mfg.strategic cost management_for_steel_companies

Strategic cost management for steel companies:Building competitive edge through cost reduction

Over the past couple years, the global steel industry has undergone an unprecedented turbulence: 8 out of the global top 10 steel-producing nations fared a sharp decrease in crude steel output in 2009, and over half of them shrank heavily. Being the global largest steel producer, China has stood against the crush of financial crisis, achieved a two-digit growth in crude steel output as well as maintained the whole industry's profitability by support of national policies and rigid market demands. However, the old good days before 2007 are no longer with the industry. Looking forward, steel producers are facing tremendous internal and external challenges: the changing competitive landscape, increasingly tougher M&As and integration, demand instability, mounting material costs, pressure from the move towards a low-carbon economy and rising environmental cost, as well as more stringent corporation governance and regulatory requirements, all of which exert a lot of cost pressure on steel producers, even shaking the leadership. Under such background findings, Deloitte co-authored this report with China Steel Industry Development Research Institute (CSDRI) to inspire Chinese steel producers on taking initiatives in terms of cost reduction, efficiency improvement and profitability management from the perspective of strategic cost management.

Preface

Strategic cost management for steel companies: Building competitive edge through cost reduction 1

Chinese steel producers need cost and profitability management

The world's total crude steel production was 1.22 billion tons in 2009, with about 47% taken by China for its 570 million tons outputs. Chinese steel producers took up 38 seats among the World Steel Association's list of top 80 large steel producers with capacity above 3 million tons; 5 seats among the global top 10 steel producers, as well as 9 seats among the top 20 producers with 10 million tons capacity. The above statistics indicate that Chinese steel producers have played a significant role in the global steel industry. However, the major powers really dominating global steel industry are still those world-class multinational steel producers overseas, and the majority of China's individual steel producers still have weaker position over the global arena. In addition to the lack of raw materials, partially, part of outdated production facilities, inadequate technical innovation, mid and low-end products and un-rationalized sales channels, other causes such as the over-expanded operation and less focused management as well as low margin also attributed to this.

According to CSDRI's analysis, the top 20 foreign steel producers in 2007 maintained an average pre-tax profit margin of 12%, while the figure of China's counterparts was merely around 6-7%. In the 4th quarter of 2008, as the international financial crisis broke out, both domestic and foreign steel producers encountered tremendous impact: the average pre-tax profit margin of major foreign large steel producers per annum dropped to 10.5%, while the China counterparts dropped to 3.1% (Figure 1). That is to say, before the international financial crisis broke out, foreign steel producers maintained comparative advantages in costs and higher profits than domestic peers.

Along with the global pervasion of economic crisis in 2009, the major large foreign and domestic steel producers made cutbacks as a result of the shrink in market demand and sales, with annual profit level slumping to the lowest. In 2009, the average pre-tax profit margin of global major large steel producers was -3.9% with losses occurred (Figure 2). Chinese steel producers also faced up with similar external environment and challenges; however, thanks to the support of national policies and rigid demands from domestic market,

Figure1. The comparison of pre-tax profit margin among domestic and foreign large steel producers, 2008（Notes 1 and 3）

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Figure2. The comparison of pre-tax profit margin among domestic and foreign large steel producers, 2009 (Notes 1 and 4)

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the extensive losses did not occur to the whole industry. According to CSDRI's analytical statistics, the 9 Chinese steel producers ranking in the global top 20 achieved a 3.2% average pre-tax profit margin in 2009 (Figure 2). That is to say, in 2009, Chinese steel producers exceeded foreign peers in the overall performance.

However, it is a fact that Chinese steel industry underwent a profitability decrease in 2008 and 2009. Despite various economic protection policies and the decreased production cost due to the decreased purchasing price of iron ores compared to 2008, the average pretax profit margin of major domestic large and medium steel producers dropped to 2% (Figure 3), the lowest point ever since 2000. As another matter to be concerned, a 10.1% pre-tax profit margin was still been achieved by some world-class producers overseas (Figure 2) in 2009, overtopping Chinese steel producers. This represents that foreign steel producers' competitive advantages still exist despite the short-term setbacks. In virtue of the mature cost and profitability management, they will bring forth a new round of fiercer competition and challenges to Chinese peers as the economy recovers. As a matter of fact, in order to adapt to the ever-changing economic environment, accumulate long-term competitive advantages and rank among the world-class producers, the majority of Chinese steel producers have to exert persistent efforts in a longer term to pursue operation efficiency and profitability management. Otherwise, they will encounter great difficulties to sustain the profit growth in the long run.

