Academic journal article The McKinsey Quarterly

New Game, New Rules

Academic journal article The McKinsey Quarterly

New Game, New Rules

Article excerpt

An overview of the long-deferred challenges now facing the Japanese steel industry

Since the second half of 1991, the Japanese steel industry has been going through a restructuring process. Output is falling. Profits are declining. Investment plans are being cut back. Across the board, the end of the so-called "bubble economy" has abruptly immersed these companies in the kind of volatile environment that has by now become second nature to their counterparts in Europe and North America. That the immersion has been so long delayed is, in many ways, a tribute to the great accomplishments and capabilities of the Japanese steel industry. But the delay is over. And the capabilities that have served the industry so well in the past may now prove a burden.

TRADITIONAL STEEL COMPANIES in all advanced economies confront much the same economic forces: stable or, more likely, declining demand for their products, dramatic shifts in technology, escalating capital costs, and intense competition from both new materials and new entrants. The Japanese come to these challenges with several unique advantages: strong technical capabilities; a history of close, positive ties with customers and government; attractive overall price levels; and healthy balance sheets. In today's restructuring environment, however, some of these strengths may equally prove a burden - an unwelcome limitation on the industry's ability to adapt and adjust.

The real situation in steel

During the late 1980s and early 1990s, Japan's bubble economy boosted domestic steel consumption (and thus steel output) far above sustainable levels. Before then, in the mid-1980s, Japanese steel companies had uniformly projected a dramatic fall in production levels to roughly 90 million tons, down from the 110 million tons projected for 1990 and 1991. Some forecasts were more pessimistic still: 80 million tons or less.

By the end of 1988, however, these worrying numbers -- and the downsizing plans to which they had given rise -- had faded. Instead, steel consumption boomed in Japan and around the world. In fact, Japanese crude-steel demand rose from 70 million tons in 1987 to almost 100 million in 1990.

Moreover, the nature of this demand growth, linked as it was to the strength of the domestic construction sector, proved especially beneficial to just those products (bars, plates, and structural shapes) that were most vulnerable to the restructuring crisis and that had been hardest hit in Europe and North America (see Exhibit 1). As a result, the restructuring programs announced in the mid-1980s were only partially or halfheartedly implemented, and the industry quickly revised its overall market expectations.

This was a mistake. A hard-headed look at the evidence strongly suggests that the pessimism of the mid-1980s was indeed warranted, despite the recent experience of the bubble. As Exhibit 2 indicates, an updated projection for average annual crudesteel output by the year 2000 comes in at about 90 million tons. The reason is simple: in an average year, domestic consumption is unlikely to exceed 80 million tons, and net steel exports are unlikely to exceed 10 million tons.

The figure for domestic consumption rests on an analysis of "steel intensity" -- the observed relationship between steel consumption and the level of development in a particular economy. As Exhibit 3, which maps the steel intensity of several economies, shows, Japan is already at the high end of the band for developed countries. There are several reasons for this, including Japan's net trade surplus in steel-containing manufactured goods and the predominance of steel in Japan's construction sector as a result of earthquake risks.

Now, assuming that net exports remain constant at the 1991 level of 9 million tons (an assumption dicussed below), the relatively smooth shape of the intensity curve implies total annual output levels of less than 90 million tons for the remainder of the 1990s. …

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