UK: The squeeze is on.

UK: The squeeze is on. - As sterling soars, it's sink or swim for British Steel. Transformation is proving difficult but signs are that real change is under way.

by Andrew Lorenz.
Last Updated: 31 Aug 2010

As sterling soars, it's sink or swim for British Steel. Transformation is proving difficult but signs are that real change is under way.

When, in June, British Steel chairman Sir Brian Moffat unveiled a halving of pre-tax profits to £451 million he was by no means the first to warn of the damage the surging pound was doing to British manufacturing industry. What makes British Steel different is that it is not waiting for the British Government or the Bank of England to do something about it.

Along with an accelerated programme of job cuts, the company has embarked on an unprecedented shake-up of its 1,500 suppliers in a bid to get a better deal on everything from raw materials to spare parts. Between March and June the company told about 700 of its UK suppliers at a series of seminars that they must cut their prices and improve their service. British Steel is planning to work with individual suppliers, at home and overseas, to devise cost-saving methods.

This was no knee-jerk reaction but part of a major change programme already under way, the aim of which is to elevate an already-efficient enterprise to a new level of operating effectiveness. What is true is that the programme has been brought forward as the pound has outstripped British Steel's wildest predictions particularly against the Deutschmark - British Steel's key exchange rate since 82% of sales last year were in Europe, where Germany is the largest national market and the biggest steel-producing country.

Not only does the strength of sterling impact upon British Steel's competiveness against cheaper subsidised foreign products but, as the firm points out, it is also a problem to a large number of its UK customers who are significant exporters.

There is no recent Western parallel for the dimensional shift in performance that is now being attempted by British Steel. For an exemplar, the observer must look east, to Japan. In the early 1990s, Japan's leading car manufacturer, Toyota, revolutionised its ostensibly hyper-efficient business to cope with the yen's upsurge against the dollar. Toyota dissected its entire operation, from the design studio through the production line and the distribution channels, turning accepted wisdom on its head. It emerged with efficiency gains of around 30%, something most experts, particularly in Europe and America, would have reckoned impossible.

Cagey as ever, Sir Brian Moffat, British Steel's chairman, and his team will not quantify the efficiency improvement that they are targeting.

But even for the privatised steel giant, transformed since 1979 from Britain's lamest industrial duck into a corporate swan, the complexity, speed and scale of the reformation that is now being attempted make this an ambitious exercise.

The change programme was conceived several years ago to counter the threat posed to British Steel by the new-style American mini-mills: steel makers such as Nucor and LTV which developed highly-flexible small plants using the latest electric arc manufacturing technology, employing no more than a few hundred workers. With mind-boggling output per head and low capital intensity, they threatened to make the big integrated works obsolete - and, in America, are well on the way to doing so. Before 2000, Nucor, the biggest mini-mill company, is likely to take over from USX, the former US Steel, as America's largest steel company.

British Steel was not so vulnerable as its American counterparts, which were shackled by rigid working practices and over-mighty unions. Indeed, under Sir Bob Scholey, the chairman who piloted it through privatisation and into the 1990s, the company pulled back from a potential joint venture with the US manufacturer Bethlehem Steel, one of the largest established US manufacturers, because it realised the operating economics would have been wrecked by the union agreement costs.

Moffat knew that Europe, with its entrenched indigenous companies, would be tough for the US mini-mills to crack. The big threat they posed was in the high-growth markets of Latin America and Asia, where their operating efficiencies could win them much of the new business, thus denying British Steel the lifeblood it needed to avoid stagnation.

In January last year, when Moffat's economists modelled the currency outlook, sterling stood at 2.22 Deutschmarks. 'In our model we had it going to DM2.35-DM2.40,' he says. But within a year, the pound had soared to DM2.7. While British Steel's profits in the year to March 31 were affected by the strength of sterling, the impact was cushioned by the company's hedging policy. The main reason for the fall to £451 million, less than half the 1995/96 all-time high of £1.1 billion, was destocking by customers across Europe last year, which pushed down prices.

