Commercial excellence in mining - McKinsey & Company

31Mining in Africa Untapped Potential

Commercial excellence in miningUnlocking the full potential of marketing and salesMining managers who have taken the lead in the new era of commercial excellence have shown that it helps companies stand out in the marketplace and creates significant value for very little investment.

More and more mining and minerals companies are investing in marketing, and using increasingly sophisticated strategies and tools to do so. For a handful of skillful companies, commercial excellence has delivered EBIT margin increases of as much as 8 percentage points. Their success is raising the bar. Our research shows that commercial excellence has become a core element of metals and mining company capabilities and strategy.

While mining companies are focused heavily on delivering maximum value from their operations, few apply the same rigor to their marketing and sales. Some assume that, in a seller’s market, it’s not worth the trouble. Others apply tactical marketing measures and capture modest upside, such as through pricing of premium products. Yet several companies are systematically pursuing excellence in their commercial functions, and are reaping very attractive rewards. Our own analysis and experience makes it clear that marketing and sales represent an opportunity for mining companies in nearly all regions and commodities to add substantial value to the bottom line. While many companies recognize this, only a few have developed truly ambitious commercial aspirations and shaped robust strategies to deliver on them.

Andreas MirowJukka Maksimainen

32 McKinsey on Metals & Mining Number 07

The opportunity: creating major long-term value from marketing and sales

Mining companies that systematically pursue excellence in marketing and sales can reap very attractive rewards. Our analysis suggests that improved pricing, contract management, trading, and key account management can together boost EBIT margins by between 3 and 8 percentage points, depending on the metal, the asset base, and the company’s context (Exhibit 1).

There is growing recognition of the opportunity: in the past few years we have observed a clear shift towards a more commercial orientation in mining companies’ marketing and sales efforts. However, there are still striking differences between companies. This reflects the fact that most mining companies remain tactical in their marketing approaches. Only a few have built competitive marketing strategies that truly assess, and fully develop, the company’s unique commercial opportunities.

Tactical moves can certainly produce results: for example, an iron ore producer can typically add an incremental value of between 1 USD/t and 3 USD/t by capturing pricing premiums for particular product grades. But for the most successful companies, such steps pave the way for a more systematic approach to marketing. These companies have made a very clear evolution from an exploratory phase that tackles a limited set of attractive opportunities, to a coherent go-to-market strategy that shapes the value chain from mine to customer.

Consider the example of a medium-sized mining company. It had traditionally paid little attention to marketing, but began exploring a more active commercial role by modeling how valuable its products were to particular export customers. Next it focused on capturing additional margin through shipping and stockpile sales in key export markets. The success of these tactical moves

prompted the company to adopt a more strategic approach to capturing value along the marketing and sales value chain.

The company undertook a thorough scan of its product market to identify customers for whom its product grades were particularly valuable. Leveraging its shipping and stockpiling capabilities, the company positioned itself as an integrated solutions provider to such customers, commanding a significant price premium as a result. It also began shipping the orders of multiple customers in bulk, so boosting margins further. To support the strategy, the company built a proactive marketing function, organized around key account management and enabled by technical capabilities such as a sophisticated “value in use” capability. All in all, the company’s commercial strategy has been a major source of value creation, adding 10 to 15% to its market capitalization.

Achieving commercial excellence: a systematic approach

How, then, does a mining company chart its own course to unlocking the full value? Our research across the industry suggests that, for true commercial excellence, companies must be distinctive in every element of a five-layer pyramid (Exhibit 2). They must have:

� A clearly defined, and ambitious, commercial aspiration

� A robust product-market strategy

� A clear set of choices on which parts of the mining value chain to participate in

� Well-honed levers to capture commercial value, including pricing, contract man-agement, trading, branding, and key account management

� A powerful commercial operating system.

33Commercial excellence in mining Unlocking the full potential of marketing and sales

Clearly defined commercial aspirations – setting the ultimate target

The starting point is to define the company’s commercial aspirations very clearly. This choice will be aligned with the company’s overall strategic aspirations, and informed by a fact-based assessment of its asset base and of the market conditions of its main commodities. There is certainly no one right aspiration: in our analysis of the most successful marketers in the industry, we have identified three quite different archetypes:

Solution providers typically have an asset base that is technically unique, (for example, of very high grade), and thus are able to capture maximum value based on their distinctive position in the market. This may take the form of a niche product

or a special service, such as the concept of total delivery from mine to customer gate. Solution providers are able to command an additional premium because of their unique position and deep understanding of what creates value for a customer.