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Figure3. Developing trends of the pre-tax profit margin and cost ratio of domestic large and middle sized steel producers in recent years（Notes 1 and 2）

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Key approaches for cost and profitability management for Chinese steel producers

Figure 4. Comparison of cost ratio among large domestic and foreign steel producers（Notes 1, 4 and 5）

Cost ratio in 2009 of domestic steel producers (%)

Cost ratio in 2009 of foreign steel producers (%)

Cost ratio in 2008 of foreign steel producers (%)

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Figure 5. Comparison of period expense ratio among large domestic and foreign steel producers（Notes 1, 4 and 5）

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Period expense ratio in 2009 of foreign steel producers (%)

Period expense ratio in 2008 of foreign steel producers (%)

In perspective of the ability to create enterprise value, cost ratio represents mainly the raw material cost and production efficiency, while the periodic expense ratio represents mainly the enterprises' management efficiency in sales, management and financing except production. Compared to the performance of large domestic and foreign steel producers, in 2009, Chinese steel producers achieved an average cost ratio of 90.9%, ahead of the average 92.7% of foreign peers (Figure 4). However, the best performance among foreign peers is 84.2%, better than Chinese steel producers' 85.8%. With regards to periodic expense ratio, Chinese and foreign steel producers are both around 8%, with the best level being merely about 3% (Figure 5). However, despite the sharp decrease in sales, we didn't see obvious increase for the period expense ratio of foreign steel producers, which is largely attributed to their efficiency and profitability oriented management. In general, the average operation cost ratio of Chinese steel producers in 2009 is 98.7% (Figure 6), ahead of foreign peers. While the year's best performance of operation cost ratio is 89.5%, maintained by foreign peers.

Here we compare the performance of 9 Chinese steel producers among the world top 20 with capacity over 10 million tons, without taking account of the international variance factors. According to CSDRI's analysis, Jiangsu Shagang Group achieved the best periodic expense ratio of 3%; while Baosteel Group presented the lowest operation cost ratio of 96%, the best performance in overall operation cost management due to its strong and solid overall advantages. Taking the above as a whole, in perspective of profitability, Baosteel achieved the highest 7.6% in pre-tax margin rate, and also ranked the first place for comprehensive competence among domestic steel producers, in virtue of its sound return on assets and considerable profits, well-performed current asset structure and large industrial scale and impact in 2009.

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Figure 6. Comparison of operating cost ratio (OCR) among large domestic and foreign steel manufacturer（Notes 1, 4 and 5）


Operating cost ratio in 2009 of domestic steel producers (%)

Operating cost ratio in 2009 of foreign steel producers (%)

Operating cost ratio in 2008 of foreign steel producers (%)

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98.7 101.796.0

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These ratios represent the successes achieved by those steel producers in various aspects, which provide lesson learnt for Chinese steel producers on management, covering cost reduction, efficiency development, improvement in profitability and return on assets. Based on Deloitte's experience in strategic cost management and the understanding of major cost and profit drivers, Chinese steel producers may consider the following 5 approaches when developing cost and profitability management with higher level of maturity and sustainability:

1. Integrate business and operation model by rationalizing products, customers and services

2. Strengthen the operation governance, and M&A integration

3. Improve the level of integration and efficiency in operation processes (ex. purchasing and production processes)

4. Persistently control expenses and cash receipts and payments, and

5. Establish a consistent cost management mechanism and information system


A key indicator to measure the "rationale" of business model is the Return on Assets (ROA). In 2009, Chinese steel producers achieved a ROA of 2%, exceeding the average performance of foreign peers; however, the best performance of domestic enterprise is 3.8%, far short of the foreign peer's 7.7% (Figure 7).

