Steel Pipes & Tubes is a commodity type of business, where for most of the products, the lowest cost producer benefits. For company to make profit they should mainly focus on their Revenue & Costing. Major cost of company comes from their raw materials. Hence, Raw Materials and Revenue are two major line items which determines profitability of Industry. Revenue realizations and Raw Materials costing are determined by our buyers and suppliers respectively. Hence, both the buyers for sales, and supplier for raw materials are important factor determining the Sales, its costs and finally profits.

As said, Revenue, Raw Materials and Profits are major items determining profitability of any company. Let us look at the data analysing these items for each company:

When you closely observe, “Reduced Gross Profit have been due to Increased Material Costs”. This means a lot of things:

1. With conjunction to the table below (Realizations per tonne), Buyers are purchasing pipes & tubes at flat rates or able to bargain very well leading to sub-normal realizations.
2. Suppliers are able to easily pass on increased costing to our industry.
3. Hence, when materials procurement is at lower cost, we enjoy the profits. When materials are procured at higher costs, we incur loss.

When we see realizations per tonne for the whole industry, they have never really grown and remain at flat levels for many years justifying point no. 1 above:

From the above, we get a hint regarding the bargaining power of our supplier & our buyers. We are exposed to supplier’s burden and does not really enjoy pricing power in front of our buyers.

A Steel Pipe & Tubes Company will be advantageous if they acquire Raw Material at lower cost or if they are able to sell at higher prices to suppliers. Companies will be able to command better bargains only if they buy raw materials in very huge quantities. Hence, economies of scale or higher production leads to higher demand for inputs, higher demand will allow company to ask for better discount. This is major source of scope to reduce input costs i.e. Economies of Scale.

But, the benefit of economies of scale is usually limited. Basic commodity prices like Billets, Bars, Sheets, Plates and Coils are determined by market forces. Companies usually accept the market determined prices and this leads to lesser bargain power for a pipe & tube manufacturer. These were all on the front of Raw Materials, but the system to execute Revenue is different for different companies.

Pipe companies are sometimes able to command a very high prices form their buyers. This is especially for companies who has clients demanding Pipes with specific requirement (Size, Grade, etc.). There are two types of clients on broad basis for Steel Pipes & Tubes segment. The first type if one who opens tender for their requirement (and most probably one who understanding costing of Steel Pipe Producers) and second who directly places order with companies (Clients with custom or specific orders). Let us understand these two revenue streams for better understanding of profitability:

1. The tender system is just simple to interpret. Buyer companies i.e. majorly government companies like IOCL, GAIL, BPCL, HPCL, etc. open tenders. In tenders anyone having licence and requisite approval (sought easily) can bid. The lowest bidder (low cost to buyer) is awarded the contract. Hence, the window to sell steel pipes & tubes is open for everyone in public, both domestic and international companies, companies try to take order by bidding lowest. Hence, with that, there is competition to acquire orders and so bidding process leads to less realization per ton, leading in turn to lower margins. Margins are stressed especially if international companies (they are very low cost producers) are allowed to bid, because generally international companies emerge as the lowest bidder. This states that bargaining power in tender based system is higher of the buyer, and when this happens the margins shrink and so is the profitability. Have a look at the snapshot of IOCL tender website:

Scuttlebutt activities states that due to competitive bidding, we need to sacrifice on margins to win the orders. On top, government companies are usually very slow to pay-off their dues. This leads to additional interest loss and working capital blockages. Hence, tender being not immediate profit opportunity and not a preferred revenue stream. Companies only bid for tender if they do not have good inflow of orders coming from other clients.

2. This is Order Based system. It is very important source of profitability and important source of continued profitability as well. Majorly companies like Ratnamani Metals have direct relation with big companies abroad and in India. They are in constant touch with them for their special requirements and custom requirement as well. This personal touch, long standing relationship and history of providing materials to them with lowest failure rate and highest quality is very important for big buyer companies. Majority of big buyers build their organization with high quality standards, long term relationship and benefit for all. Hence, where big organizations earn huge they happily give away share of their growth to the suppliers (i.e. here our segment) leading to pipe companies commanding higher prices. Add on top the reference of our company which these big companies give to others and leads to better prospect of making new clients. Also, the long standing trust, requisite certifications with the pipes manufacturers which are required by buyers and many small factors combine, leading to a better advantage for the pipe & tube manufacturer. Hence, new clients are made with referencing and long standing relation and replacement demand for pipes comes leading to higher profit and protected demand for our companies’ product.

