President Trump announced sweeping tariffs on steel and aluminum last week to the tune of 25 percent and 10 percent, respectively. However, imports from Mexico and Canada are provided an exception. The tariffs are supposed to strengthen the competitive advantage for local mills in the United States when compared to foreign competitors, especially Chinese metal producers who have been repeatedly accused of dumping.
This traffic will likely result in less supply of metals available to U.S. buyers. With a promise from President Trump that more tariffs are under consideration, other industries could see a similar scenario in the coming months. So, what kind of an effect do tariffs and more restricted supply have on a marketplace platform business model in B2B?
Marketplaces perform better with oversupply than with undersupply.
The more fragmentation there is in an industry, the better for a marketplace. As a result, when there is more supply than demand, the marketplace is able to deliver optimal results to the end customer.
In China, metal marketplaces like Zhaogang and Ouyeel have become the dominant channel for metal purchases much faster than any other region. These marketplaces followed a similar model as Alibaba's Taobao by not charging fees on transactions and instead charging producers to advertise on the marketplace.
The Chinese metal market has over 200 million metric tons of steel oversupply, almost the same amount as the collective steel demand from Europe and the U.S. combined. The Chinese metal market has such enormous oversupply because of a big slowdown in demand and government subsidies to metal producers to keep creating. This is also a big reason why the Chinese have been so aggressive with dumping.
For comparison, in the electronic distribution vertical, supply is very restricted. A handful of manufacturers control the creation of semiconductor chips and products comprising 70 percent of electronic distributors like Arrow and Avnet. This consolidation of supply is also represented in the size of Arrow and Avnet. They each have over $20 billion in revenue, while the third largest distributor is at only about $2 billion. The reason for this discrepancy is linked to supply-chain consolidation.
As a result, all distributors, especially small, mom-and-pop operations, cannot get access to the same product catalog from manufacturers as the larger distributors. Smaller distributors have to purchase from larger distributors, creating a cascading effect of distribution from the initial source of production to progressively smaller distributors. For this reason, electronic distribution is one of the least likely verticals within B2B distribution, where a marketplace will gain traction in the short term.
Oversupply in the metal industry.
The metal industry has been notorious for its oversupply since the 2008 recession. In 2005-2007, the regional capacity utilization ratio in North America was over 80 percent, and that dropped by over 30 percent in 2009. In 2016, North American demand for steel was roughly 133 million metric tons, compared to a regional capacity to produce almost 160 million metric tons. North American production was estimated at 111 million metric tons, with about 50 million metric tons of imports and about 25 million metric tons of exports. By comparison, Asia exports about 10X that amount, with over 200 million metric tons of exports in 2016.
Net-net, with a significant decline in Asian imports to the U.S., there will still be oversupply in the market based upon North American production capacities. And there is likely to be a reciprocal decrease in U.S. metal exports to countries that potentially create tariffs on U.S. steel. In a perfectly symmetrical market, the North American steel market would operate at about 80 percent of regional capacity utilization. Pre 2008, peak ratios were above 85 percent.
How to predict how this dynamic will play out?
Well, we decided to call up small, mom-and-pop steel distributors and ask them! We spoke to roughly 20 distributors in California, Illinois, and Pennsylvania, and asked them:
Question 1: Do you think A) the tariffs will make it harder, B) there'll be no difference, or C) you're unsure in sourcing metal?
Question 2: Do you think mills and/or larger service centers will have stricter buying requirements or larger minimum order sizes?
Some of the distributors that said the tariffs would make it harder to source metal said the market would even out after one year or so. In essence, in the short term, the tariffs will make it more difficult to source metal, but as the market has time to adjust and North American mills ramp their production, the difference should be negligible. Visit here for more information on the survey results, respondents and raw data.
The damage to a marketplace in B2B.
When small, mom-and-pop distributors have restricted access to supply, marketplace dynamics are hindered. Even at a roughly 80 percent regional capacity utilization, we predict that access to supply won't materially change for smaller distributors.
Decades ago in the steel industry, larger distributors had similar cascading dynamics as exist today in the electronic distribution industry. Larger metal service centers would buy from mills in quantities that would prevent smaller distributors from buying direct. Therefore, larger distributors would sell to end-customers and sell to smaller distributors. This dynamic still happens today in the metal industry, but small distributors have a much more fluid market to acquire metal from a variety of sources.
However, if smaller distributors see existing sources of supply creating barriers or heftier purchasing requirements, this would be a material difference which would work against marketplace dynamics.
Given the short-term constraints on supply, it could be more difficult for a marketplace to scale across North America within the next year. However, over the longer-term, increases in domestic production and decreases in exports will likely balance this out.