In general, foreign steel producers tend to modify their business and operation model by rationalizing products, customers and service offerings. The "rationalization" by differentiated modification approaches on product pricing, customer management and service level will strategically achieve a more effective allocation of resources, so as to establish the profit model. Whereas, such decision-makings have to be based on the long-term and accurate knowledge on product and customer costs, profit information, and the penetration into the reasons behind the facts, which is exactly the bottleneck faced by many Chinese steel producers. The less delicate cost accounting is unable to support the product projects and customer life cycle management, including the collection, calculation and reporting of comprehensive cost information of sales, manufacturing and services.

Deloitte's research found that with effective and integrated sales plan, inventory and supply & demand plans as well as the optimized management on operating capital (including accounts payable, accounts receivable, inventory), as high as 40-50% of forecast errors has been reduced, and 10-30% inventory lowered, which naturally contributed to cash flow optimization. Besides, other two critical components in cost and profitability management are to establish the key performance indicators fit for profit model, and rationalize the cost structure. According to Deloitte's research, the adjustment on business model and the optimization of a rationalized cost structure will produce about 10-30% savings in effectiveness.

Integrate business and operation model by rationalizing products, customers and services

In China, Jiangsu Shagang Group and Baosteel Group are proven cases in this area. They achieved a respective 3.8% and 3.7% of ROA (Notes 2). One of the key reasons to this is that they adopted the business model optimization at varying degrees. Take Shagang Group for instance. In recent years, the Group was persisting in technological and independent innovation and gave full play to the advantages of technical talents, advanced technologies and devices, with a view to focus on developing high-tech and high value-added products such as hot rolled coils, wide thick plates and high-quality wire rods. With their success in developing high-end products and optimization of product structure, the profitability of Shagang Group was boosted.

The CSDRI's analysis demonstrates that under a unified strategic planning, Baosteel Group has well defined its subsidiaries' product portfolio, based on the strategy's overall requirements and all subsidiaries' specific geographies, management and technical characteristics. For instance, Baosteel Group Shanghai No. 1 Iron & Steel Co. Ltd. has achieved the production transformation from low technical and low value-added plain carbon steel sectional materials and medium plates to high technical and high value-added stainless steel, low-alloy steel and carbon steel plates and strips; Pudong Iron & Steel Co. Ltd. is placed to produce ship plates and special plates; Baosteel Group Shanghai No. 5 Steel Co., Ltd. fully exited the production of plain carbon steel and began

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Figure 7. Comparison of the return on assets (ROA) among large domestic and foreign steel producers (Notes 1, 4 and 5)


ROA in 2009 of domestic steel producers (%)

ROA in 2009 of foreign steel producers (%)

ROA in 2008 of foreign steel producers (%)

to concentrate on development of special steel, positioning itself to competitive special steels led by high-grade bearing steel, refractory alloy and titanium alloy, etc. In regions of Yangtze River Delta and Pearl River Delta, the production concentrates on high-end plates so as to meet the fast growing demand of auto, household appliances and shipbuilding industries within these areas; for Northwestern areas, Baosteel Group Xinjiang Bayi Iron & Steel Co., Ltd. ("Xinjiang Bayi") concentrates on development of long products and pipe work pieces to meet the steel demand of construction and petroleum drilling, driven by western development initiative and energy exploitation. Meanwhile, it also covers the production of hot rolled sheet and medium plates, etc., thereby to become the most competitive steel manufacturer in western regions. In virtue of the above rationalizationon industrial layout and product structure, Baosteel Group has achieved a significant growth in return on assets.


According to Deloitte's research, 10-25% of enterprises' cost optimization is derived from the improvement on the enterprise governance and organizational structure of their affiliates, e.g. centralization of procurement, establishment of shared service centers and R&D centers, as well as further optimization of the plant layout. The benefits from the improvement include reducing the production management costs by 5-15%, shortening processing cycle of purchase order by 8-16 days, increasing the turnover times of raw materials by 26-52, decreasing the product development cycle by 50%, and cutting down 30% of R&D project costs. In addition, the efficiency of supporting functions is also enhanced due to shared services.

