INTRODUCTION Decisions form the basis of strategy. Each firm must make choices regarding what resources and capabilities to invest in, as well as what to do with such resources and capabilities in order to achieve sustainable competitive advantage. The star of this week’s case, Nucor Steel, finds itself at a critical inflexion point: Should it invest in a new steel mill to commercialize thin-slab casting? This paper examines why Nucor is considering making such an investment and what risks are involved if they choose to adopt the technology. Based on this analysis, the paper will conclude with a recommended path for Nucor Steel. YOU CAN NEVER BE TOO RICH OR TOO THIN The flat sheet segment accounts for 52% of the U.S. market for steel. The large integrated steel mills such as U.S. Steel, LTV Steel, and Bethlehem Steel dominate this important segment. Minimills such as Nucor are shut out of the flat sheet market because with conventional steel-making technology, the minimum efficient scale for flat sheet production is too high, with optimal capacities for each plant reaching 3 million tons per year and investment costs close to $2 billion. In contrast, minimills typically only produce 800,000 to 1 million tons per year, with investment levels closer to $300 million. The cost advantages from thin-slab casting are substantial. If viable, thin-slab casting minimills could become a category killer in the flat sheet segment. For hot rolled flat sheets, the operating costs per ton for a thin-slab minimill is 14% less than a modernized integrated steel mill, and 25% less than an unmodernized mill. For cold rolled flat sheets, the cost advantages are even more dramatic – with thin-slab minimills costing 19% less than a modernized steel mill, and 30% less than an unmodernized mill.

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Thin-Slab Minimill Hot Rolled Sheet Operating Costs per Ton Revenues per Ton Income per Ton Operating Cost Advantage of Thin Slab Minimill (%) Operating Income Advantage of Thin Slab Minimill (%) Cold Rolled Sheet Operating Costs per Ton Revenues per Ton Income per Ton Operating Cost Advantage of Thin Slab Minimill (%) Operating Income Advantage of Thin Slab Minimill (%) 283.0 390.5 107.5 225.0 306.5 81.5

Modernized Steel Mill 261.5 326.0 64.5 14% 21%

Unmodernized Steel Mill 300.0 325.0 25.0 25% 69%

349.0 454.5 105.5 19% 2%

403.0 453.0 50.0 30% 53%

Figure 1: Operating Cost Advantages from Thin-slab Casting Source: HBS Case Exhibit 12B: Comparative Operating Data

Thin-slab casting could therefore be the tool for minimills to break the integrated steel mills’ stranglehold on the flat sheet segment. The technology permits efficient entry into the flat sheet segment on a much smaller scale, allowing minimills to compete for a slice of the hitherto forbidden flat sheet market. Without entry into the flat sheet segment, minimills are forced to compete for niches in the non-flat categories or to stake out geographic strongholds. In 1983, Nucor experienced its first sales decline under CEO Ken Iverson – perhaps a telling sign that the company must expand outside of its traditional focus. FLIES IN THE OINTMENT The promise of thin-slab casting is indubitably enticing, but is it practicable? What are the risks that could throw a spanner in the steel works? Technological Chief among the risks is the uncertainty surrounding the very technological viability of thin-slab casting. The two most promising approaches in the 1980’s were the Hazelett Caster

and Compact Strip Production (CSP). Initial experiments with the Hazelett Caster yielded mixed results – the process created many problems that overshadowed the promise of continuous 2

casting. For CSP, experiments did yield positive results, but no tests had yet been done on a production basis. The lack of testing with continuous operation is particularly worrisome given that the CSP process must achieve a stringent 96% reliability to be cost-effective. Nucor had already spent $6 million on a Hazelett caster. If further tests were to be performed on CSP, a second-hand cold rolling mill could be bought and renovated for $11 million. Technological leapfrogging is another important consideration. Direct casting techniques were projected to become commercially viable in 14 more years. Even if further tests on CSP or the Hazelett caster could prove its production feasibility, would it be worth it to invest in thinslab casting in the interim, with the possibility that it could become obsolete by the turn of the century? In addition, SMS - the company that invented CSP, would be sure to promote the technology to as many steel mills as it could; Nucor Steel would be grappling with the twin risks of obsolescence and imitation. Financial Building a new thin-slab minimill will cost Nucor a projected $280 million. The firm also has a joint venture with Yamato Kogyo that is projected to cost $175 million. These projects would be undertaken in parallel and would stretch the firm substantially outside of its target maximum of 30% debt-to-equity ratio. Nucor has a preference for not issuing new stock, so the combined financing for two new plants would push its debt-to-equity ratio up to 55%.
1987 Capital Expenditures Discount at 8.34% 8.34% 100,000,000 92,306,272 Capital Budget in 1986 Less Cash and short term securities Amount to finance Current Debt Current Equity Current Debt to Equity Ratio 1988 250,000,000 213,011,197 1989 60,000,000 47,189,447 352,506,916 185,000,000 167,506,916 42,148,000 383,699,000 11%