Same can be observed in Profitability i.e. EBITDA/ton margins and especially for Welspun Corp. & Ratnamani Metals which are having a lots of clients of such nature internationally.

Realizations and profits therefore are high in case of companies with better relation, better quality products and long standing relation with clients. The tender based system is something where lowest seller emerges as order winner but often leads to lower margins.

Apart from above, realizations and profit margins also depends on many other factors. Application industry is one such factor. Why profits of Stainless Steel Seamless Pipes made by Ratnamani Metals and Gandhi Special very high? SS Seamless Pipes are used in very critical applications of Power, Aerospace, Defence, Automobiles, etc. Firstly, due to critical application the clients do not compromise on quality and rely on long term suppliers to buy their products. They focus more on quality and are ready to shell out more money. Hence, critical application of Pipes & Tubes leads to higher realizations and higher profitability. On the contrary, for basic requirement of pipes & tubes i.e. mainly for transportation purposes, the bargaining is usually on higher side which leads to lower realization and profits.

Another factor resulting in higher profitability and realizations is the complexity of the final product. Companies like Ratnamani & Maharashtra Seamless produce commodities which are complex to make. Ratnamani making welded “Titanium Pipes”, special alloy pipes, heat exchanger tubes & Monel/Inconel Products are niche category products for which there are limited suppliers in the World. Hence, they are able to have a good price command over their buyers leading to higher average realizations and EBITDA margins.

Hence, in a nutshell. Custom Requirements, Good Clients Relation, Complex End Product, Complex Applications brings in more revenue and profits.

We have understood the most important points so far for bargaining power of buyers and suppliers. Let us now focus on few other points:

• Ability to integrate backward/forward.

What if pioneers in steel business like Tata Steel, SAIL, Jindal Group, etc. starts producing Pipe? This could be a major threat for current Pipes & Tubes producers as the likes of SAIL, Tata Steel, etc. will clearly emerge as lowest cost producer in the market. This has already happened i.e. Jindal SAW & Maharashtra Seamless (on backing on JSPL and Jindal Steel) and Welspun Corporation (on backing of WSL) are already integrated producers involved in manufacturing and selling pipes and tubes.

APL Apollo in its Concall have indicated that they can start backward integration but as of now they are completely focused on ERW Pipes segment due to higher growth prospects. Also, Maharashtra Seamless is entering into JV’s to acquire pellets for steel making indicating the interest to start backward integration on standalone basis (despite backing of Jindal Group).

Hence, our suppliers very well can forward integrate into Pipes & Tubes segment, but for Pipes & Tubes industry, starting backward integration is also possible. Huge companies like SAIL & Tata Steel do not have Seamless and SAW capacities at all. What they have is only minimal and negligible ERW capacities. These companies have been around for too long, still they are not starting business into core pipes & tubes production. This gives a hint about least possibility for bigger companies to enter this segment.

As far as our buyers are considered, they hardly have power to integrate backward and start pipe production. It is completely a new line of business for them, and it requires special expertise and attention. If our buyers start producing pipes, it will be difficult to concentrate on their own core business. This is the reason why there are only few companies firstly in the market in steel pipes & tubes segment.

• Channel Influence.

ERW & Seamless pipes are of less weight per pipe, and require small quantities of custom size. Hence, they are sold through many dealers, stockiest and distributors of company. Selling through distributors and stockiest is not possible for heavy and high diameter SAW pipes due to problem of transportation and storage. Hence, many smaller markets in India store ERW & Seamless Pipes & Tubes. It is choice of distributors, stockiest and dealers as to which pipe to sell and at what prices. Companies provide product to Dealers at fixed costing, dealers have open choice to sell at whatever price they want, and that is their incentive i.e. difference between company price and selling price. They have another incentive i.e. in form of commission on selling certain quantity of tonnes monthly. Hence, if dealers sell at higher prices, less quantities will be sold w.r.t. lower priced competitors. Hence, dealers influences sale of company a lot.

One statement from my scuttlebutt revels “There is one man, who sells cost to cost i.e. buys from companies and sells at same price. He does a larger volume turnover in tonnes and earns handsome commission from company. He earns commission more than what he could have earned by selling at profit margins.” This states that channel influence is very important for ERW and Seamless Pipes.

Now, for dealers who are very important for company’s turnover, companies give better earning opportunity to them, because that in turn will bring sales and profits to companies through their distributors. Hence, in a way, distributors/dealers are our buyer and because of this unique channel influences, they are able to get better bargains from us. This is the reason why APL Apollo have huge dealer base followed by Surya Roshni. Currently, Surya Roshni has dealer network of 250. APL Apollo have extensively added distributors under its belt from 175 in 2011 to more than 800 currently.

