Arauco Case Study

STRATEGIC MANAGEMENT

CASE SUMMARY

Arauco (A): Forward Integration or Horizontal Expansion?

GROUP 6

HIMANSHU KHANDELWAL (0155/53)

JASDEEP GARG (0166/53)

MAHAK AGARWAL (0209/53)

MAHEK CHHEDA (0210/53)

MANU GARG (0217/53)

MAYANK TYAGI (0222/53)

1. Should Arauco build the Nueva Aldea project? Can you make some NPV projections using, among others, the information given in Exhibit 6? Explicitly state the assumptions you make.

Arauco should invest in Nueva Aldea project as it makes sense to expand horizontally, since they already have the cost advantage in pulp production and they can control supply if they expand. They can do competitive positioning in the growing paper market in Asia. Using average prices for bleached and unbleached pulp and the production of each of them, the average price comes out to be $444/ metric ton.

Assumption The producers cost of pulp is taken same for both bleached and unbleached pulp and is $294 per metric ton.

Hence the profit per metric ton comes out to be $150 which represents a healthy operating profit of 33%. Thus it can be seen that Arauco has a substantial cost advantage over others in terms of pulp production. So it should build the Nueva Aldea project to become the market leader in this product and strengthen its cost advantage further by economies of scale.

1. Explain the economies of scale and scope enjoyed by Arauco.

Arauco was formed through a merger of between Industries Arauco and Celulosa Constitucion. Due to its large size, it was a leading business unit in the volatile market pulp industry due to its low cost production capabilities. The firm’s gross margin increased from 41% to 43% between 2000 and 2004, although the pulp prices were going down in this period. 50% of it’s sales came from pulp sales and the other half came from forestry products and wood products.

1. Explain the vertical chain of the market pulp industry. Does Arauco also enjoy sequence economies?

The global pulp and paper industry consisted of five main activities: forestry, pulp production, paper and board production, distribution and converting. Pulp mills were highly capital intensive. It took 3 years to build a mill with an estimated life of 40 years. It was specifically designed for particular types of wood and was not flexible.

1. Overall, what are the foundations on which Arauco builds its corporate and /or competitive advantage? What are the threats to Arauco’s corporate and / or competitive advantage?

Aruoco is the cheapest producer of pulp and its competitive advantage. Also 50% of its revenues come from this stream. It has young forest and other resources and capabilities using which is the lowest cost producer of pulp. Also it has good employee relations which is another advantage. It has a gross margin of 42% which is pretty high.