ESSAR STEEL – IMPLICATIONS OF CEO DECISION ON

CORPORATE STRATEGY.

Mr. Dilip Oommen, CEO and MD, Essar Steel told in an interview of Steel Insights, “Extra pellets if any
will be sold.” 1 This statement was on account of commissioning of 6 mtpa pellet plant at Paradip,
Odisha and it came as an element of surprise as none of the steel players in India has followed such
strategy at any point of time. It was because steel market in India was highly regulated till
liberalization and afterwards companies focused on increasing markets, revenues and number of value
added products through organic and inorganic growth strategy. This was the first time any steel
industry focused on revenue generation by selling the product in market which in itself is used for
captive consumption. Is this strategy synergistic with current trends in Steel Industry of India? If yes,
how will Essar implement such strategy and what will be its revenue model and cost structure?

Essar Group of Industries

Evolution

In 19th century, the Ruia family moved to Mumbai and set up their own business. In 1956, Mr
Nandkishore Ruia, father of Mr Shashi Ruia and Mr Ravi Ruia, moved to Chennai, capital of the
south Indian state of Tamil Nadu, to begin independent business activities. He mentored his two sons
in the intricacies of business. When Mr Nandkishore Ruia passed away in 1969, the brothers laid the
foundation of the Group.

The Essar Group began its operations with the construction of an outer breakwater in Chennai port. It
quickly moved to capitalize on every emerging business opportunity, becoming India’s first private
company to buy a tanker in 1976. The Group also invested in a diverse shipping fleet and oilrigs,
when the Government of India opened up the shipping and drilling businesses to private players in the
1980s.

Then, in the 1990s, Essar began its steelmaking business by setting up India’s first sponge iron plant
in Hazira, a coastal town in the western Indian state of Gujarat. The Group went on to build a pellet
plant in Visakhapatnam, and eventually a fully integrated steel plant in Hazira.

Through the 1990s, with the gradual liberalization of the Indian economy, Essar seized every
opportunity that came its way. It diversified its shipping fleet, started oil & gas exploration and
production, laid the foundation of its oil refinery at Vadinar, Gujarat, and set up a power plant near the
steel complex in Hazira. The construction business helped the Group build most of its business assets.
Essar also entered the GSM telephony business, establishing India’s first mobile phone service in
Delhi (branded Essar Cellphone) with Swiss PTT as the joint venture partner.2

The 21st century for the Essar Group has been all about consolidating and growing the businesses,
with mergers and acquisitions, new revenue streams and strategic geographical expansion.

Business in India

1
“Extra pellets, if any, will be sold: Essar Steel”: Exclusive interview of Mr. Dilip Oommen, CEO Essar Steel and Mr.
Pramod Gupta, Head Paradip plant with Steel Insights magazine on 22 May, 2012.
2
Genesis and Evolution of Essar Group of Companies;
http://www.essar.com/section_level1.aspx?cont_id=FENytf1sB94=, last accessed on 16 May 2013.
Essar group has diversified into many businesses ranging from Steel to Publishing. Briefing of all
businesses of Essar Group is as below;3

Essar Steel 4

We are a fully integrated flat carbon steel manufacturer – from iron ore to ready-to-market products –
with a current capacity of 14 million tonnes per annum (MTPA). Our products find wide acceptance
in highly discerning consumer sectors such as automotive, white goods, construction, engineering and
shipbuilding.

Essar Energy

Essar Energy is a world-class, low-cost, integrated energy company focused on India and positioned
to capitalize on India’s rapidly growing energy demand. We have an established track-record and
assets worth US$12 billion across the power and oil and gas industries

Essar Oil and Gas

Essar has a global portfolio of onshore and offshore oil and gas blocks, with about 35,000 sq km
available for exploration. We have over 750,000 bpsd (barrels per stream day) of global crude-
refining capacity (Vadinar+Stanlow+Kenya). In marketing, the company operates a network of over
1,400 retail outlets across India, with another 200 under various stages of commissioning.

