Presentation to Steel Survival Strategies, New York, June 23, 1999

On the Brink of Change

US integrated steel producers have come to the brink of change in their ability to implement strategies for growth based on more cooperative and effective labor-management relations. But, they have yet to regain the strategic initiative from non-union producers.

The industry seems to have hit a roadblock that has it circling, talking and apparently agreeing about issues, but generating only sparse action. It would seem either that:

a) the companies and the union do not really agree on the importance and urgency of developing a strategically useful form of cooperation;

b) the two parties have divergent goals;

or c) change is being approached in the wrong way.

In fact, these are all true.

The Importance of the Labor-Management Issue

There should be no doubt that a strategically useful labor-management relationship is critical to the industry’s survival and growth. The division between union and non-union companies in the industry is a clear fault line and one that's hard to cross. On one side of it, non-union mini-mills have expanded aggressively over the last twenty or so years with a distinctive brand of innovative technology, organization and commercial policy. On the other side, predominantly integrated unionized mills have seemed in almost perpetual retreat.

For the most part unionized mills produce flat rolled, but they also include older facilities producing everything from rebar to engineering bar and seamless tube.

A few steel groups, for instance North Star and Ipsco, successfully manage both unionized and non-unionized facilities. But the attempt to manage both often presents problems, as in Dofasco’s acquisition of Algoma, Oregon’s acquisition of CF&I in the other direction, investment in Trico. Managing in both segments has proven to be a tough task and serves in turn to reinforce the differences.

Given these proven difficulties of managing both union and non-union facilities, the consolidation of the industry across the union/non-union line rarely happens. It is thought highly unlikely that a non-union company would acquire a unionized business, which would be necessary to consolidate the structural long products business. And similarly, the unionized segment has been reluctant, except in a few small instances, to make acquisitions of downstream processing or distribution assets where the targets have been non-union.

The fault line is important because it makes the US industry structurally rigid. It inhibits the growth of successful firms on either side of it, because it makes growth by acquisition and merger more difficult to manage and more risky. In doing that, it contributes to industry fragmentation and lessens the role of US producers globally. Finally, it divides two industry segments that achieve very different levels of performance. This leaves the US industry, as it has for the last 20 or so years, with only one favored way to change, namely by a process of creative destruction in which new non-union capacity drives out established unionized firms.

Two Segments two levels of performance

The chart below maps the performance of selected union and non-union companies by two measures - annual sales growth and cash flow return on net assets over the period 1990 to 1998. With the exception of a couple of outliers, the unionized companies cluster in circle A and the non-union companies cluster in the upper right in circle B. All the non-union companies have achieved average sales growth of over 5% per year and average cash returns of 12% or above. Two unionized companies have achieved the same level of cash return, but only one, AK Steel, has also achieved sales growth of over 5%.

There are obviously other factors besides unionization that affect this differential, including the age of the companies, the variety of their activities, and chosen product segments.

And this is not to say that being unionized determines organizational success or failure. Just as there are mediocre and poor facilities in the non-union segment, so there are examples of outstanding unionized performance within the aggregated data shown above. However, the strategic issue is this; that generally superior corporate performance of the non-union segment attracts to it, and away from the unionized segment, a greater share of capital and human resources.

The Labor-Management Impact on Investor Choice

The fault line only has impact as long as the segments on either side of it continue to look and operate distinctly, and offer very different prospects to investors. This had led capital to flee the unionized sector to back mostly greenfield, non-union investments. In order to combat this, unionized companies have tried to define new investments in the same terms, viz. off-site, non-union, greenfield. North Star Steel, for instance, that has operated both union and non-union businesses successfully, chose to operate its most recent investments as non-union facilities.

And non-union status is considered desirable, not because the rates of pay or the broad conditions of work are dramatically different, but because work organization and work re-organization will be. Work will be unencumbered by a complex contract and accepted practice so that workforce flexibility can be maximized.

Of course there are a few contrarian investors, like ISPAT and The Blackstone Group, that have chosen to invest in the unionized portion of the industry rather than build new. But this investment strategy also follows the logic of the fault line. Assets in their target segment are generally sold at discounted value because their prospects are viewed poorly relative to alternatives. If there were no distinction between the two segments, asset valuations would likely make this strategy less viable. (ISPAT’s Inland acquisition was something of a departure from this pattern).

The reason that investors have preferred greenfield investment over the strategies pursued by ISPAT and The Blackstone Group is that dramatic transformation of existing facility performance has proven elusive except in one or two cases. It has always been easier and faster to build something the way you want it from the start than to try to get there from old, established, hidebound operations.