As decentralized order handling process caused too much turnaround, through the design and establishment of a centralized customer order processing center, a foreign steel company reduced order processing costs by over 12% and average order processing time by over 15%. In China, Baosteel Group is the best practice to cut down management expenses and enhance operation governance on business operation and risks, through management integration (e.g. the comprehensive integration of information, technologies and systems at the company level, and build B2B e-trading platform at Bsteel.com.cn) as well as the establishment of finance shared service center. Without any doubt, these optimization measures greatly improved the standardization, automation and information quality of Baosteel Group, and maintained its competitive edge in cost and price in domestic and international markets. In another example, Jiangsu Shagang Group has significantly reduced its operating costs and achieved positive efficiency by streamlining organizational structure and abridging management hierarchy through reducing intermediate management sections.

Strengthen the operation governance and M&A integration

Moreover, large-scale M&A activities in China steel industry started from 2005, i.e. after the launch of Development Policies for the Iron & Steel Industry. Those enterprises that had M&As and restructurings with assets integration included Angang Steel and Ben Xi Iron & Steel; Wuhan Iron & Steel and Echeng Iron & Steel, Kun Steel, Liuzhou Steel; Baosteel and Xinjiang Bayi; Shagang and Yonggang; Taiyuan Iron & Steel and Shanxi Xinlingang Steel; Pangang and Chengdu Iron & Steel. Following suit of Arcelor Mittal, the world’s top steel producer, Beijing Jianlong Heavy Industry Group, a private steel producer, conducted low-cost mergers towards state-owned enterprises and downstream industry. Year 2008 is said being "the year of Integration” for China’s steel industry, as a serial of newly consolidated steel producers consecutively emerged – including Shandong Iron and Steel Group, Hebei Iron and Steel Group, Guangdong Iron and Steel Group, Guangxi Iron and Steel Group. Although M&As are often taken by Chinese steel producers as an approach to reduce cost and enhance efficiency, it is time for them to think about that after a series of M&A myths: has the synergy in terms of cost reduction and efficiency enhancement been actually achieved as expected?

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CSDRI's research shows that Baosteel Group, Shagang Group and Shandong Iron and Steel Group are typical cases among a series of M&As during recent years. In 2007 and 2008, Baosteel restructured Xinjiang Bayi and Guangzhou Iron and Steel Group. By relatively thorough integration of these invested steel mills on production, supply chain and human resources, Baosteel Group achieved advantage complement and scale economy in resources and technologies, including cost advantages in terms of purchase of raw materials, product distribution, sales, R&D, and overhead expenses. Jiangsu Shagang Group initiated M&A strategy in the second half of 2006 and subsequently acquired Jiangsu Huaigang, Henan Yongxing, Xinrui Special Steel, and Jiangsu Yonggang, with the Group’s capacity up by 10 million tons. By transforming and managing the acquired enterprises, the Group increased its scale economy and competitiveness. The founding of Shangdong Iron and Steel Group originated from the merger and restructuring between Jigang Group and Laigang Group in 2008. After the merger, Shandong Iron and Steel Group centralized its treasury management, procurement, sales and operation coordination so as to build up a preliminarily unified operation platform. Through this series of substantial restructurings, the advantages of scale and concentrated operation began to emerge. In another case, Hebei Iron and Steel Group conducted centralized financing after

the integration, which transformed the up floating interest rate under original scattered status into down floating interest rate under centralized credit authorization, saving interest of RMB300 million in one year (Notes 2). That is also the successful experience for reducing cost and enhancing efficiency through M&As. Nevertheless, steel producers that intend to reduce cost and enhance efficiency through M&As should conduct a series of effective integration after M&As. Therefore, the effect of cost reduction and efficiency enhancement after M&As might not be reflected within a short term, as many integration measures have not been thoroughly implemented within a short period.