Essar Ports

Essar Ports develops, owns and operates ports and terminals, and is India's second-largest private
sector port and terminal company by capacity and throughput. The company's ports business is held
by Essar Ports Limited (EPL), which is listed on the Bombay Stock Exchange and National Stock
Exchange of India. EPL, which was previously named Essar Shipping Ports & Logistics Limited
(ESPLL), recently went through a demerger process pursuant to which the shipping, logistics and
oilfield drilling businesses were demerged from ESPLL and transferred to another company

Essar Projects

Essar Projects Limited (EPL) is a class-leading Engineering, Procurement and Construction (EPC)
contractor offering innovative execution and delivery solutions to its clients in multiple sectors for
projects of scale and complexity, whilst managing diverse technological interfaces

Essar Telecom

With almost a decade-and-a-half of experience in the telecom business, Essar’s expertise in

telecommunications is unquestioned. In Kenya, Essar became the country’s fourth telecom operator
with the launch of its cellular services brand ‘yu’. A GSM-based mobile services network, yu has over
three million subscribers.

Consumer durables and IT retail

India's first countrywide chain of multi-brand and multi-service outlets in the telecom retail space —
The MobileStore — was launched by Essar in 2007.

3
Corporate Profile – Essar Group; http://www.essar.com/section_level1.aspx?cont_id=SD7sjPUVBkw=, last accessed
on 18 May 2013.
4
Profile – Essar Steel (India) Ltd.;
http://www.essarsteel.com/section_level1.aspx?cont_id=torXTeKrpXc=&path=About_us_%3E_Profile, last accessed on
17 May 2013.
Today, The MobileStore currently runs over 900 outlets in over 150 Indian cities and towns. The
MobileStore is the largest Indian telecom retail network in the organized sector.

Essar Realty

Equinox Realty, headquartered in Mumbai, made its entry into the real estate business in 2007. It has
grown rapidly since its inception and has a current portfolio of approximately 16 million sq. ft. under
various stages of development. A part of the multinational conglomerate, Essar Group, it is currently
present in the Indian states of Maharashtra, Karnataka, Gujarat and Madhya Pradesh.

Essar Shipping

Essar Shipping is an integrated logistics solution provider with investments in logistics services, sea
transportation and oilfield drilling services. Essar's logistics business provides end-to-end logistics
services – from ships to ports, lighterage services to plants, intra-plant logistics and dispatching
finished products to the final customer. We own transhipment assets to provide lighterage support
services, and onshore and offshore logistics services. We also manage a fleet of 5,000 trucks for the
inland transportation of steel and petroleum products.

Essar Steel (India) Ltd.

Background

In year 1976, Essar Gujarat Limited was incorporated as Essar Construction Limited. The Company
undertook specialized marine construction activity, offshore installations, drilling for oil and gas and
manufacture of hot briquetted sponge iron. The Company is a part of Essar Group of Companies and
is a subsidiary of Essar Investments Ltd. The Company is divided into 4 divisions as,

(i) Essar Offshore - It undertakes lying of submarine oil and gas pipelines, submarine
outfalls, underwater rock drilling and blasting and dredging activities.

(ii) Essar Energy - This unit is the first of its kind in the private sector to own and operate
super-deep land drilling and rigs. The division was awarded the World Bank aided contract for
operating 4 mobile rigs for drilling oil.

(iii) Essar Construction - The division specialises in breakwater construction, ore and oil
berths, Wharfwalls, over ground and underground storage silos etc. and

(iv) Essar Steel - The division manufactures hot briquetted sponge iron.5

In year 1989, Essar Steel installed 2 DRI modules at Hazira with capacity of 0.9 mtpa. This increased
to 1.5 mtpa by installation of another DRI module in 1993. This was increased to total capacity of 3.5
mtpa in 2003 after commissioning steel capacity to 3.6 mtpa in 2002. Afterwards in 2007, Essar
installed fifth DRI module increasing DRI production capacity to 5 mtpa. In FY 2011, Hazira
complex of Essar doubled its capacity of steel production.

