The dilemma of the CEO, Arauco - Case Study Example

Case Study The Arauco Case Study: Dilemma of the CEO Submitted Management September 15, Arauco Case Study: Dilemma of the CEO Case background ARAUCO is a large wood and pulp manufacturing company based in Chile. Its basic products are composed of pulp products, such as bleached and unbleached kraft pulp; forestry products like pulp wood and saw logs; and wood products which include lumber, remanufactured wood products and panels, and energy generation. Arauco is a fully integrated company whose growth was brought by acquisition and mergers of related companies that eventually grew its base to be known as one of the top pulp and wood manufacturer in Brazil. It has four mills in 3 regions of Chile, with a total production capacity of 1,223,000 metric tons. The fifth mill is in Argentina with a production capacity of 350,000 metric tons. Easily, this assortment of assets places Arauco as one of the top pulp and wood manufacturers in the world. In 2001, company went into another expansion called the Nueva Aldea project. First phase of the project cost US $150 million that consisted of construction of a building, a sawmill, plywood mill, and an energy complex. The second phase was the construction of the pulp mill following the inauguration of the Valdivia plant on January 2003. The Valdivia plant has a production capacity of 700 tons of pulp, which has an expected operating life of between 30 to 60 years and an expected sales of USD $350 million a year. The company’s CEO, Alejandro Perez was in a dilemma over his recommendations to the Board of Directors as to whether the company should invest US$1billion to construct a new state of the art chemical pulp plant. Perez believes that his recommendations would increase Arauco’s pulp production capacity from 800 tons to 3.2 million tons. This improvement in capacity would put Arauco as the largest producer of pulp in Brazil, next to its biggest competitor, the Aracruzin. Perez further believed that the Board of Directors would question his recommendations particularly in committing a large amount of resources at the time when economic conditions are not good and his proposal that involves a horizontal growth rather than a forward integration plan into a paper manufacturing plan which the Board of Director contemplates. Web definition of forward integration is a strategy that calls for doing away with the company’s usual doing of business. Aside from the concerns of the Board, he was also uneasy with the downward trend of market pulp prices for the last three years and that buyers of market pulp are backward integrated into the production of pulp. Backward integration is defined as a kind of integration in which the consumers of raw materials purchase the suppliers. Questions raised are: Should Arauco build the Nueva Aldea project? What are the sources of Araucos competitive advantage? Based on the Alto Parana project, should Arauco own both forests as well as pulp production facilities? 1. The reply on the first question is that : Arauco is justified in building the Nueva Aldea Project based on the following assumptions: The project would increase its production capacity from 800,000 tons to 3.2 million tons, with an operating life of between 30 to 40 years. By this time, the company has fully recovered from its investments and has reaped substantial benefits. Major revenues of the company come from pulp sales mostly exported to other countries, with U.S and Asia as major trading partners. So pursuing expansion plans as in Nueva Aldea is trailing one opportunity at a time while selling related products to customers whose behavior is already known to the company. Build up of assets is a formula that will strengthen the company’s foothold of the market since it is already familiar with the industry’s environment.(Zooke and Allen, 2000 p. 7) First phase of the Nueva Aldea project has already been approved and implemented. Second phase is the construction of a pulp mill following the inauguration of its Valdivia plant. Perez’s recommendation to install a state-of-the art-chemical plant would raise production capacity to 3.2 million tons that would also increase sales and profitability that would satisfy stockholders of the company. Based on the prevailing market pulp price of US$510 per ton (Casadesus, et al, p.14 ) the production capacity of 3.2 million tons would give the company an estimated revenue of $1.632 billion, an ROI of 61%. (Investment of US$1Bn/ Revenue of US$1.632bn.) The core business of Arauco is pulp and wood products. By expanding horizontally or adjacently means they are expanding their core business in the markets where they excel (Zooke and Allen, 2003). By doing so, they continue to focus on their core product but sell it to different segments or market. The rule of adjacency as prescribed by Zooke and Allen is to make an adjacency move if you are sure to be one of the top players and not to be afraid of using repeated formula. In our case, Perez was sure that the chemical plant would put the company amongst the top pulp manufacturing plants in the world. Perez also believes that his moves will not put the core business at risk since profitability is measured and that he is not moving away from it and that he is pursuing one opportunity at a time. Horizontal integration which Perez is proposing an acquisition of additional business activity that is in the same value chain while the forward integration that the Board of Directors favor with is a form of diversification from the company’s usual business. The Board favors forward integration of paper product manufacturing that is doing away with the company’s core business. This means threading in unknown waters that is very risky for a business particularly when it entails big investments. A wrong decision might pull the company down, so Perez thinks. Perez believes on horizontal integration as shown by his strategies. First he reoriented company’s strategies to exporting its products to US, and other countries and by doing so, the company was able to survive the economic hardships and pricing problems of the paper industry. The doubts of Perez on the downward trend is erased by the trend analysis of an Analyst (Casadesus et al, 2009. p. 9) that tells the recent global demand for paper would lead the price recovery of paper market, thus this would be an enlightening news for Arauco. 