Prices are now firming, but that is scant comfort for British Steel as it watches the pound's apparently inexorable rise. City analysts, who in January had been forecasting pre-tax profits of £700 million for the year to March 1998, have cut more than £550 million from their estimates. And their new forecasts of about £140 million this year are predicated on an average exchange rate of DM2.75 to the pound. At around DM2.95, profits could be wiped out.

'The currency situation is extremely serious,' says Janet Sidaway, engineering analyst at Dresdner Kleinwort Benson. 'As well as exports, they're worried about the knock-on effect on their customer base - 60% of their sales are still in the UK.' And she sees more trouble ahead: 'They'll soon start losing money on their carbon steel division - and their continental counterparts still have a 20% cost advantage.'

The share price has held up but only because, with net cash of £785 million, investors regard the 10p dividend as secure. Because of its cyclicality, British Steel is seen as a yield rather than a growth stock. In the recession of the early 1990s, when the company's £733 million profits fell to a £149 million loss, the share price collapsed to little more than 40p, largely due to a reduction in the dividend to a nominal 1p.

But without radical action this time, Moffat and his colleagues knew that their cash would drain away. Capital spending - which last year reached its highest level in six years - would have to be slashed and the dividend cut again. Like Toyota at the time of the yen-dollar earthquake, British Steel went into overdrive.

Implementation time for the performance upgrading programme was drastically cut. 'We anticipated bringing it in over five years or more,' says Moffat.

Now experts believe, the company is trying to halve that. Moffat and co want the new British Steel up and running by 2000.

Besides conventional measures such as the disposal of non-core businesses, the reformation has three central elements. In only one - sweeping redundancies - does it resemble the equally extraordinary post-1980 steel strike transformation that saw almost 46,000 jobs go in a single year. Today, the company employs about 43,000 in Britain (from a total of 50,400 worldwide) and under the original timetable planned to cut 500 to 1,000 a year over the next five years. Now, City analysts believe, British Steel would like to lose 4,000 jobs this year alone, although under its decentralised structure, it is up to local plant managers to execute the streamlining. In total, the company aims to shed about 10,000 people, almost a quarter of its UK workforce, by the year 2000.

What this will mean for the future of the four surviving integrated works - Llanwern, Port Talbot, Scunthorpe and Teesside - is far from clear.

The last major closure was of the giant Ravenscraig works in Lanarkshire - a casualty of the early 1990s recession. Moffat says the current streamlining, 'will not, one hopes, be hitting the basic configuration of our plants because they are working flat out'. However, he warns: 'They are still competitive, but they aren't as competitive as they were'.

Sidaway's conclusion is more ominous: 'They'll probably accelerate plant closures and might even have to cut an entire site out,' she says, adding that she expects the company will channel more of its investment overseas, especially in North America.

Unlike previous culls - which were largely an attempt to deal with the overmanning and surplus capacity that were the legacy of British Steel's days in the public sector - this redundancy programme is a means to an end, not an end in itself. As a result, many of the staff who go will not be production line workers but lower and middle managers. 'We want a flatter organisation,' says Moffat. 'We've still got a plethora of layers, although we have slimmed down in the past and by the standards of other integrated companies we are very good. Some of them have 4,000 people in their headquarters; we have 200, and that is too many. The middle management area will be hard hit. The mini-mills have three layers from the board to the guy who turns out the lights in the plant. We still have five.'

But if middle management is being pared down, the shopfloor level is being raised. 'The objective is to land up with single status,' says Moffat.

By this he means that terms and conditions of employment, from working hours to health benefits, are being equalised for all levels of staff, including managers. The old white-collar/blue-collar divide will be scrapped.