In terms of the integration and efficiency in operation processes, especially in purchase and production, Anben Iron and Steel Group and Baosteel Group are the pioneers. Their cost ratios are relatively low at 86%-88%, among domestic steel producers. (Note 2)

To achieve breakthrough in the integration and efficiency in the purchase and production, foreign steel producers usually concentrate on traditional issues such as vertical integration, lean production, improvement of efficiency on production equipments, distribution models and transportation speed, as well as emerging issues including the development of lean suppliers and outsourcing. According to Deloitte's research, the positive effects of these breakthroughs include 40% decrease of processing cost, increased utilization ratio of fixed assets, 5-10% decrease of labor cost (including 20% decrease of labor cost for product repair), reduction of waste and rework cost to 1.5% of the total cost, 50%-75% decrease of urgent order cost, 20% decrease of logistics cost, and 20% decrease of materials in transit. These considerable profits directly facilitate the enterprises to create value.

Take a steel producer in North America for example, due to the requirement from its automobile customers to cut down the price of its major iron and steel products, the management faced the pressure of decreasing profits. Particularly dissatisfied with the progress of operation efficiency, the management decided to evaluate the operation process to identify cost optimization opportunities and implementation accordingly.

Improve the level of integration and efficiency in operation processes

The enterprise said these measures reduced over 13% of the cost within the improvement scope. The company reduced machine shutdown time and maintenance cost through analysis and revision of maintenance process; reduced over 12% of maintenance costs, over 18% of labor shutdown cost caused by inventory flow and over 15% of customer service management cost by strengthening business process and labor skills; cut off more than 300 indirect material suppliers to increase the purchase price negotiation ability and decrease transaction expenses, saving around 15% of procurement cost of indirect materials; enhanced product price negotiation ability and abandoned some customers that may not provide profits, through optimization management on the profit information of the products and customers.

As for the costs of main material inputs before iron making to domestic iron and steel producers, e.g. coking coal, coal injection, metallurgical coke, concentrate fines, imported rich ore fines, pig iron and hot metal, the company’s geographical location, transportation conditions, self-owned mine and self supply, the ratio of the ores from long-term purchase agreement are determinant elements to procurement cost. Of course, to a certain extent, procurement cost reflects the procurement efficiency of the company. A successful case is Baosteel Group's acquisition of Xinjiang Bayi, which has rich resources like coals and iron ores and geographical advantages with favorable development potential. Relying on Baosteel’s advantages in technologies, talents, management and marketing, the integration of Baosteel and Xinjiang Bayi promoted the efficiency in the purchase and production. Compared with the average unit procurement cost of large-and-middle-sized steel producers in China, Baosteel Group reduced the externally purchased material cost in 2009, saving RMB1140 million of coking coal and RMB700 million of coal injection. (Notes 2)

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In the production cycle (including the manufacturing stages i.e. before iron making, iron making, steel making, finished iron rolling), the cost control depends mostly on technological equipments, production craft and manufacturing management in each production process. The research of CSDRI shows that during the period of 11th Five-Year Plan, Anben Iron and Steel Group conducted massive technology transformation on steel plants and comprehensive upgrade of main equipments and strengthened production management and quality control, enabling the Group’s production craft and technological equipments reaching worldwide advanced level, which greatly reduced the production costs in iron and steel making and continuous casting process. Take the main outputs of this process (plain carbon casting billets and slabs) for instance, under the situation that procurement cost of raw materials had no significant advantages, the production cost per unit of plain carbon casting billets and of slabs by Anben Iron and Steel Group were 2% and 4% lower than the average industry level respectively, saving considerable costs for the group.

As regards to Hebei Iron and Steel Group, its procurement cost of raw materials had no advantages; however, the Group also remarkably saved the production cost per unit, by upgrading production equipments, strengthening technological flow control, optimizing technological parameters of product lines, as well as refining key index to support lean production. For example, in 2009, the unit production cost of non-alloy steel (Note 7) products was lower than average industry level. The production costs per unit of high speed wire, Grade II reinforcing bar, Grade III reinforcing bar, plain carbon round bar, plain carbon medium plate, plain carbon hot-rolled coil were 1-9% lower than their respective average industry level, saving considerable costs for the Group (Note 2).

In general, based on CSDRI's analysis, the cost ratio of China’s steel industry (including main raw materials, supporting materials, fuels and powers, direct labor cost, and manufacturing expense) is between 85-90%, varied by product structures. The cost composition is, approximately, 59% for materials, 32% for energy, 2% for labor, 6% for equipment utilization such as depreciation, repair, spare parts and machinery consumables, and 1% for incidental expenses of transportation and administration.