I have tried to explain this porter’s force in detail. Look at the table below, pointing out few parameters to check whether bargaining power exists with buyers or suppliers:

Sr. No.	Points	Current Situation	Future Outlook	Reasoning	Data Extraction
1	Ability to integrate backwards.	We can integrate backward. Our buyers can’t integrate backwards.   Our suppliers are very source and they can integrate forward easily.	Backward/forward integration is not seen both by our buyer and supplier.	Commodity business working on low margins and market determined pricing. (Explained above)	A.R., Concall, Scuttlebutt, General Sense.
2	Buyers Substitute.	No Product Substitute.   Substitute within segment i.e. Import v/s Local (Lowest cost)   D.I. Pipe v/s SAW is possible substitute	Steel pipes application is unique and will not attract substitute in near future.   D.I. Pipes threat explained in “Threat of Substitute”.	Steel Pipes pressure handle, high life, lowest cost, etc. will not attract any substitute in future.	A.R., Concall, Scuttlebutt, General Sense.
3	Does industry need them more or they need the industry.	Our industry is very important and is required by water, oil, gas companies. Hence, buyer needs us.   Also, we are dependent on ISP for steel sheet, plate, coils, etc. So, we do need our supplier.	Steel Pipes & Tubes are very important commodities, hence our buyer needs us more for their steel requirements.	Most important commodity with no replacement.	A.R., Concall, Scuttlebutt, General Sense.
4	Buyer Information	For Tender orders: Buyer have all our information.   For Order to Make: They rely on cheapest supplier and do not know our costing.	Continue to remain same.	The norms of Tender and Order to make are around for long time. Hence, not expected to change easily.	A.R., Concall, Management Interviews.
5	Buyers concentrated or fragmented.	Tender Companies: Have very concentrated buyers. Usually Water, Sewage, Oil & Gas companies.   Order to Make Companies: Buyers are very fragmented. Companies like Auto, Solar Power, etc.	Buyers are concentrated in Oil, Gas government companies and expected to remain same.   Many buyers in other application/buyer industry and buyers might increase over time.	Less government companies like IOCL, HPCL, BPCL, etc. whereas there are lot of buyers across globe for other application industry.	A.R., Concall, General Research, etc.
6	Channel Influences.	For ERW/Seamless: Distributors /retailers /agents should push our products more leading to higher sales.   For SAW & Seamless: There is less channel influences as orders are usually to companies directly or tender system.	Continue to remain same.	ERW/Seamless Being light weight and small quantities require agents to push our products.   SAW/Seamless works on tender basis and order to make directly.	A.R., Scuttlebutt, Distribution network for Surya & APL Apollo and not for others, etc.
7	Price Sensitivity of Buyer leading to negotiations.   A) Undifferentiated Product. B) Expensive related to income. C) Inconsequential to own performance.	Our Pipe & Tube have no product differentiation (Hardly Any).   Some industry like Power, Oil & Gas: they are expensive relative to their income. No such case for other industries.   Very important product for buyer industry, hence it is consequential to buyer’s performance.	Continue to remain same.	When A, B, C are met, the bargain goes higher. They depend upon buyer to buyer and hence should be understood in context.	A.R., General Sense, Concall, etc.

Conclusion: An analysis of Revenue, Material Cost and Gross Margins state how our supplier are able to pass on their costs to us. But, unfortunately our dealings with customers are not favouring us. Apart from Gross Margin Analysis, we saw how Revenue and Profitability differs in case of Tender and Custom Orders, later giving us better profitability.

Better revenue and profitability is also available for critical application industry, critical and complex products, long standing relation with clients and so on. This is majorly applicable to Seamless Pipes & Tubes manufacturer and to an extend SAW Pipe manufacturer.

Hence, the rule of bargaining power of buyer and supplier depends on company to company and products to products. There is no fixed stance here and it depends on context, company’s business model, revenue stream, clients, product mix amongst others. But, to give a general comment on overall industry’s angle: Bargaining power of supplier is low, but for buyer it depends on companies and on products it sells.

 

Source: Link of Excel File containing all calculations.

 

Disclaimer: Views are personal and presented through independent research. By no means there is any stock advice. Also, presented content is for learning purpose only. I might be wrong in presenting data and inaccurate data, let me know if you find any discrepancies.