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Our strategy: "Klöckner & Co 2020"

For several years now, the steel and metal industry in our core markets of Europe and North America has suffered from severe global overcapacities and insufficient demand outside the automotive sector. The resulting high availability of supply, especially for standard goods, has led to a small potential for differentiation. This situation is exacerbated by the highly fragmented market in which too many suppliers compete for the same customers. For years, this extremely competitive environment has been putting pressure on margins in steel and metal distribution.

Our “Klöckner & Co 2020” strategy was designed to set ourselves apart from the competition by applying two main leverage points: first, by digitalizing the supply and value chain with the goal of developing an Internetbased industry platform and, second, by driving forward our business in higher value-added products and processing services. Our newly established “One Europe” optimization program will enable us to leverage additional earnings potential after we have successfully completed the restructuring of the business. With regard to acquisitions, we are focusing on companies in specialized – i.e. higher-margin – market segments, in line with our strategy.

DIGITALIZATION

The supply and value chain in the steel industry remains highly inefficient to this day. Many transactions continue to be carried out by telephone, fax or e-mail. There is no end-to-end digital order and production management. The intransparency resulting from the disruption in the flow of information at multiple points means that too many market participants are stockpiling a lot of steel at all levels of the supply chain. Process costs are also too high.

Klöckner envisions an industry platform for the steel and metal industry in which information asymmetries have been eliminated by digitally connecting all market participants in order to enable significant efficiency increases for all.

All projects and initiatives relating to digitalization and digital networking are being driven forward by kloeckner.i, our Group Center of Competence for Digitalization, from the heart of the German start-up scene in Berlin. Approximately 40 employees now work at kloeckner.i in the fields of product innovation, software development, online marketing and business analytics.

We make use of methods such as design thinking, agile product development and the lean start-up approach to design digital solutions for our customers and partners in the shortest possible time. To this end, we first go directly to the customer’s premises and evaluate on site how we can create added value. Once we have made our evaluation, we need just a few weeks to develop simple prototypes. The initial prototypes are specifically designed to cover solely the most important functions. Through constant testing, we then check with our customers whether and to what extent the individual tool meets the given requirements. This ensures that only prototypes that have already been validated with customers are developed into solutions.

To give us our own start-up enterprise, we founded kloeckner.i as a separate operation in Berlin. The new company is far enough removed from Klöckner for it to act more independently in the rapid development of digital tools and platforms than would be possible from within Klöckner. However, kloeckner.i is connected closely enough with Klöckner for it to harness the Company’s in-depth expertise in steel distribution and leverage our relationships with customers and suppliers in developing platforms.

Not only does this make Klöckner faster than the competition in developing tools and platforms, but it also gives us a clear advantage over independent start-ups due to our sector expertise and our relationships.

Thanks to our agile working methods, the online order processing system first outlined in our 2014 Annual Report has now largely become a reality. Our customers have already successfully implemented digital tools such as contract portals, online shops and order reviews. Apart from developing new tools, we also continued to roll out existing solutions across the Group during the reporting period. As a result, the percentage of sales generated via digital channels rose steadily during the reporting period, increasing from 9% in the first quarter to 12% in the fourth quarter. Also on the procurement side, we have achieved integration with wholesalers and major steel producers.

As the second step in our digitalization strategy, we have integrated digital tools into our “Kloeckner Connect” service platform at many of our country organizations. The platform gives both customers and partners a central access point for all tools and data, which they are then able to use much more efficiently than before.

In the current year, we will be gradually opening up the service platform. Initially, we plan to include companies whose products complement our portfolio or cover regions in which we do not operate. As our service platform is made available to more and more competitors and a marketplace function added, it will gradually become an open industry platform. Customers particularly appreciate digitally integrated, open platforms because of the large variety of products to select from and high degree of price transparency gained by pooling offers from different competitors.

On the supply side, the efficiency increases resulting from digital platforms will lead to a market in which those suppliers who digitalized their processes early on and have mastered online selling will emerge as the winners. Operators of dominant platforms will enjoy even greater advantages, as they will generally be able to design the platforms in line with their own economic interests. Not only will this give them access to valuable data, but they will also be able to leverage added profits by collecting transaction fees and placing advertisements.

It is expected that both cross-industry platforms for standardized products, known as “horizontal” platforms, as well as industry-specific “vertical” platforms for specialized offerings will prevail on the market. While in the case of horizontal platforms market leaders such as Amazon or Alibaba are anticipated to play a globally leading role also in the B2B sector, established companies such as Klöckner will enjoy a head start when it comes to vertical platforms.

We benefit from our specific industry expertise, longstanding relationships with suppliers and customers and specialized logistics, the latter of which is of particular significance in steel distribution. There will also be overlaps with what is known as “long-tail business,” in other words, serving customers with minimal requirements. Klöckner will engage in long-tail distribution via equity investments, such as its stake in Contorion, an online marketplace for tradesmen and private individuals.

Alongside digitalization of processes throughout the Group, intelligent use of the data generated is increasingly gaining in importance. We entered into an alliance with Arago, one the leading providers of artificial intelligence, in order to gain an early foothold also in this market. Going forward, better evaluation of data incorporating a wide variety of factors will make it possible to predict demand for steel with much greater accuracy. At the same time, a more in-depth analysis of customer behavior will open up additional growth potential.