Along with growth in steel manufacturing capacity, Essar Steel followed organic growth where in
1997, it spread out in Indonesia and diversifying into value added products of steel when it started
production of Cold rolled and Galvanized coils. The capacity of plant was increased to 1.2 mtpa in
2006.

Essar for ramping up production capacity followed inorganic growth strategy as well at different
points of time and particularly to develop international presence. It was first implemented when it

5
Web article on Essar Steel History; http://www.moneycontrol.com/company-facts/essarsteel/history/ES01#ES01, last
accessed on 20 May 2013.
acquired Algoma steel and Minnesota steel in 2008 and then acquired Shree Pre-coated steels, Pune in
2010 finally acquiring Servosteel, UK in 2011.

Organic or Inorganic acquisitions followed by Essar were linking to its basic strategy of vertical
integration. It started with Iron and Steel production and then vertically integrated from Pellet
production to Essar Hypermart (where final products of Essar Steel are sold directly to customers).
Essar Steel started its 3.3 mtpa pellet production plant in Vizag (formerly Vishakhapatnam) in 1999
which increased to 8 mtpa in 2007. In same year, it also commissioned 8 mtpa beneficiation plant and
267 km long slurry line (longest slurry pipeline in India). In 2010, Essar commissioned Plate and Pipe
Mills at Hazira complex. On customer side, it started Essar Hypermart in 2006 to directly reach the
customers coming under unorganized sector of steel market. With this, it also established 3 service
centers across India in 2009 and finally commissioning service center in UAE in 2012.6

The detailed portfolio of products with technologies used in production and process is described in
Exhibit – 1.
Steel Industry of India

Background

The establishment of Tata Iron and Steel Company (TISCO) in 1907 was the starting point of modern
Indian steel industry. Afterwards a few more steel companies were established namely Mysore Iron
and Steel Company, (later renamed Vivesvaraya Iron & Steel Ltd) in 1923; Steel Corporation of
Bengal (later renamed Martin Burn Ltd and Indian Iron & Steel Ltd) in 1923; and Steel Corporation
of Bengal (later renamed Martin Burn Ltd and Indian Iron and Steel Co) in 1939. All these companies
were in the private sector. Key events of Indian Steel Industry are tabulated in Exhibit – 2.

Steel manufacturing got importance from first five year plan onwards and continues to gain
importance till date as it plays a major role in socioeconomic development of country. During 1950s
and 1960s the growth rate persisted to be above 8% and it was foreseen to have good growth in future
leading to birth of NN Steel (India) Ltd. as a construction unit in 1967.

The decades of 1970’s and 1980’s showed growth rate of 5.7% and 6.4% per annum respectively, far
behind expected growth of steel industry credited to closed economy and dominance of public sector
steel units which could not use their resources efficiently.

Till early 1990s, when economic liberalization reforms were introduced, the steel industry continued
to be under controlled regime, which largely constituted regulations such as large plant capacities
were reserved only for public sector under capacity control measures; price regulation; for additional
capacity creation producers had to take license from the government; foreign investment was
restricted; and there were restrictions on imports as well as exports.

Undoubtedly there has been significant government bias towards public sector undertakings. But not
all government action has been beneficial for the public sector companies.

However, after liberalization—when a large number of controls were abolished, some immediately
and others gradually—the steel industry has been experiencing new era of development. Major
developments that occurred at the time of liberalization and thenceforth to were:

➢ Large plant capacities that were reserved for public sector were removed;
➢ Export restrictions were eliminated;
➢ Import tariffs were reduced from 100 percent to 5 percent;
➢ Decontrol of domestic steel prices;

6
Essar Steel – Milestones;
http://www.essarsteel.com/section_level1.aspx?cont_id=nvx53tv3Wx0=&path=About_us_%3E_Milestones, last
accessed on 21 May 2013.
 ➢ Foreign investment was encouraged and the steel industry was part of the high priority
industries for foreign investments and implying automatic approval for foreign equity
Participation up to 100 percent; and
➢ System of freight ceiling was introduced in place of freight equalization scheme.7