Labor-Management Relations & Change by Displacement

As already noted, the superior performance of non-union mini-mills and their attractiveness to investors has led to a typical pattern of change in the US industry whereby new entrants displace incumbents. As an example of the speed and intensity of integrated mill dislocation, the growth of mini-mill hot rolled market share in only five years is shown here.

It is this kind of rapid incursion into product line after product line that has driven the growth of the non-union industry segment and hastened the exit of integrated production.

The combined effects of similar retreats from products it was no longer possible or desirable to defend, and the need to improve productivity in the remaining product lines has dramatically changed industry employment. Estimated unionized industry employment (including salaried) between 1974 and 1998 fell by more than 80%, from about 500,000 to about 100,000. At the same time, non-union employment grew from an estimated 10,000 employees in 1974 to approximately 70,000 employees in 1998.

The mini-mill threat to enter any and every product line has had its benefits, chiefly by forcing the integrated industry to adapt. A recent working paper published by the OECD analyzed the relative productivity of integrated mills in the US producing cold rolled as compared to mills in Europe and Japan between 1980 and 1995.

The results, shown below, identify that the US mills were estimated to have a slight man-hours per tonne edge on both the Japanese and European mills, and to have improved productivity by over 40% since 1980. But while incremental change has been achieved at unionized integrated mills, change sufficient to restore a growth trajectory has been elusive.

To some extent, this is because the same mini-mill pressure that helped drive improvements has left insufficient time for labor-management relationships to evolve before the next round. The fastest, most effective integrated response to pressure has been to exit threatened products. And this has been the preferred method of defense and consequently the way by which the US industry overall has achieved most change. In other words, while the pressure to change the way of working together has been perhaps the greatest in the US integrated industry, the environment in which to achieve it gradually has been one of the poorest.

As a consequence, change has very often only come out of the trauma of Chapter 11, with new owners reaping the benefits, or through ESOP-type reorganization. But while these ‘safe harbors’ have given producers an explicit agenda and more time for reorganization, they have (without an ownership change) often proved more successful at preserving ways of doing things than really changing the nature of methods and practices.

All this stands in contrast to the kind of change achieved in Europe, or that now going on in Japan, where there is greater focus on allowing existing institutions time to change, rather than freeing competitive forces to displace them.

Opportunity to Improve?

There are signs however, that the intensity of change by displacement has relented. First, the logic of continuing to retreat to higher value added flat rolled products is not open to all integrated mills. AK Steel has perhaps been most aggressive in maximizing its percent of value added products. AK forecasts that, by the end of 2000, less than 5% of its output will be in the form of hot rolled coil.

But this is a strategy that only a few mills can successfully pursue. There isn’t enough room at the top of the pyramid for everyone. So most producers will be forced to develop viable competitive strategies in the product lines they currently supply. This means that where there is no longer room to retreat from threatened product lines, survival will have to be achieved by change within the organization itself.

Second, mini-mill advantage in flat rolled products, while significant, is less severe than it was few years ago. In addition, the opportunities to build new flat rolled facilities to exploit the advantage are much fewer than they once were. Existing mini-mills will continue to expand current operations of course both in terms of melting and finishing, but this will be more gradual.

Third, there is evidence that displacement is a less effective strategy than it once was. For instance, Qualitech had difficulty entering the engineering bar market in typical non-union mini-mill fashion, indicating perhaps a kind of high-water mark for "forced entry" strategies. The Blackstone Group’s alternative approach to extending their SBQ position by acquiring Republic Engineered Steels and joint venturing with USS/Kobe looks, for the moment, a more effective approach.

But Qualitech is only the most obvious example of frustrated entry. There are others. Most of the new flat rolled mills have found market entry troublesome for a variety of reasons and a number of proposed greenfield projects in the industry have foundered for lack of backing.

If it's true that "forced entry" has lost some of its effect, there would seem to be an opportunity, brief though it may be, for the integrated labor-management relationship to change in ways that the speed of retreat has not allowed for in the past. The opportunity cannot be wasted.

US unionized mills that have survived so far must now discover the difference between surviving to die more slowly and surviving to fight back and grow. They must be able to wring further productivity improvements from existing facilities to maintain competitive cost levels, improve asset utilization, minimize capital investments and develop differentiated customer service. In order to do this, they must show that change inside a unionized company does not have to come at the expense of new capital, bankruptcy or industrial action. They must show that détente and cooperation pay dividends in the form of improved competitive performance.

Developing Shared Goals

So if the issue of labor-management effectiveness can be shown to be vital to the strategic future of the unionized mills, is it divergent goals that hold up the industry’s progress?

