Arauco - What Are the Source of Competitive Advantage?

What are the source of competitive advantage?

• Economies of scale. Arauco was able to secure pulp prices at half the cost of some of its competitors. This is seen in Exhibit 6 where its price per bleached softwood is $119 versus Finlands $265.
• Technical expertise. Arauco was able to optimize the tree cutting process through “log merchandizing” that allowed them to maximize their output per tree.
• Arauco owned its own forests, it could control the quality of wood being produced. Higher quality raw materials allows for less waste and higher product output.
• Arauco was able to genetically replicate high quality trees. This allowed for a better quality and more standardized product to be produced.
• Arauco used labour contractors. This allowed Arauco to separate the HR needs of its company from its business. By outsourcing labour activities Arauco is likely to have achieved cost savings on human capital. This also allows Arauco flexible staffing solutions in a volatile economy.
• Transportation was outsourced. Transportation and logistics are not Arauco’s core activity and by outsourcing this activity the company is able to focus on its core competencies.
• Arauco owned all its own assets (except trucks). By having asset ownership Arauco reduced its reliance on third parties for the company’s core activities. This means less risk and reduced volatility in supply volumes and costs.
• Arauco strategically located its saw mills to plantations and ports. This allows a reduction in both cost and time.
• The pulp trees in Chili take 16 – 18 years before they are ready to harvest. In the Northern Hemisphere pulp trees take between 18 – 45 years. The trees in Chili are able to be harvested at half the time needed in the Northern Hemisphere. This means that there is a greater output rate in Chili, lower risks and higher levels of production – a great competitive advantage.

Is Arauco’s advantage sustainable?

• Yes.
• Arauco owns its own assets and can therefore maintain its strategic locations. Arauco will not need to negotiate new lease contracts or relocate any of its premises in the foreseeable future.
• Arauco is an exporting company and therefore the decline in paper use in the Western world will have little effect on their sales figures.
• Demand controls the price in this industry. Should pulp demand decrease, Arauco will be able to increase the asking price of its pulp.
• Arauco has diversified its sources of revenue. By having income from a number of sources Arauco is not reliant on a single source allowing it to remain more resilient to market changes.

How would assess the degree of vertical integration within the company?

• Vertical integration is often measured by the amount of value a company is able to add to a product. Arauco owns a large portion of its supply chain starting from the raw materials and extending into pulps and panels. This shows that there is a great amount of vertical integration within Arauco.
• Arauco has yet to move into the paper business. If Arauco moves into the paper industry it will achieve full vertical integration.

Why has Arauco moved away from its traditional “pulp” alone strategy?

• Risk reduction. By diversifying its revenue sources Arauco is able to reduce its reliance on a single industry.
• Value added. The vertical integration used by Arauco allows the company to add value to its product and they are therefore able to ask a higher price for their final product.
• Pulp price volatility makes it an incredibly competitive business. As it is a raw material industry it is also a “price taker” industry. This would not allow Arauco any opportunity to negotiate with suppliers or set prices.

Do recommend Arauco to integrate to the paper business?

• Yes.
• The paper business has higher margins and would therefore result in higher revenue for Arauco.
• Diversified revenue streams will allow for risk reduction.
• Further vertical integration would occur. Vertical integration allows value to be added to the final product. Arauco is therefore able to add value to the paper business.
• The world’s largest paper companies have followed this strategy and have found success in doing so. If Arauco is able to move into the paper industry it is likely to achieve the same levels of capital growth and profitability.
• The company would be able to increase its operational effectiveness.
• Arauco would have higher levels of control within this industry.