Corus Acquisition: Gambling for Growth?

A critical analysis of Tata Steel's acquisition of Corus, viewed in the backdrop of the development of the steel industry internationally and in India.

Corus Acquisition:Gambling for Growth?

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Economic and Political WeeklyMarch 17, 2007922to build some comparable, if not identical,facilities in India, but, going by the costestimates of various steel projects in thecountry in the recent times, some fullyintegrated brand new capacities of about15 million tonnes could have been builtwith that kind of money. One requires togo deeper into it for a clear position, but,the understanding that not so much ofvalue would have come from an invest-ment of corresponding size in India re-mains questionable. At the core of the issuelie a few other strategic considerations ofthe Tatas in respect of the steel industry.Tata Steel has been advocating a glo-bally disintegrated model of steel produc-tion to maximise economies of scale andcut transportation costs through opti-misation of movement of raw materialsand finished products by carefully locatingproduction and distribution facilitieseithercloser to the sources of raw materials orto the market. If there are world-classcapacities lying idle or there are capacitiesbuilt to remain dependent on purchasedsemi-finished, as in the case of Corus, bymoving these intermediate products fromtheir own facilities, Tata Steel can eitherreplace an existing source (seller) of pro-curement of semi-finished or any upstreamproduct or raise capacity utilisation in theplants if hitherto lying underutilised. Thereis no great economic sense to replace anexisting source unless the company saveson freight costs, simply because exactlythe same amount of money can be madeby selling that product internationally ratherthan to Corus so long the intent is not tosubsidise the latter.The captive arrangement, however, pro-vides security and reliability of suppliesthereby reducing the effective costs ofsupplies to the downstream processing unit.But, what will the upstream unit get fromsuch an arrangement is a matter of debateand will vary nevertheless along specificrelationships. But, such benefits may notbe very significant under the normal condi-tions of the market. Also, the overall aggre-gate benefits will depend on the specificfreight rates and distance moved for bothraw materials and finished products andthere are no clear reasons to believe thatthe disintegrated or a horizontal model willnecessarily work for overall efficiency gain.But in general, considering the case thatraw materials to be moved are bulkier thanthe finished products, it should make moresense to have basic productionfacilitieslocated closer to the sources ofraw materials and finishing lines close tothe market. While this may work wellwithin a national economy, it may nothappen exactly that way in the globalcontext. As on date, there are over-whelmingly larger number of steel produc-ers with complete vertical integration thathave done better. Costs of production willalso rise due to lack of economies of scalein disjoint facilities.Iron Ore SynergyAnother aspect of competitive produc-tion was seen in the context of possibleiron ore synergy. Tata Steel has iron oremines in India and may be able to acquiremore with their new projects. Corus isdependent on purchased iron ore and if thesame is made available to them by TataSteel will see significant gains coming ontheir way. But, somewhere down the lineit looks pretty clear that it will not be easyfor Tata Steel to export iron ore even ifthey manage to corner new mining blocks.Iron ore is being seen as one of the morecrucial factors that will shape up thecompetitive positioning of the steelmakersworldwide. If iron ores are not to beexported, advantages from iron ore can beexported in the form of semi-finishedproducts, a product where the inherentrelative advantages will still remain fairlystrong. As one goes downstream, the energyand other costs will become more and morerelevant reducing the relative importanceof iron ore. Had iron ore prices been thesame all over, the disintegrated modelwould not have worked at all. The advan-tages of iron ore are mainly due to theirlowextraction costs and non-proportionatelyhigher global prices. There is no competi-tive market for iron ore and with a widerange of regulatory practices followedworldwide by individual iron ore-richnations, there are rents for the miners totake. The steel mills in India have madea huge hue and cry over the exports of ironore as loss of secure iron ore is being seenas frittering away the natural advantagesof steel making in India. By exportingaway semi-finished products, the countryin any case benefits marginally only fromthe consequent value addition. Ifdisintegratedapproach is to be accepted,the best global efficiency model wouldbethe one that would include export ofiron ore from India to coal- and labour-rich China for steel making and thentakethem all over the world to makefinishedproducts. India may end up withrolling mills!But, there will definitely be some syn-ergy gains. In the estimates of Tata Steel,reported somewhere, the synergy gainswould be about $350 million per yearonce the process of integration is com-plete. There are other researchers who putthe figure higher at even $550-600 millionper year. These are estimates which willhave to be very carefully examined beforetaken for acceptance. Arcelor Mittal Steel,another large recently consolidated com-pany says, it has already captured $269million of synergies from merging theworld’s two largest steel companies, andexpects further savings of up to $500million on an annualised basis by the endof the first quarter of this year.For a nation, from a purely economicpoint of view, this specific deal may notbe a great significance in terms of gainsor even losses to it at the end of the day.There are questions whether the money theTatas are spending on this deal could havebeen invested in India itself to raise steelcapacity to some comparable levels gen-erating employment and incomes, if not inthe steel sector, somewhere else, if theirhands are full with steel sector projects andcommitments already. In an economy, full
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