The primary visible outcome of greater labor-management cooperation, and one of the keys to moving integrated growth and profitability performance into the non-unionized league, will be changed work systems. Important features of these new work systems include:

• Fewer job classifications, where employees work within broader job categories allowing assignment to a number of different tasks within and across work areas.
• Job rotation facilitated by employees training in multiple jobs within a given area. Work in teams, occasionally without supervisory oversight. Changes from seniority to competence-based job structures.
• And pay, much of which is variable, tied to performance and skills.

All these elements of a new work system are well known and some of them have already been adopted in whole or part in US unionized settings, mostly to accompany new capital investments. Yet despite widespread agreement over design changes, and commitments to proceed with innovative approaches to reduce employment and redesign work, actually changing the workplace has yet to move beyond slow, tentative experimentation.

The hesitancy to commit to more widespread rapid change seems to be rooted in deeper goal divergence – for instance jobs versus corporate health – tied to a skepticism on each side that cooperation will never really deliver what’s needed. On the company side this might be a lack of belief that superior performance will ever be achieved through union involvement. And on the union side, it might be a fundamental concern that industrial fairness can ever be reconciled with corporate success. If it really is the case, that the two parties have not spent enough time developing shared goals or rooting out real unexpressed concerns that cooperation won’t work, then they need to be addressed jointly and quickly. Or both will suffer.

The Approach to Change

Finally, are there ways in which the approach to change can be improved?

For the most part, the focus of change so far has been at too high a level in the management-union hierarchies. It is easier to establish urgency and align goals at the local level and within a single company than it is at the International level and across companies. This means that the focus of change and responsibility for change should be at the level of the plant (or even the department) and the regional or local union representatives.

A 1997 report by the International Labor Office in Geneva identified "devolution to single business units with related changes in management status and function" as one of six integrated developments that have driven change in steel plants around the world. This is not only good involvement practice, but it sets the change within the context of the unit that should develop the business strategy and achieve the financial targets. Not only that. Tthe kind of practice changes that can be seen to have a direct beneficial effect on the operating unit’s ability to deliver its strategy are often known only to those actually doing the job itself.

Pushing decision-making down to the level where the implementation takes place is as hard, if not harder, for the union to countenance as it is for traditionally centralized management systems. It has been an axiom of the USWA negotiating stance that centralized bargaining is vital to sustaining a ‘level playing field’ between producers in terms of labor costs. Contracts outside of the ‘pattern’ are actively discouraged.

Of course this position is compromised by a change of ownership or bankruptcy. Either of these events can precipitate more beneficial contracts and terms than exist in healthy companies. But there needs to be some alternative to these two negotiating modes, one that produces real change well before the company fails. The benefits of an influential centralized union have to be reconciled with the speed of response and apparent adaptability demonstrated by independent (sometimes derisively called ‘sweetheart’) unions.

Centralizing responsibility for change has two other benefits. First, it facilitates communication. Information about the nature of the business, the need for change and the ways to improve performance is still not getting far enough into the organization to make sufficient difference. Union officers and senior managers accept the needs for change, but the average employee is often not given sufficient information and training to understand it to know what’s at stake. Managers should communicate these messages directly with employees as well as with and through the union

Moreover, decentralization can help shared goal development by defining locally valid, credible and motivating goals for the change process. Work redesign, like quality circles, is too often measured in terms of employment outcomes not the impact on the business.

The targets for a partnership approach should be clear and verifiable performance measures that demonstrate the business’s increasing competitive strength such as operating profit per ton or returns to net assets. And to the extent that these improvements are achieved, so they will reduce the fault line’s stifling impact on value-creating corporate strategies.

Risk and the Labor-Management Relationship

Finally, the hesitancy in tackling the issue of workplace change more aggressively and quickly reflects a general conservatism and risk aversion in integrated mills and their unions. Most integrated industry change has been reactive. The motivation to change has come from outside forces and therefore those forces have been blamed for the unpleasant actions needed to adapt.

But the industry must become more proactive about change. Proactive change is harder because it means taking the initiative and the responsibility. It means finding the solution inside the company itself. It means making commitments to pursue those shared goals rather than to avoid undesirable penalties. And finally, it means taking action when all the evidence for why the actions are necessary is not available. In other words it means taking the risks that you choose to take not those that are imposed on you.

It is this entrepreneurial risk-taking behavior that has been so difficult for the integrated industry to develop – and even more difficult for the union to follow. But it is the key to achieving change and growth, which is the only way that the differential between union and non-union companies will be minimized.

Managers must lead this process. Too often good ideas have foundered because they relied on elected union officials’ ability to provide leadership that, in the final analysis, they could not risk. But managers providing determined leadership will test to the limit the partners’ commitment to cooperation.