Nanjing is not renowned for having a progressive, outward looking government, yet the reform of one of its loss-making state-owned enterprises shows that it is prepared to take the occasional risk.
Nanjing No. 2 Iron and Steel Works suffered many of the typical problems facing companies in the heavy industrial sector – excess workers, low productivity, inefficient working practices, poor quality control and furnaces that belched foul pollutants into the air. These problems were exacerbated by the onset of the Asian financial crisis and the resultant downturn in construction activity in China and across the region.
With pig iron prices plummeting, plants across China were contemplating closure. The Nanjing plant was a relatively small but highly unprofitable example making pig iron at Yn1,400 a tonne when the local sales price was just Yn1,000.
The local government was so desperate to find a solution that it was prepared to sell off part of the company to a foreign group and lay off more than half the workforce. In taking this radical decision, it helped that the current mayor of Nanjing was a manager of the plant a decade ago. A deal was struck in January 1999, giving the Swiss-based commodities group Glencore a 70 percent stake in a division of the company that makes pig iron. The original owners took the remaining 30 percent but they became silent partners in the project.
Predictably, the lay offs caused consider-able unrest, threatening the future of the entire project. However, the foreign management team persisted with its belief that the plant could be profitable without the need to make significant investment.
Indeed, local government and company officials were not the only ones breaking new ground when they decided to let this division fall into foreign hands. Glencore itself has little experience in direct investment, being primarily a commodities trader. None of the foreign management in Nanjing had worked in such a plant before, although they did get technical help from the likes of British Steel.
"We had no idea what we were doing except for a sense of business," says Mr. Dano Chan, vice general manager.
Previously, the group had taken a view that the development of the internet and other technologies was eroding the traditional advantage of the middleman – information. Glencore believes its trading days in steel are coming to an end. Now, it is an active direct international investor, with a steel operation in Russia and vanadium facilities in South Africa and Australia.
Sharp Base Steel, as the Nanjing plant is now called, is Glencore's first direct investment in the Mainland. The company had looked at 20 plants from Heilongjiang to Hunan before settling on Nanjing. Negotiations were smooth, despite all the political ramifications. The city took responsibility for laying off more than 700 of the 1,300 workforce, although much of the resultant anger was directed at the four foreign managers at the plant.
In the early days, general manager David Garcia was involved in four fistfights with disgruntled former employees. Elsewhere, a worker slept on a conveyor belt while others lay down on a railway line, preventing materials being transported within the plant complex. In May 1999 there were pickets at the gates, stopping inputs and finished products from coming in or out of the plant.
"The facility was on the edge of falling apart," says Chan. "There was low worker morale, we were running out of materials and the outdated equipment was in poor repair."
With just one week's worth of supplies, the plant was facing closure until the city authorities decided to act. Riot police with video cameras were sent to the picket line and the mob soon dispersed.
Stabilising the workforce
By June, production could continue but this was hardly a stable working environment, so Glencore moved quickly to improve morale. Workers were reassured about job security and for the first time they were issued with proper uniforms and a strict hard hat policy was enforced. Wages were kept at the same level as before but payments were actually made on time – previously, the salary back-log stretched back three months. Medical insurance was covered and living quarters were improved, with decent shower rooms and toilets installed. Divisional heads were given more power, including responsibility for salary reviews.
The second priority was to improve efficiency. Roads that used to get flooded during the rainy season were re-laid and the stockyard was cemented. Warehousing operations were fully computerised so managers could know exactly how much raw materials were in stock.
Some US$30,000 was invested in recycling water, cutting the amount of water used to produce a tonne of pig iron from 20 cubic metres to 2 cubic metres. Likewise, electricity consumption was reduced from 180kWh per tonne to 1 l0kWh per tonne. By improving machine maintenance, operating time increased from 85 percent to 97 percent. Proper conveyer belts were installed and the transportation of raw materials within the plant was simplified. Performance bonuses were introduced on the basis of operating efficiency – for example, pay is docked if machines break down or if inputs exceed a certain level. Likewise, workers are encouraged to save money by recycling and picking up spillage.