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New Debt to Equity Ratio

55%

Figure 2: Financial impact of investment in Yamato-Kogyo and CSP mill Source: HBS page 14 (Assumption: 8.34% is average of Grade A corporate bond rate and T-bill rate)

Competitive If Nucor decides to compete in the flat sheet market, it will face challenges from incumbent conventional mills, other minimills, and imports. 75% of the conventional mills’ shipments are flat sheet, so these firms can be expected to fight tooth and nail to avoid being pushed out of their remaining stronghold. Other minimills may also be expected to follow Nucor’s lead in adopting CSP because it would give them the same entry into the untapped flat sheet market. To compound matters, Japan and Canada already produce quality steel for the

high end of the segment, while cheap imports flood the low end of the segment. SILVER LININGS Given the many serious risks that might derail Nucor’s plans to build a thin-slab minimill, should metallurgist Ken forget the whole concept and concentrate instead on exploiting non-flat niches? While the way ahead is uncertain, there are mitigating factors and other options that Nucor Steel can explore. Technological To prove that CSP is indeed commercially viable, Nucor should consider investing the $11 million dollars needed to renovate the cold rolling mill in Germany. This would be a small investment when compared to potentially banking $280 million on a procedure that isn’t production-ready. To quell the question of leapfrogging, Nucor should practice more stringent capital budgeting standards and project the present value of the annual operating income from the thin-slab minimill and compare this against its present cost. For example, the following simple calculation shows a positive net present value for the minimill - therefore it should be undertaken.

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Tons shipped /year HR CR 500,000 350,000

Income/Ton 81.5 107.5

Total Income 40,750,000 37,625,000 Less PV Construction Cost Total NPV

PV $329,418,327 304,156,185 352,506,916 $281,067,596

Figure 3: Simple capital budgeting model for Nucor thin-slab minimill Source: HBS Exhibit 12A and 12B (Assume 8.34% rate of return)

The question of imitation by other minimills is more challenging. In Nucor’s favor, the only minimill that could or would likely imitate is Chaparral. Minimills such as North Star and Northwestern Steel and Wire have suffered financial losses that make them unlikely to invest in new technology, while other minimills like Florida Steel are regional specialists and would not likely imitate unless Nucor encroached on their geographic territory. Financial The necessary financing to build the thin-slab mill would push Nucor’s debt-to-equity ratio up to 55% - a whopping 25% jump over their 30% target. While alarming, this debt-toequity ratio is actually in the normal range for the 3 largest integrated U.S. steel makers. One could argue that since Nucor is breaking into the flat sheet segment and playing with the big guns, that they should adjust their ratio targets. Being highly leveraged is a concern though, and given Nucor’s policy, this might be a deal breaker for investing in the thin-slab minimill in parallel with the Yamato Kogyo joint venture. Competitive Nucor is confident that it can penetrate the low end of the flat sheet segment - the labor cost advantage from CSP is sufficiently low to be on par with the freight costs incurred by imports. The first plant’s capacity could therefore target the low-end segment and leave the high-end segment for the high-quality imports and the integrated steel makers. Nucor can also focus its production on cold rolled flat sheets that offer a higher return with a lower quantity

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demanded. Again, this would encourage the integrated steel mills to accommodate Nucor, instead of competing head-on. DECISION TIME Given the rewards, probable risks, and mitigating factors in Nucor Steel’s decision, I believe that Nucor should strongly encourage SMS to perform more tests with a pilot plant of industrial scale. With its strong expertise in building plants, Nucor could contribute to the effort with capital and human resources. This offer would be attractive to SMS since no other steel mills are considering investing in CSP as of yet. In addition, such an experiment could only help SMS to market its efforts to other steel mills. For Nucor, this would lessen the chief uncertainty in its decision – namely, the commercial viability of the CSP technology. This route would also allow Nucor to complete its joint venture with Yamato Kogyo first, instead of undertaking two large projects in parallel, especially when one of the projects is as risky as the CSP minimill. While it is true that another minimill such as Chaparral could leap on the CSP technology first, Nucor could still profit from becoming a fast follower. Indeed, Nucor would be the most able imitator given its operational expertise in building and running plants. If another mill, either mini or integrated, proves that CSP is viable, then Nucor would be the quickest to leap on the bandwagon and cash in. “Good managers make bad decisions,” says CEO Ken Iverson. A culture of innovation and risk-taking is one of the key factors that make Nucor the most progressive steel mill in the U.S. The risks must be justified by the rewards however and minimized as much as possible given the competitive environment. I think Nucor has time to evaluate CSP further and still reap rewards from thin-slab casting. Sometimes, the wisest course is to wait and see.

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