A key component of our digitalization strategy involves establishing direct access to our customers’ ERP systems via interfaces in order to fully automate the order process, among other things. One of the alliances we entered into in 2016 for this purpose was with Sage Software, a market leader in integrated systems for financial accounting, payroll accounting and payment transfers. Together with Sage, we are marketing the Sage Office Line – a special version of the accounting and goods management solution preconfigured for steel and metal processors. Klöckner customers will be able to harness the solution to professionally manage their business processes at attractive conditions while at the same time gaining online access to our extensive range of steel and metal products.

Not only that, but customers using other ERP or goods management systems will have access to the platform via the open OCI interface and thus avoid double entries. Besides that we are an exclusive partner in machinery manufacturer Trumpf’s Industry 4.0 project Axoom, in which production machines will in the future order steel from us autonomously. To that end, the Klöckner & Co contract portal has already been integrated into the customer solution’s software user interface.

While kloeckner.i operates like an internal start-up, it is through our venture capital company kloeckner.v that we establish links with external start-ups. This company invests both through selected venture capital firms and directly in start-ups that support our digitalization strategy with disruptive approaches. Moreover, we joined the German Stock Exchange’s Venture Network during the reporting period to give us greater access to attractive direct investments in the area of venture capital.

With regard to the ongoing implementation of our digitalization strategy, we have set ourselves ambitiousgoals: As early as 2019, we aim to generate more than half of Group sales online and cut net working capital by about a third relative to the 2014 year-end.

Our digitalization strategy also goes hand in hand with a profound cultural shift within our Company. For example, the innovative working methods employed in the start-up scene are being applied more and more throughout the Group. Those efforts are underpinned by in-depth dialogue between our digitalization subsidiary kloeckner.i and employees from other divisions in all of the country organizations. Online training is also being provided by Klöckner & Co Digital Academy to get the workforce in shape for the digital age. This lends employees support in developing and implementing new ideas, which they can discuss and fine-tune with their colleagues across national and divisional borders in a non-hierarchical way using innovative channels of communication, such as Yammer, the Group’s internal social network. We have thus broken down the existing vertical communication silos in favor of an unfiltered, increasingly horizontal form of communication.

ACCELERATING THE SHIFT TO HIGHER VALUE-ADDED PRODUCTS AND SERVICES

Alongside digitalization, our second strategic blueprint for setting ourselves apart from competitors is to increase the proportion of higher value-added products and processing services. There is huge market potential here as many of our customers are highly vertically integrated and still carry out tasks we could perform more efficiently by consolidating orders. A good example of this is our investment in 3D lasers, which we can use to combine several conventional customer tasks such as drilling, sawing and slitting at an attractive price and with significant gains in precision. In addition, we will also be undertaking a major expansion of our higher-margin business in higher value-added products. At our Bönen location in North Rhine-Westphalia, Germany, for example, we are building a service center to process aluminum flat products for the European automotive and manufacturing industries.

In the period under review, we succeeded in expanding the percentage of sales of our higher-margin business from 39% to 46%. This significant increase was also the result of scaling back low-margin business in standard products (“commodities”) as part of our KCO WIN+ restructuring program, in addition to our investments in high-margin business segments. This means we already exceeded the 45% target originally announced for 2017 in the reporting period. Due to the rapid progress made here, we now anticipate generating the lion’s share of sales from higher value-added products and services as early as 2018 rather than in 2020 as previously forecast.

KCO WIN+ PROGRAM

Thanks to a range of measures designed to improve workflows and processes in our business operations, we achieved an incremental EBITDA contribution of €26 million in 2014 and 2015 under the KCO WIN+ program. We expanded the program considerably to include additional restructuring and improvement measures, primarily in France but also in other European countries. As a result of the program, a total of 16 locations were closed, the country organizations’ headquarters were downsized and headcount was reduced by more than 600 employees. The expanded program is expected to have an annual impact on EBITDA of some €30 million from 2017 onward, most of which (€28 million) was already realized during the reporting period. This puts the annual EBITDA contribution from all program measures at up to €60 million since 2014.

“ONE EUROPE” PROGRAM

Over the last few years, we have restructured the European distribution business at the country level, downsized capacity and pooled operations. Under the “One Europe” program, we are now bringing the activities of our country organizations in Austria, Belgium, France, Germany, the Netherlands and the United Kingdom even closer together. In this way, we not only aim to generate cost savings and synergies more readily – especially in purchasing and logistics – but also to enable even faster, more efficient implementation of the “Klöckner & Co 2020” strategy. Plans are for “One Europe” to deliver an incremental contribution to EBITDA totaling some €30 million by 2019, €10 million of which is to be contributed in the current year.

RETURN TO GROWTH PATH THROUGH EXTERNAL AND ORGANIC GROWTH

In terms of regional growth opportunities, we regard the USA as our most attractive market over the medium to long term despite the sharp decline in demand seen last year. This market is especially attractive for us because of the far better match between steel demand and local supply compared with Europe, coupled with the strict separation of producers and distributors. The infrastructure investments announced by the new administration are expected to make the US market even more attractive. We aim to expand our share of US shipments from 41% in 2016 to more than 50% over the medium term.

When it comes to strengthening higher-margin business, we have set our sights on a mix of organic and external growth. We are therefore considering acquiring additional companies that offer a wide range of higher value-added products and processing services following our successful acquisition of American Fabricators, Inc. in the USA.