TCA Apr 2014

Baosteel Group: The Steel Flagship of China Inc.

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Since the start of China’s economic reforms, Chinese steel giants have progressively been gaining global market share and catching up with their foreign counterparts. Baosteel Group, China’s largest steel producer and second-largest worldwide, is a pioneer of this trend. In this edition, we take a closer look at this company’s corporate strategy and its competitive advantages. By Javier Cuñat

In March 1978, shortly before the start of China’s economic reform and opening up policy, China’s State Council formally announced the establishment of a large-scale integrated steel mill at Baoshan, near the port of Shanghai. With this new project, the government had the ambition to build a world-class steel mill by bringing together the most skilled engineers and by importing advanced equipment and technology. At that time China's existing steel plants had in place outmoded and inefficient equipment, and they were producing low-grade steel products.

That was the beginning of Baosteel Group, today the largest steel producer in China and the second-largest worldwide, after only ArcelorMittal. In 2009, Baosteel’s crude steel production was about 38.87 million tons, which included a mix of high-quality steel products; it employed  more than 100,000 professionals globally; it had revenues of 28.59 USD billion; and ranked 276th in the Fortune 500. What were the drivers behind these outstanding achievements?

Baosteel’s catch-up strategy

China’s endowment factors, strategic industrial policies and the overall transformation of the domestic steel industry is integral to understanding the fundamentals of Baosteel’s corporate strategy. Since the beginning of China’s economic reform and opening up policy, Baosteel has had to face a twofold challenge: meeting a dramatic domestic increase in steel demand while facing increasing domestic and international competition (both of which intensified after China’s accession to the WTO in December 2001). Hence Baosteel had to adapt fast and catch up with stronger competitors. It favoured M&A and strategic alliances over organic growth in order to grow more rapidly, and as a state-owned enterprise it enjoyed strategic support from the Chinese government during the implementation phase. In essence, Baosteel’s strategy emerged as a catch up strategy based on three main pillars: integration, internationalisation and diversification.

Integration

Baosteel’s integration strategy was coherent with the highly fragmented nature of China’s steel industry (the leading 11 domestic steel mills, for example, are responsible for only 45% of total steel production). In general, international competitors enjoy better economies of scale and bargaining power across the value chain. A good example is the high prices that Baosteel have had to pay for iron ore over the past few years, which can partially be ascribed to the less concentrated buying power of China’s steel industry. Baosteel had to integrate, both horizontally and vertically, in order to increase production capacity while better controlling for key elements of the value chain.

Assisted by ongoing consolidation in China’s steel industry, a process which encourages trans-regional domestic M&A, Baosteel progressively expanded its domestic production capacity. In 1998, the merger with Shanghai Metallurgical Holding Group and Shanghai Meishan Group transformed Baosteel into China’s largest steel producer with an annual steel production of 16 million tons. Baosteel also completed a series of domestic acquisitions such as Lu Bao Pipe Steel (seamless carbon steel pipes), Nantong Baori Steel Wire (former joint venture with Nippon Steel) and Ningbo Baoxin Stainless Steel Co. (cold rolled stainless steel sheet), among others.

In order to upgrade production lines and improve technical proficiency, Baosteel also partnered with key international players who were attracted by China’s rising domestic demand and cost advantages. Good examples of these partnerships include  joint ventures with ThyssenKrupp (stainless steel) and Arcelor and Nippon Steel (cold rolling and galvanized steel), with both facilities located near Shanghai. Bearing in mind that China was already the world’s largest steel producer by 1996, these transactions and alliances strengthened Baosteel’s global competitiveness by substantially expanding its global market share. Yet they also enabled Baosteel to meet increasing domestic demand—especially from the booming construction industry as well as the automobile and electrical appliance industries—while at the same allowing the company to move more upmarket with a more value added product mix.

Baosteel also integrated vertically, incorporating both a domestic and an international approach. Domestically, Baosteel signed long term off-take agreements with a few large Chinese coal mining enterprises, and it established four coal joint-ventures and bought shares in six coal enterprises. Baosteel also set up a joint venture with China Shipping Group in order to control shipping costs, especially of iron ore. Internationally Baosteel attempted to replicate its domestic approach with a strong focus on iron ore, but it would encounter new difficulties in this attempt.

Internationalisation

Mindful of China’s entry into the WTO and the resultant increasing foreign competition, Baosteel listed its shares on the Shanghai Stock Exchange at the end of 2000 and raised capital to provide for its international expansion. This would set the stage for a later international listing on the Hong Kong Stock Exchange. Baosteel understood that going global was not only a matter of growth but also of survival in the long run. In fact, its cost advantage is heavily dependent on access to high-quality iron ore and this is something China does not have. Hence, Baosteel put in place a well-grounded yet aggressive internationalisation strategy which balanced both the upward side (preference for M&A) and the downward side (preference for organic growth) of the value chain.

On the upward side, Baosteel signed several off-take agreements with major iron ore producers in Brazil, Australia, India and South Africa and established domestic joint ventures. In 2002 for instance, Baosteel and the Australian firm Hamersley concluded a joint venture to mine iron ore in western Australia  that included a 20 year off-take agreement of high quality iron ore. A similar structure was planned for a joint venture with the Brazilian Vale, yet this was subsequently cancelled. More recently, Baosteel acquired a 15% stake in Aquila, an Australian iron ore miner, making it Aquila's second-largest shareholder. On the downward side, Baosteel’s ability to progressively meet international standards and product requirements has allowed it to developed strategic alliances with key industrial clients in the automobile industry such Audi, General Motors, Ford and Volkswagen. In 2002, for example, Baosteel began to provide high-grade sedan sheets for the Audi A6 of First Automotive Volkswagen and Buick of Shanghai General Motors. Such strategic alliances strengthened over the years as the Chinese car market boomed, and this allowed Baosteel not only to maintain its current dominant market position but also to open new distribution channels abroad. Today, Baosteel has 45 wholly-owned subsidiaries with its markets spread over Brazil, France, Germany, Hong Kong, Japan, Russia, Singapore, South Africa and the US.

Diversification

Baosteel’s diversification strategy is complementary with its core business and includes investments in steel-related industries. The rationale for diversification includes the better exploitation of know-how and providing overall support to integration and internationalisation strategies. Good examples of this diversification are some of Baosteel’s subsidiaries such as Baosteel Resources which specialises in commodity trading and logistics, Fortune Trust which specialises in asset management and fund raising, Baoxin Software which specialises in information technology and automation, and Baosteel Chemical which specialises in coal chemistry using by-products from steel manufacturing.

Future challenges

Baosteel’s financial performance, production capacity expansion and technological upgrading in the last three decades have been impressive but do not necessarily guarantee long term competitiveness. Difficult challenges lie ahead such as increasing competition, rising shipping costs, increasing iron ore price and access to long term supplies, overcapacity in production and local protectionism against China’s consolidation plans, among others. While it is still uncertain how successfully Baosteel will handle these challenges, based on China’s rapid economic growth, low steel consumption per capita and state-backed investment in high steel consumption sectors, Baosteel can be optimistic on their long-term outlook. Whatever happens, Baosteel’s domestic and international competitors will be watching closely.

Javier Cuñat, Manager: Sourcing Strategy & KM/Research
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