As a result, the domestic steel industry has since then, become market oriented and integrated with the
global steel industry.
Current Scenario

Steel industry has a major role to play in the economic growth of India. With new global acquisitions
by Indian steel giants, setting up of new state-of-the-art steel mills, modernization of existing plants,
improving energy efficiency and backward integration into global raw material sources, India
nowadays is on the centre of the global steel map. Consumption of steel in the construction sector,
industrial applications and transport sector has been on the rise and special steel usage in engineering
industries such as power generation, petrochemicals and fertilizer industry is also growing.

India’s economic growth is contingent upon the growth of the Indian steel industry. Consumption of
steel is taken to be an indicator of economic development. India occupies a central position on the
global steel map, with the establishment of new state-of-the-art steel mills, acquisition of global scale
capacities by players, continuous modernization and up gradation of older plants, improving energy
efficiency and backward integration into global raw material sources.

The global steel scenario is in favour of steel producers, as restocking in countries such as Europe and
North America has led to a recovery in 2010, after the slump in 2009. Worries, if any, were on the
raw material front; both iron ore and coal prices have begun to increase again in recent months. But
companies have used the stronger demand environment to hike prices to end users, which should
offset the impact of higher costs on margins, to some extent. Companies have also been disciplined in
keeping production under check, with utilization falling to the 73%-75% range in the second half of
2010, compared with the highs of 83% seen in April 2010.

India has recorded a growth of over 8.6 per cent, producing 6.35 MT of steel in March 2011 as against
5.85 MT in the corresponding month in 2010, according to World Steel Association (WSA).

Steel is manufactured as a globally tradable product with no major trade barriers across national
boundaries to be seen currently. There is also no inherent resource related constraints which may
significantly affect production of the same or its capacity creation to respond to demand increases in
the global market. Even the government policy restrictions have been negligible worldwide and even
if there are any the same to respond to specific conditions in the market and have always been
temporary. Therefore, the industry in general and at a global level is unlikely to throw up substantive
competition issues in any national policy framework. Further, there are no natural monopoly
characteristics in steel. Therefore, one may not expect complex competition issues as those witnessed
in industries like telecom, electricity, natural gas, oil, etc.

This, however, does not mean that there is no relevant or serious competition issue in the steel
industry. The growing consolidation in the steel industry worldwide through mergers and acquisitions
has already thrown up several significant concerns. The fact that internationally steel has always been
an oligopolistic industry sometimes has raised concerns about the anticompetitive behaviours of large
firms that dominate this industry. On the other hand the set of large firms that characterize the
industry has been changing over time. And today, Steel Industry has become a fragmented market
especially after liberalization.

7
Report on Steel Industry by CCI (Competition Commission of India) published in January 2009 in association with
Indicus analytics, New Delhi.
Current Position of Essar Steel (India) Ltd. in Indian Steel Industry

Indian Steel Market is highly fragmented in nature with presence of SMEs and non major companies
involved in production of particular steel product. These SMEs and companies account for just more
than 50% of Steel production and sales.8

Remaining of the pie is almost symmetrically distributed among SAIL (Steel Authority of India Ltd.),
VSP (Vishakhapatnam Steel Plant), Essar Steel (India) Ltd. and others. In the fragmented steel
market, JSWL (Jindal Steel Works Limited) is the market leader with approximately 14% market
share followed by SAIL with approximately 12% market share. Essar Steel (India) Ltd. currently has
6.98% market share marginally more than TATA Steel Limited ranking 3rd overall after JSWL and
SAIL. The market shares of the major steel players of India are as follows,

Market Share of Major Steel

Manufacturers
SAIL TSL VSP Essar JSW Ispat JSWL JSPL Other

11.71%

6.97%
3.04%

6.98%
52.07%
4.04%
13.61%

1.59%

Chart: Market Share of Major Steel Industry player

Implication of strategic initiative by Essar Steel India Ltd.