2. Competitive advantage of the company. Web definition of Competitive advantage describes it as a lead that a firm has over its competitors, allowing it to generate greater sales or margins and/or retains more customers than its competition. There can be many types of competitive advantages including the firms cost structure, product offerings, distribution network and customer support. Aligned with this definition, competitive advantages of Arauco are: Its strategy of expansions ushered to the company a total of 1,200,000 hectares of forest plantations in 2003. This large area assures company of sources of raw materials for production. Arauco’s total acreage puts behind its closest competitor, the CMPC, that owns 424,000 hectares of forests plantations only. (Casadesus, et al, 2009, p. 12). Its cost advantage due to low cost production capabilities allows it to produce at lower cost than its rivals. Exh. 6 of the case study would show Arauco having the lowest production of pulp cost from among the manufacturers of British Coast, United States, Sweden and Finland. This cost advantage improved cash flows of the company that permitted it to protect the company from the impact of price swings. Its strategy of exporting has dramatically increased its sales earnings from US$ 1.173 bn. in 2001 to US $1.458 bn. in 2003. Efficient forest management wherein company developed other businesses like woods and panels while developing the young forests. Company also made other investments to improve its financial condition like the favorable exchange rate for export industries. Its investments and usage of advanced technology in forest management help the company to add value to its forests products. The diagram of a tree shown as exh. 8 in the case study would show whole parts of a tree utilized in the manufacturing. The top most part of the tree, or the softest part is cut and used as pulp logs or MDF; the middle part is converted as a saw timber, and the lower part is used as clearwood, saw timber or plywood. Distribution network supported by fleet of trucks and freight outsourcing to support customers. 3. Based on the Alto Parana project, should Arauco own both forests as well as pulp production facilities? From the case study analysis, acquisition of the plant is not a wise decision because of the problems of shortage of raw materials and cost of transporting the materials due to distance of plant to the port. The plant has a producing capacity of 350,000 tons a year of bleached softwood kraft pulp, and has 173,000 hectares of plantation However, out of 173,00 hectares only 83,000 hectares are planted, thus wasting 90,000 hectares of forest lands. Initially, this shows poor forest management. It would take 25 years or more to grow trees and make the plantation productive. So, there is lack of wood materials for production requirements. To carry on with the operation, Alto Parana has to get its materials from outside sources that often charge loading and transportation costs that would reduce its profit margin. Loading costs of moving the raw materials from the forests to the plant is $1.20 per ton plus additional cost of $0.048 per 1000 km. Plantation owners chose to export their product or to sell them to local based companies. There are six local based companies with a total requirement of 300,000 tons who are ready buyers of these raw materials. So the company is not assured of supply. Moving of raw materials from other areas is found to be expensive. Thus, the acquisition would not add value to the worth of the company because operation is not sustainable. In conclusion, a company can achieve growth from its core business by the adjacency moves. Perez’s move of acquisition of a new chemical plant is a strategic plan of horizontal integration and expansion so that it could better serve its new segment of international customers using the same core products of pulp. Horizontal integration is an effective strategy for Arauco because it is competing in a growing industry such as the pulp market. It would put company ahead of the race because competitors lack some capabilities, competencies, skills or resources that Arauco already possesses. Its advantage on economies of scale would play an important role and that the organization has sufficient resources to put plan into effect. Horizontal integration increases product differentiation and allows access to new markets. By investing in the new chemical plant, company would be able to enter new geographies; Company would be armed with expertise and capabilities in exploring opportunities driven by government trade negotiations with other countries. It will be able to address new segments of customers using modified techniques of production. By building a strong capability thru the new chemical plant, it will be able to develop a new distribution channel through global marketing and positioning. It will allow the company to be a leader in the supply of pulp market chain. This strategy assures Perez, the CEO to gain approval of the Board of Directors towards his proposal of construction of the new chemical plant. References Zook, Chris and Allen, James. “Growth Outside the Core” Harvard Business Review. 2003. Harvard Business Publishing Corp. Casadesus Ramon, Tarzijan, Masananell Jorge and Mitchell, Jordan. “Arauco (A) Forward Integration or Horizontal Ezpansion. Harvard Business School 2009. Read More