Active traders seek to capture additional value through continuous arbitrage opportunity scans and superior insights into short-term price developments. They typically have swing assets and access to tactical market information that enables them to exploit differences in product quality, across time periods, or between geo-graphic markets. Active traders are recognizable by their sophisticated understanding of short-term price movements and the action they take to capture maximum value with that knowledge.

Exhibit 1

Commercial value-capturing levers provide the practical means and ways to materialize created value

0.8 - 1.9Key account management

?Branding

0.5 - 1.41Trading

0.9 - 2.0Contract management

0.9 - 2.7Pricing

Understanding the differences between customer accounts at a very granular level to capture client-specific value

Differentiating the product/the company or developing the image of the commodity in ways that improve margin, secure volumes, or increase sales

Capturing opportunistic profits with a trading strategy, typically focusing on either arbitrage or speculation

Having an optimal contract portfolio to capture maximum upside with given risk profile, combined with managing negotiations and existing contracts

Capturing the value driven by a company’s position, quantifiable differences in products, and transaction-specific conditions

Value estimateEBIT margin improvement

Levers to capture commercial value Description

3.0 - 8.0Total value potential

Value creation potential in metals and mining

1 Includes only the margin improvement, not the increased revenue or new business creation potential

Source: McKinsey analysis


Strategic marketers create value by “shaping” the market. They typically have significant market power as well as an in-depth understanding of long-term market dynamics – including supply-demand sensitivity, market mechanisms, and value-in-use differences between products. The market-shaping moves can range from a change in pricing and contracting principles, to the introduction of a new logistics system, to the development of a totally new market segment for a particular commodity.

Of course, bold strategic marketing aspirations are not appropriate for all companies. For example, a gold mine that distributes its gold through one agent might elect to be commercially

passive. Such a company would not aspire to add further value to the standard market price of its metal; it would see marketing and sales merely as a means to place all of its output in the market. On the other hand, in setting a clear strategic aspiration, companies should be careful not to settle simply for a fragmented list of marketing initiatives. In our scan of the industry, we have identified several agile agents that seek to capture a premium on top of the reference price, but have not developed a coherent strategic position. The commercial departments of such companies typically have a long list of value-capturing initiatives, but lack a strong strategic rationale for value creation that ties their commercial activities together.

Exhibit 2

World-class commercial excellence requires a holistic set of closely linked organizational best practices

Product-market strategy

Value chain choices

Commercial value- capturing levers

Commercial system

PricingContract managementTradingBrandKey account managementTotal

Management infrastructure

Mindsets and capabilities

Operating system

vs.

Strategic commercial aspiration (“archetype”)

?

Organizational best practices

Source: McKinsey analysis


A robust product-market strategy – matching the company’s assets to the market

Guided by its commercial aspiration, a distinctive marketer develops a clear product-market strategy – the second layer in the pyramid. This defines the optimal portfolio of products for the company given its asset base, and links that portfolio to the most attractive market segments or to individual customers.

An optimal product-market strategy should have a clear value creation rationale that supports the company’s commercial aspiration. For example, an “active trader” would invest in swing assets that are flexible in terms of volume and geography. Further, an effective strategy requires an extremely detailed level of market insight. A product-market strategy for manganese ore, for example, has to reflect that the overall market is made up of multiple smaller segments – each with different asset configurations, access to local manganese ore, energy availability, and target markets.

The product-market strategy should also be based on a thorough analysis of where the company’s products are on the quality curve, for example, in terms of impurities and grade. This is critical to make sure the product meets technical cut-off points and other customer specifications – and that the company gets maximum value from its reserve. For example, alumina in iron ore at 2.0% is a well-known cut-off grade, as higher alumina content significantly decreases steel mills’ ability to work with the ore. Suppliers must respect this limit, but below it they have multiple different product options to offer to customers – at potentially very different margins.