Dilip Oommen made this statement in the press considering the operations strategy of Essar Steel as it
will be having excess capacity of Pellet production after installation of 6 mtpa plant in Paradip. This
alternate strategy will optimize operational performance but it will demand changes in revenue and
cost structures along with transaction type and legal consideration of agreement of sale of pellets.

The focus here will be the process point where pellets are transferred to Iron manufacturing plants.
After implementation of this strategy, pellets will simultaneously used for captive consumption as
well as sold in market. Essar Steel has to follow absorption costing where previous costs involved in
production of raw material (here pellets) are absorbed on intermittent/final product in value chain
(here iron) thus on a whole, all the costs from mining and calibration of Iron ore to production of HR
coil are included in final cost of HR Coil. Thus, if at any process point the cost is changed it will
affect the costs of final products.

8
Author’s analysis from data available from website http://www.steelworld.com/ispro.asp, last accessed on 25 April
2013.
For fair dealing and competition, Essar steel will have to use the sale price of pellets as absorbed cost
for reference in further process. Costing department has been notified to deliver a decision on whether
to use indigenously produced pellets or should they also buy pellets from other suppliers. As a matter
of quality maintenance, Essar Steel follows a strict policy of only accepting orders qualifying their
rigorous criteria. Refer Exhibit – 3 for relevant data for analysis. What should be there decision
framework for this strategic initiative?
Exhibits

Exhibit – 1: Essar Steel Product Portfolio with technologies.

Iron Ore Procurement

Technologies Beneficiation Plant

Iron Ore Pellets Calibrated Lump Ore (CLO)

Hot Briquetted Iron –
Direct Reduced Iron

COREX Furnace Iron Production Process

Blast Furnace

Steel Production
Process
Simple Caster Products

INI Caster Steel Slab Production Steel Slab

CSP Caster

Normalized Plate
Plate Mill
Shot Blasted Plate

Hot Strip Mill

Steel Coil Production Hot Rolled Coil

CSP Mill
Cold Rolled Coil

Pickled Coil
Cold Rolling Mill

Galvanized Coil

Down Stream Complex Down Stream Coil

Colour Coating Complex Polymer and

Colour Coated Coil

HSAW Pipe
Pipe Mill
LSAW Pipe
Exhibit – 2: Key events of Steel Industry

1907 Tata Iron and Steel Company set up.

1913 Production of steel begins in India.
1918 The Indian Iron & Steel Co. set up by Burn & Co. to compete with Tata Iron and Steel Co.
1923 Mysore Iron and Steel Company set up
1939 Steel Corporation of Bengal set up
1948 A new Industrial Policy Statement states that new ventures in the iron and steel industry are to
be undertaken only by the central government.
1954 Hindustan Steel is created to oversee the Rourkela plant.
1959 Hindustan Steel is responsible for two more plants in Bhilai and Durgapur.
1964 Bokaro Steel Ltd. is created.
1969 Essar Steel (India) Ltd. is set up.
1973 The Steel Authority of India Ltd. (SAIL) is created as a holding company to oversee most of
India's iron and steel production.
1989 SAIL acquired Vivesvaraya Iron and Steel Ltd.
1993 India sets plans in motion to partially privatize SAIL.
(Source: Report on Indian Steel Industry by Competition Commission of India, January 2009)

Exhibit – 3: Costing data for Iron Manufacturing process.*

(In Rupees/tonne, else stated)

Annual Net Selling Production Raw Material Fixed Asset

Plant Output (KT) Price Cost Cost (of Pellets) (in Rs. Cr)
HBI-DRI 847 15,681 14,731 12,422 1800
Blast Furnace 219 16,575 14,946 12,505 1200
COREX 420 16,874 16,028 15,342 2000

Other relevant data

1. Market dependent Expected Rate of Return (for Pellets) is 6.5%.

2. Selling Price per tonne increases by 2% for all products.

(*Data for representational purpose only)