The control of the three items of periodic expenses, namely selling, general & administrative and financial expenses, mainly depends on the enhanced efficiency and scale of sales, overheads and financing and on the enhanced control of cash receipts and payments. Take selling expenses for example. With regard to the topic of cost management, the external expenses such as advertisement and promotional expenses are often the most controversial ones, mainly because of their expense nature - not driven by the improvement needs of operating efficiency, but depending on management's professional judgment when making operation decision. Other factors include the large amount involved and the difficulty to calculate the opportunity cost. Current practices mostly rely on ex ante assessments on benefits, but lack grounds for quantifying the effect. When manufacturers are under great cost pressure, such expenses are easily reduced although such reduction might cause adverse effects. Accordingly, Deloitte advises steel producers, pursuant to their strategic objectives, to make good planning for the expenses and cash receipts and payments from budgeting stage, and exert strict control over consistently, whether under favorable or adverse economic environment. Only in this way, can the steel producers maintain a certain capacity and capability to prevent profit slip in different economic environments.

By comparing large Chinese steel producers' performance, we found that in 2009, Masteel Group has the lowest selling expense ratio, only 0.4% (Figure 8); Shagang Group has the lowest general & administrative expense ratio, about 1.4% (Figure 9); and Baosteel Group has the lowest financial expense ratio, 0.8% (Figure 10). On the whole, in terms of period expenses, Shagang Group excelled itself from its peers. As a result of its economical budget and strict control over expenditure, Shagang Group's period expense ratio was only 3% in 2009 (Figure 5), more than 50% lower than 7.9% of the industrial average. Shagang Group provides a reference for its domestic peers.

Persistently control expenses and cash receipts and payments

Figure 8. Comparison of selling expense ratios among large Chinese steel producers in 2009 (Notes 1, 4 and 6)

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Figure 9. Comparison of general & administrative expense ratios among large Chinese steel producers in 2009 (Notes 1, 4 and 6)

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Figure 10. Comparison of financial expense ratios among large Chinese steel producers in 2009 (Notes 1, 4 and 6)

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According to the analysis of CSDRI, in Chinese steel industry, the ratio of periodic expenses (including selling, general & administrative and financial expenses) that affects manufacturers' operational profits remains around 6%, of which 1% is selling expenses, 3.5% being general & administrative expenses, and the remained 1.5% being financial expenses.

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Chinese enterprises customarily take costs as their competitive edge. In comparison with the cost management system of foreign steel producers, however, the managements of Chinese enterprises are still dissatisfied with their current cost information and analyses, mainly because they are facing the following challenges:

1. Dis-linkage of cost measurement from operating efficiency performance, resulting in timely less information providing ;

2. Dis-linkage of cost measurement from strategy initiatives, resulting in the constrain of value-added information;

3. Cost reporting is mostly inclined to financial reporting purpose, without effective refection of operation performance and business achievement;

4. Focusing on the subdivision of cost elements instead of tracking to the cost drivers;

5. Lack of logical models for allocating total costs to product items and individual customers; and

6. Failure to extend the focus on costs from manufacturing costs to hidden costs such as quality cost, R&D cost, distribution cost and customer service cost.

According to the findings of Deloitte's research on a steel producer in the North America, its false cost accounting resulted in 24% of distorted product costs and profit information in its financial statements. Try to imagine that how significant unfavorable effects such distortion would generate in the decision of business portfolio, pricing and investment. It is exactly a loss of competitive edge. The key to make improvements is to perform more accurate analyses of product costs and profitability by means of operational activity and cost driver-based allocation.

Establish a consistent cost management mechanism and information system

In relative terms, considering the major challenges Chinese steel producers are facing when making more precise product costs and profitability analysis, it is vital for them to build an integrated cost management mechanism and information system. Specific areas in which steel producers can make improvements or changes include: connecting cost measurement with the measurement of operating efficiency and operating strategies; integrating cost and performance reporting; and acquiring a more comprehensive view about the cost (including hidden costs such as quality cost, R&D cost, distribution cost and customer service cost) by tracking the causes of cost incurrence (cost drivers) and establishing reasonable costing models for allocating total costs to product items and individual customers.