The final element of robust product-market strategy is a detailed value-in-use analysis. This entails quantitative comparison of how different products might perform for a given customer. The results yield a detailed understanding of the value of the company’s product compared with the customer’s other options. With this accurate

measure of the true value of the product’s characteristics, a company can make the correct trade-offs in product design and pricing

Once all of these factors have been analyzed and a tentative product-market strategy has been developed, the strategy should be rigorously checked against market realities using multiple, sequential filters including:

� A logistics filter: What does it cost to get our product to the customer?

� A feasibility filter: Can we realistically capture the value-in-use advantages of our product? What is its competitive position against other suppliers?

� A potential filter: How large are the customer segments we are targeting?

This exercise will yield a shortlist of high-potential customers for each of the company’s key products.

Choosing the company’s role in the value chain – from mine gate to shipping, financing, and processing

As part of their commercial strategy, metals and mining companies also need to make clear choices on which parts of the value chain to participate in. The broader value chain goes beyond the mine or smelter gate and includes elements such as logistics (transport); stockpiling or warehousing; technical services; financing; third-party trading; and, in some commodities, processing. Value chain choices should be closely matched to strategic objectives, which could include the following:

Gaining superior market insights. Having an active role beyond the mine or smelter gate can provide access to superior insights on how the market may evolve over the short term (relevant for a company aspiring to be an active trader) or long term (key for a strategic marketer). For example, selling third-party volumes or owning

Metals and mining companies need to decide which part of the value chain to participate in


a minority stake in strategic assets can lead to superior insights on operational performance.

Complying with legislation. In many countries, governments are requiring metals and mining companies to take over a larger portion of the overall value chain. For example, Nigeria has content laws requiring a portion of all commodities exports to be transported using Nigerian vessels.

Capturing additional margin. As the owners of a commodity, metals and mining companies often have the ability to capture additional margin from other players in the value chain. This typically applies to adjacent businesses that do not require any special capabilities and are financially attractive. Examples include financing a customer’s working capital, and capturing margin from banks when supplying a customer in a region with high interest rates.

Reducing risk. A company’s production footprint and logistics chain must be sufficiently flexible to minimize the risk that a shutdown could render it impossible to ship product. For example, an iron ore miner could own part of a pelletizing plant to ensure it has a secure route to market for iron ore concentrate; or it could own the railway used to transport its product to port.

Capturing a greater share of the value pool. Most of the value chains in metals and mining have undergone major shifts in the value split between players. Logistics today account for about half the landed cost of bulk commodities. This might prompt a mining company to take over and manage logistics for particular bulk commodities so as to gain broader exposure to the market.

Increasing volume stability. Several companies position themselves in the value chain to achieve increased volume stability. One way to do this is to develop closer relationships with customers, for example, by providing sophisticated technical services, keeping a consignment inventory on the client’s premises, or managing the client’s inventory.

Boosting operating efficiency. A company’s position in the value chain may be driven by the objective of strengthening operating efficiencies. This is often the case in bulk materials where, for example, a company might combine shipments to multiple customers to achieve economies of scale.

Creating new opportunities for the core business. Companies should make value chain choices in conjunction with the strategy for the core mining business. For example, since a wider role in the value chain can help overcome limitations in mine planning and trading, a company could establish a blending yard for a discharge port in a target market, enabling a value-maximizing mine plan for assets in different continents.

Shaping effective levers for value capture – making the most of the company’s strategic position

Primary levers for capturing commercial value are pricing and contract management as well as trading, branding, and key account management (cf. Exhibit 1). By nature, a company will need to work through these levers and shape their two to three most important aspects to make the most of its specific strategic position, talent, and aspirations.

Pricing, for example, can be optimized from the strategic, value, and transactional perspectives. Strategically, what is the company’s overall price-setting mechanism, such as import parity versus export parity? For value pricing, the crux is to quantify and charge for tangible differences in product value for customers, as mentioned for manganese ores. Optimal transactional pricing requires skill in selling spot prices and the premium based on contractual terms on top of the reference price.