Below plant management level, Moffat wants a single tier of well-educated, highly trained, multi-skilled operating technicians. 'We are building skills into the team to give everyone both operating, maintenance and diagnostic ability,' says Moffat. 'We will have a far more competent and consistent workforce, and that makes the product more reliable and consistent.' The company is already ahead of most in its commitment to training and development: last year it spent £52 million in the UK which works out at an average of 11.5 days' training per employee.

The model for the multi-skilled operator, once more, is the mini-mills.

British Steel prepared the ground well by establishing its own mini-mill type operations in America. First came Tuscaloosa, where British Steel started up under Scholey in the late 1980s. Then Moffat forged the triple alliance with LTV and Sumitomo Metal Industries to create Trico. LTV has 50% of the venture, the British and Japanese 25% apiece. They intend to go on to develop mini-mills in Europe and Asia, while under its own steam British Steel is developing a £500 million Indonesian mill with a local partner.

'Part of the reason for our ventures in the US was to learn some of the new technology and new management philosophy without exposing the whole company in the sense of risk,' Moffat says. Trico's productivity in particular will be remarkable. When the plant goes fully operational next spring, a workforce of about 300, highly-incentivised by a profit-sharing system, will produce about two million tonnes of steel a year. At a traditional integrated works such as Llanwern, it takes about 4,000 workers to produce four million tonnes.

In parallel with the replacement of engineer, electrician and blast furnaceman, by the operating technician, British Steel aims to harness information technology to empower its new multi-skilled cadre. 'The IT system will link everything up,' Moffat says. 'Guys will be able to organise their work - through their screens they will be able to order the spares or services they need against their budgets. They won't need a mass of managers vetting what they have done. Some businesses will move faster in progressing things than others, but we want to encourage that. It's not a negative thing; it helps the competitive factor within the company.'

One task that will be facilitated by the IT development will be the suppliers' initiative, the unprecedented shake-up of British Steel's supply base which is the third element in the British Steel reformation, along with the workforce metamorphosis and the IT drive.

Moffat says: 'Year on year, we have watched our prices and costs get closer together so that our margins have been squeezed and our improvement in productivity is largely due to increased efficiency. This time, we have decided that our suppliers must tell us how they are going to justify being long-term suppliers. Most of them are not exporting, so they aren't feeling the impact of the pound in the same way as we are.'

Moffat thinks the outcome will be a substantial reduction in the number of suppliers, as some firms trade prices for higher guaranteed volumes on long-term contracts. But the step-change is also classic British Steel: raising the standard for UK manufacturers against a domestic service sector that is immune to the pressures of currency change and globalisation.

The British Government may be wrestling with the need to restore that balance, but Moffat and co are already out there, blazing the trail.

The idea that British Steel could ever be a pioneer would have appeared ludicrous in the year of the steel strike, when the state-owned British Steel Corporation ran up losses of almost £1.8 billion. Margaret Thatcher seriously considered breaking up the monolith before privatisation, before finally bowing to the dictates of the flotation timetable and the Treasury desire to maximise the sale proceeds. Yet today, with annual output of more than 16 million tonnes, British Steel is the largest company in its field in the western world. Only Nippon Steel and South Korea's Posco are bigger.

No other British engineering group enjoys such pre-eminence in a mass market.

Yet - or perhaps because of this - British Steel is still, largely, a company apart from the rest of British engineering industry to whom its attitude might be characterised as: 'We bite the bullets, but do other companies have the guts to do the same?'

In line with this tendency to aloofness, British Steel managers are a home-grown, tight-knit group. Apart from finance director, where John Rennocks is the second successive incumbent from outside the industry, the top executives all have at least 25 years' work in the company under their belts. Moffat himself joined what is now British Steel 29 years ago and ran Port Talbot works in south Wales before becoming finance director for five years.

A low-profile, quietly-spoken but utterly determined team leader, Moffat is now effectively trying to secure British Steel for his successors.

Can he do it? Sidaway says the jury is still out but praises British Steel as one of the 'best managed companies I have come across, both in a British and a global context.' She admits, however, that 'they're pushing water uphill at the moment'.

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