According to the analysis above, to achieve a more precise cost and profitability management, Chinese steel producers shall take the following actions:

1. Integrate business and operation model by rationalizing products, customers and services Steel producers shall integrate the business and operation models by rationalization of products, customers and services. Through product pricing, customer management and differential adjustment of service levels, "rationalization" enables resources allocation to become more strategically effective and helps steel producers to build a precise profitability management model.

2. Strengthen the operation governance and M&A integrationCost optimization can be achieved through enhancement on operation governance and organizational structure of the affiliated enterprises, e.g. to adopt centralized purchasing, establish shared service centers and R&D centers or further optimize the facilities layout. In addition, steel producers intending to expand business scale, reduce costs, increase efficiency and improve competitive edge through M&As, will have to take a series of effective post merger integration actions to achieve the expected effects.

3. Improve the level of integration and efficiency in purchasing and production processAs for optimizing the efficiency in purchase and production process, the breakthrough of enhancing operating efficiency mainly centers around topics including vertical integration, lean production, efficiency of production equipment, distribution models and transportation speed, development of lean suppliers and outsourcing.

Conclusion

4. Persistently control expenses and cash receipts and paymentsSteel producers, pursuant to their strategic objectives, shall make good planning for the expenses and cash receipts and payments from budgeting stage, and exert strict control over them consistently, whether under favorable or adverse economic environment. Only in this way, can the steel producers maintain a certain capacity to prevent profit slip in different economic environments.

5. Establish an integrated cost management mechanism and information systemSteel producers shall integrate their cost and information systems to drive their cost management and profitability analysis. Specific areas in which steel producers can make improvements or changes include: link cost measurement with the measurement of operating efficiency and operating strategies; integrating cost and performance reporting; and acquiring a more comprehensive view about the cost (including hidden costs such as quality cost, R&D cost, distribution cost and customer service cost) by tracking the causes of cost incurrence (cost drivers) and establishing reasonable costing models for allocating total costs to product items and individual customers.

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Figure 11. Deloitte's Methodology to Develop Enterprise Cost Improvement Roadmap

Typical Work Scope

Pre-launch

Key deliverables

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Data request

High-level Work plan

Baseline cost model

Service deliverymodel analysis

Initial change management plan

Opportunity assessment

Prioritize opportunities

Initial organizational model

Recommendation for prioritized opportunities

Quantified savings & costs

Defined organizational model

Action plans in key areas

Performance mgmt, indicators & tools

Defined change mgmt plan

Phase 1 Phase 2 Phase 3 Phase 4

Stage 1:Establish baseline, quantifying and evaluating cost saving opportunities

Stage 2: Propose cost reduction suggestions and implementation road map

Stage 3: Implementation

Implementation in stages, providing both quick wins / immediate savings and longer term, transformational change.Benefits are measured and tracked – accountability is reinforced at the corporate, business unit, and functional levels.

The improvement needs vary among steel producers, depending on the pressure level they are facing and on the changes in need on the basis of their own requirements. We believe that an effective cost and profitability management plan shall be a multi-level one incorporating short, mid and long term considerations. A four-phase cost improvement approach- building a

cost baseline, quantifying and evaluating cost saving opportunities, developing a cost reduction proposal and implementing action scheme (Figure 11) – can well enable steel producers to benefit in both short and long run, and produce a greater and longer effect than the mandatory cost reduction.


Note 1:Pre-tax profit margin = pretax profit/revenueCost ratio = cost of sales/revenueSelling expense ratio = sales expense/revenueGeneral & administrative expense ratio = General & administrative expense /revenueFinancial expense ratio = financial expense /revenuePeriod expense ratio = (selling expense + General & administrative expense + financial expense) / revenueOperating cost ratio = (cost of sales + period expenses) /revenueReturn on assets = pretax profit/average value of total assets of current year

Note 2:Source: Analysis of CSDRI

Note 3:Data of 2008 (CSDRI analysis for domestic steel producers and annual report of each company-published on company website- for foreign steel producers):

Domestic steel producers refer to 10 large Chinese steel producers, including Baosteel Group, Wuhan Iron and Steel Group, and Anben Iron and Steel Group etc.