As another example, one of the top three aspects of effective contract management is striking the right balance in the company’s portfolio of fixed versus floating price contracts and spot versus long-term volume commitments. It is critical to get this right: for most commodities,


fly-ups represent two-thirds of mining company profits but only one-third of the calendar time over the cycle. Trading offers further ways to optimize how volumes are matched to contractual commitments: at the entry level, does the company succeed in putting additional volumes on the market to absorb an in-house over-supply (and vice versa)? A new breed of active traders have introduced new trading methods to the industry – such as arbitrage and speculative trading – that are also being adopted by producers.

Branding may be used to develop a preferred position: can the company create a perception of advantage, lower risk, or information efficiency for the commodity, the supplier, or a specific product? Key account management offers at least five areas for value capture with each important customer – logistics, customer processes, purchasing, regulation, and risk – but they must be systematically managed together to capture higher margin (for example, from more favorable shipping terms) or increase volume stability by providing support, for example, on technical or regulatory issues.

Building a powerful commercial system – winning team, infrastructure, and systems

The foundation of the commercial excellence pyramid is the commercial system – the operating system, management infrastructure, and mindsets and capabilities of the marketing and sales functions and the company more broadly. As the sophistication and complexity of the commercial approach increases, the requirements for these “enablers” become more demanding. World-class operating systems comprise both “hardware” and “software.” The hardware includes the company’s logistics infrastructure, including vessels, discharge ports, blending yards, and mine-to-delivery optimization software. The software side of the operating system consists of market intelligence, pricing, trading, customer relations management, and transactional systems. For value-in-use analysis,

a company requires both physical laboratories and simulation software.

With management infrastructure, the focus is on the organization of the marketing and sales function – including its structure, staffing levels, and the level of consolidation needed across commodities. Some companies have group-level marketing and sales functions; others use a business unit-driven model. The management infrastructure also encompasses performance management, including KPI systems to ensure targets are being met and specific incentives to reward marketing and sales effectiveness.

The final element of the commercial system, mindsets and capabilities, can make a major difference to its success. The mining companies that excel at marketing and sales have invested in building distinctive capabilities, including analytical skills, industry understanding, and the ability to manage complex customer relationships. Shifting mindsets is just as critical: despite the dawn of a new era in commercial excellence, many mining companies seem to find it hard to break away from the old working model, based on long-term relationships, and take an active value-seeking approach.

* * *

Regardless of their starting point, most metals and mining companies have significant opportunities to unlock value through commercial activities. When top management considers where to invest its attention and energy to increase profitable growth, commercial excellence should rank close to the top of the list.

Branding can create value by conferring a preferred position

55Appendix About the authors and the practice

McKinsey’s global Metals & Mining Practice serves clients around the world on issues relevant to the top management of companies in the metals and mining industries. As in its work in every other industry, McKinsey’s goal is to help its metals and mining clients make positive, lasting, and substantial improvements in their performance. Our staff consists of individuals who combine professional experience in these industries with functional expertise in a broad range of related disciplines and comprehensive training in business, economics, engineering, or the natural sciences.

If you are interested in further information on McKinsey’s Metals & Mining Practice or have specific questions regarding the topics raised in this issue, please contact us. We would also appreciate your feedback and comments on any of the important issues in metals and mining.

McKinsey on Metals & Mining is now also available in Chinese.

Dr.-Ing. Benedikt ZeumerKennedydamm 2440027 DüsseldorfGermanyPhone: +49 (211) [email protected]

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McKinsey & Company’sMetals & Mining Practice


Copyright© 2011 McKinsey & Company, Inc.

The material in this publication is intended to give our view of value creation in the metals and mining industries. It should not be construed as a recommendation to trade in shares of any of the companies mentioned, and McKinsey & Company, Inc., shall not be responsible for losses incurred by such trade. The analysis is based on information that we consider reliable, but we do not represent that it is accurate or complete, and it should not be relied upon as such. No part of this publication may be copied or redistributed in any form without the prior written consent of McKinsey & Company.

Picture credits: Stahl-Online/Georgsmarienhütte (cover), Schmolz Bickenbach (cover), ThyssenKrupp (page 13), RAG Deutsche Steinkohle (page 39), Fotosearch (pages 5, 23, 31, 39 and 45)

Editing/translation: Gilian Crowther, Neil Danby, Colin Douglas, Terry Gilman, Andrew Whitehouse

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Commercial excellence in mining - McKinsey & Company