This year, some US$3m is to be spent on converting leaking gas into electricity, building a new pig caster and installing a coal injection system to reduce costs. These measures will improve efficiency further but Glencore's most impressive achievement has not been investing large amounts of money on equipment but in changing state enterprise mindsets. Glencore lost no time in sending out a message that it was no soft touch multinational with millions of dollars to spend on the plant. Much of the equipment, including the blast furnaces, dates back to 1958 when the company was founded. The furnaces are fundamentally sound, says Chan, and repair is much cheaper than construction.
The plant is certainly tidier and less chaotic than it was in the past, but its appearance has not changed all that much. The difference in efficiency, however, is profound. Chan claims Sharp Base Steel is now the lowest cost pig iron producer in China cheaper than the likes of Bao Steel and the economies of scale that such behemoths enjoy. Much of these productivity gains were achieved by the strict disciplining of workers. Several were sacked for sleeping on night shift and pay is docked for machines breaking down, spare parts going missing or simply for litter being dropped.
Relationships with suppliers and service providers, such as transportation firms, have also changed. In the heavy industrial sector, buying departments are frequently seduced with financial sweeteners and lavish entertainment. Sharp Base Steel immediately sought to professionalise its relationship with Chinese companies by basing its purchasing decisions on the quality of goods and services provided. Firms were financially punished for delivering poor quality, while all corporate entertainment provided by suppliers was fully reciprocated.
At the end of this year, output should reach 18,000 tonnes a month, a 50 percent increase on the performance of the old owners. Some 90 percent of output is exported, nearby Shanghai being the only place in China that pays cash for pig iron. Sharp Base Steel was Nanjing's fourth biggest exporter in 1999 and this year it expects to be in second place, behind Ericsson.
Reduced coal supplies
By the end of this year, most of the efficiency gains will have been reached. Labour costs are down to about 5 percent of total costs, about half the national average. However, while costs have been reduced, profits have been squeezed in China because of a 25 percent hike in coke prices the result of the government's closure of small coal mines across the country and the large number of train carriages that have been withdrawn from service since last October. Coal sup-plies from the north have been strangled and all producers have been impacted.
"The situation won't improve until the end of the year," says Chan. "Everyone is crying."
In little over one year, Glencore has recouped its investment in Nanjing and operations are running smoothly. The environment has been improved and the plant attained compliance of government pollution emission standards after just six months operations. The workforce seems more content with its lot – average wages are now 30 percent higher across the board and 80 percent higher for divisional chiefs. Glencore is not subsidising the housing and schooling of workers' families as in the good old days of Communist China, but in recent years these payments weren't being made anyway.
The one unresolved area between the government and the new owners is the payment of a retirement fund to workers based on the number of years service. Glencore, which was ignorant of this issue when it took over the plant last year, faces an exposure of some US$1m. Negotiations are still going on but, even if Glencore loses this battle, it seems a relatively small price to pay for its involvement in this groundbreaking venture.
The Swiss group is actively looking at future direct investment in China's metals industry, including possible involvement in more pig iron plants as well as copper mining, ferro-alloy production and aluminium smelting.
However, it is finding it difficult to strike a deal, mainly because of the reluctance of local governments and state enterprises to exacerbate worsening unemployment levels.
Glencore reckons it could expand its China production of pig iron to 1m tonnes and it has been in discussions with three large producers. However, in each case the stumbling blocks – usually laying off staff or writing off debts – have been too large to surmount. It is also common for prominent officials or company managers to block reform because of self interest.
Even so, future opportunities are likely to arise in the area of steel production, says Chan, since many Chinese operators are doomed to close. The recent hike in prices may be keeping them in business but a future economic downturn is likely to open the door once again.