suppliers as a means to develop new processes and products. Operations were key to Nucor’s success, including both the production process and the order, shipping, and payment operations that allowed customers to order lower quantities and keep less in inventory.
Nucor’s primary customers were service centers and distributors, and it was dedicated to serving them with the most modern practices in the industry. The Darlington plant alone had been updated three times in seventeen years. Nucor maintained low costs by placing new plants in rural areas with cheap electricity and access to at least two railroads; the company also played the role of its own construction manager, utilizing experienced engineers from its own ranks to manage the project. In 1986, Iverson believed that he had found a way to break into the flat-sheet segment of the steel industry. Through SMS of West Germany, Nucor had learned of a thin-slab casting technology called Compact Strip Production (CSP). CSP was unproven, but if successful would allow Nucor to more efficiently produce flat-sheet steel at a reduced cost. The choice to build a new plant for flat-sheet production was proving to be a difficult decision, not only because of the inherent risk of a new project, but also because Nucor also had significant investments tied up in a joint venture with Yamato Kogyo, as well as $6 million on a device called a Hazelett caster. Assuming the CSP plant would be financed through issuing bonds, the company would still have a debt ratio comparable to its competitors in the steel market and cash reserves to offset any increase in the price of scrap steel. See Exhibit 3.
In an ideal situation, Nucor would substantially benefit from pioneering the CSP technology. The potential for cost reduction, coupled with the benefits associated with first mover advantage, are very appealing. There is an opportunity for increased profit through the simplification and reduction of steps that CSP provides, however the proposition of being the first adopter of CSP comes with a significant amount of risk and uncertainty.
Given that the pilot plant built by SMS could only run for seven minutes at a time and produce only 12 tons per charge, there is a great amount of uncertainty surrounding the feasibility of translating this technology from the pilot plant to an actual minimill. It is difficult to draw any conclusions from this limited scope.
Putting aside the significant risk that accompanies the CSP technology, the known risks are also cause for concern. One of the primary issues surrounding CSP is that its cost effectiveness is directly correlated with the price of the scrap steel used in the production process. The cost of scrap steel is relatively low at present, however a substantial increase in demand could cause prices to spike; the ramifications would seriously impact the profitability of the venture.
Before exploring potential catalysts for increased scrap steel prices, Nucor must consider what it means to pioneer this technology. The aforementioned unknowns and the associated costs are not inconsequential to this decision. Additionally, as the first mover, Nucor will incur operational expenses that may be avoidable in the future after the technology is further developed on a commercial scale. Because SMS owns the technology and holds the right to “observe process improvements at Nucor’s plant and to show them off to prospective customers”, Nucor will bear the brunt of start-up costs and its direct competitors would be able to build similar CSP minimills, but significantly reduce the cost through observation of Nucor’s operations.
If this was the case, and other minimills adopted CSP to enter the flat-rolled segment, the demand for and price of premium scrap steel could increase significantly. If scrap steel prices rose above $140 per ton, Nucor could react by shifting to direct reduced iron (reacted with natural gas as its primary raw input) but this approach would require Nucor to make significant changes to both its factory and its operation which would likely be very costly.
The increase in steel prices would be problematic for Nucor as it planned to penetrate the lower end of the flat-sheet market, which is a low-price business. In the case of steel, low prices mean lower margins and any pressure against the price of scrap steel could be catastrophic to the profitability of Nucor’s venture. Much of the lower end of the flat sheet market is held by low-priced foreign competition. If Nucor enters this segment and other U.S. competitors follow suit, prices will likely begin to fall after the market is saturated with competition and buyers have many options. Assuming CSP becomes widely used, the price decrease is estimated at 5% per year after Nucor’s third year of production. See Exhibit 2.
There is the potential to penetrate the high end of the flat-sheet market, however this would require a different operational strategy, as the market requires high quality, reliable delivery of large quantities, and relationship-based marketing. If Nucor wanted to operate in this market, it would likely need a second plant, as well as a significant investment of time and resources to change the operational strategy. Given the amount of time needed to accomplish this, competitors could be at the same stage or even further along in development of high quality flat-sheet steel plants.
The threat of entry by other firms is not guaranteed to be high, but if the technology were enough to give Nucor a significant competitive advantage, other firms would have the ability to literally look into Nucor’s minimill to see how best to compete. If this happened, profitability would be jeopardized and the necessary capital needed to target the high-end segment would likely be unavailable, given the resource constraints of the company and the joint venture with Yamato Kogyo.
The benefits and risks must be weighed against the knowledge that this technology might be irrelevant in 10 – 12 years. Additionally, it is important to factor in the two and a half year construction time and the subsequent two year period required to reach production capacity, which when combined, represent between 33% and 40% of the projected window of opportunity. With a defect rate of 6% and capacity utilization of 90%, the yield for the plant will be 85% starting in the third full year of production. See Exhibit 2. Once capacity is reached, the price of flat-sheet steel would likely start to decline as competitors begin adopting the new technology (or another new technology). Assuming a 5% decrease in sales price over years three through ten (the average life of a minimill), along with a decrease in costs due to increased efficiency as Nucor becomes more familiar with the technology and human resources needs for production, the plant looks to generate positive income throughout its life. However, the construction costs, startup costs, increase in working capital, and other items outweigh the future income, resulting in a negative net present value. See Exhibit 1.
Our recommendation for Nucor is to hold off on building a plant utilizing the CSP technology because with the information available, the project does not return the investment over its ten-year life, and because there are too many other unknowns to enter a segment in which the company does not have prior experience. Additionally, with 10-year U.S. Treasury Bills earning 7.26%, Nucor could invest some of its cash for adoption of the technology once it is fully developed, and in time launch a CSP plant with more certainty of success and efficiency or using another of the technologies currently being developed.
While Nucor should consider expanding production to flat-sheet steel to increase its presence in the overall steel market, the production technology in question has not been proven on a commercial scale and the company is beginning another large project with Yamato Kogyo of Japan to produce wide-flange beams for the high end of the construction market. The CSP technology plant would be producing for the low-end flat-sheet market segment, and while continued expansion of CSP technology may result in high-end flat-sheet production, Nucor should consider the potential risk of diversifying into a low-end market.
For the reasons stated above, we cannot recommend Nucor to pursue opening a plant with CSP technology at this time.