Structure of the iron ore industry
The iron ore industry could be called an oligopolistic industry—not in the strict sense of the word though. There are many players in the iron ore industry. However, there are major four players—RIO, BHP, VALE, and FMG—that control the bulk of the export market. Through their supply decisions, at any given time, they decide the price and demand being left to the prevailing market factors.
Major suppliers to the iron ore industry are labor and energy. Generally speaking, their supply is low compared to demand from the mining industry. So, labor unions do exert pressure collectively on iron ore companies.
Threat of substitutes
Aluminium is being used at certain places instead of steel. However, it doesn’t pose any significant threat to steel. For steel-making, iron ore is the vital component. It’s expected to remain so for the foreseeable future.
Buyers of iron ore are quite fragmented. Generally, they don’t exert much influence over deciding the price. However, this has reversed recently to the extent that supply is in excess and demand isn’t growing proportionately. As a result, buyers—mainly Chinese steelmakers—are asking for discounts and iron ore players are obliging.
Barriers to entry
The iron ore industry is a high volume industry. It’s characterized by high barriers to entry, due to its highly capital intensive nature, in terms of upfront investment required for heavy earthmoving equipment, buildings, vehicles, and transport networks and long production start-up lead times. These barriers reward players with huge financial muscle and scale and deter new entrants.
Understanding the industry structure in terms of previously mentioned criteria will help investors understand the standing of companies like Rio Tinto (RIO), BHP Billiton (BHP), Vale (VALE), Cliffs Natural Resources (CLF), and the iShares S&P Global Materials Sector Index Fund (MXI) because these companies make up 18% of this fund.