Foreign steel producers refer to 8 large steel producers, including ArcelorMittal, POSCO, and Nippon Steel Corporation etc.

Note 4:Data of FY2009 (CSDRI analysis for domestic steel producers and annual report of each company-published on company website- for foreign steel producers):

Domestic steel producers: the 9 Chinese steel producers which were listed among the global top20 steel producers- Hebei Iron & Steel Group, Baosteel Group, Wuhan Iron and Steel Group, Anben Iron and Steel Group, Jiangsu Shagang Group, Shandong Iron and Steel Group, Shougang Group, Masteel Group, and Hunan Valin Iron and Steel Group

Foreign steel producers: 8 of the global top20 steel producers - ArcelorMittal, POSCO, Nippon Steel Corporation, JFE Steel Corporation, OAO Severstal, Evraz Group, U.S. Steel, and Nucor Corporation

Notes

Note 5:The 2008 data of foreign steel producers include those 8 companies listed in Note 4 and listed for reference only

Note 6:Due to the different disclosure requirements under different financial reporting standards, the specific amounts of selling, general and administrative, financial expenses are not completely split. However, the total amounts of period expenses have been shown in Figure 5.

Note 7:The product structure varies from one steel producer to another. Moreover, in terms of difficulty in production and technology, quality and performance features, proportions of alloy elements, and final values, low alloy steel products and high alloy steel products of various types and notations are quite different and incomparable. In this Report, therefore, to avoid false conclusion, we did not compare unit manufacture costs of steel making, billet casting and rolling of finished steel products among steel producers by plain carbon steel and alloy steel or by physical appearance-based traditional classification (plate, pipe, thread, belt, wire and bar). In the comparative analysis of unit manufacture costs, we compare, not low alloy steel and high alloy steel, but only plain carbon steel products that are relatively comparable in the entire process, including continuous casting billets and slabs, wire, Grade II bars, Grade III bars, medium plates, medium-thickness wide belts, HR&W strips, and CR&W strips.

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ContactsDeloitte ChinaNorman SzeManaging PartnerConsultingTel: +86 21 6141 2388Email: [email protected]

Rosa YangChina Manufacturing Industry Leader PartnerEnterprise Risk Services Tel: +86 21 6141 1578Email: [email protected]

Denken MengPartnerConsultingTel: +86 10 8520 7811Email: [email protected]

Annie ChenDirectorConsultingTel: +86 21 6141 2236Email: [email protected]

Maggie YangDirectorConsultingTel: +86 10 8520 7822Email: [email protected]

Yu Yun DirectorConsultingTel: +86 10 8520 7825Email: [email protected]

China Steel Industry Development Research Institute (CSDRI)China Steel Industry Development Research Institute (CSDRI), an institute established in 1979 as approved by the State Council, was initially affiliated directly to the former Ministry of Metallurgical Industry; from 2002 administered by the State Economic and Trade Commission, and from 2004 administered by the State Council's State-owned Assets Supervision and Administration Commission, which authorized China Iron and Steel Association (CISA) to exercise the power on its behalf. The institute provides research & consulting services, and edit and publish industry publications. Specifically, the research &consulting services are mainly engaged in researches of steel industry and the costs, finance, investment, technology, competitiveness, development strategies, and reform and management of steel producers as well as the analysis of industry trends. Over the years, appointed by governmental departments including the National Development and Reform Commission, the Ministry of Finance, the Ministry of Commerce and the Ministry of Industry and Information Technology, we have completed dozens of decision making-support research topics regarding industry policies. In addition, we also provide consulting services for financial institutions and steel producers. Our publications consist of China Steel Yearbook (Chinese and English versions available), China Steel Trade Yearbook, China Steel Focus (periodical) and Metallurgical Financial Accounting (periodical).

Dr. Liu HaiminDeputy DirectorTel: +86 10 6526 1130China Steel Development Research Institute

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