Forward Integration or Horizontal Expansion

Arauco (A): Forward Integration or Horizontal Expansion?   

1、Should Arauco build the Nueva Aldea project?

   Yes, Arauco should build the Nueva Aldea project for the following reasons:

1. Growing markets in developing countries: Export sales account for the majority (around 85%) of Arauco’s sales from 2001 to 2003. In addition, developing countries in Asia, Eastern Europe and Latin America were increasing their usage of paper products. Therefore, building more mills to increase productivity to meet the increasing demands in the developing countries is inevitable.
2. Leverage more economies of scale: By increasing the scale of its plants, it will lead to lower costs and higher efficiency for Arauco to benefit more from the economies of scale.

2、What are sources of competitive advantage for Celulosa Arauco?

1. Cost advantage: Arauco has strong cost advantage, because it has the lowest cost of wood, total chemicals, labor and total mill cost in the production of bleached softwood kraft pulp for less than $300 per ton ( Exhibit 1 ) compared to the bleached softwood kraft pulp producers in the Northern Atmosphere.
2. Advanced forest techniques: Arauco has the only forestry science and technology research center in Chile – Bioforest. It has advanced technologies in genetics and pest control which are able to improve the quality of its planting.
3. High-quality radiata pine: Radiata pine is a fast-growing and high-quality tree. Also, it has a high yield in Chile. Chile has the richest natural resources of radiata pine in the world, and Arauco is Chile’s largest radiata pine owner, with 33% of the country’s total plantation.
4. Short harvesting duration: The harvesting duration of pulp logs in Chile is shorter than that in northern hemisphere – 16-18 years versus 18-45 years. And for saw logs – 25 years versus 50-150 years. This makes Arauco more competitive for higher yield with shorter harvesting duration.    

3、Do you recommend Arauco to integrate forward to the paper business?

   Compare two strategy “ Forward integration ” and “ Horizontal expansion ”. Our suggestion is that Arauco should integrate forward to the paper business for the reasons below:

1. High market dependence: Because major paper companies, the sole buyers of market pulp, were backward integrated into the production of pulp, the market dependence between Arauco and them becomes higher. To face this kind of attack from the buyers, Arauco needs to counter attack. Thus, this is one of the major reason that Arauco should integrates forward.
2. Low-cost advantage: From Exhibit 1, we can see that the wood, chemicals and labor costs of Arauco are relatively lower compared to the other pulp producers. We can also infer that if Arauco produces papers, it can take the low cost advantage from its cheap pulps.
3. Reflecting the market price change: Consider a situation, if the pulpwood price rises, the market pulp price is going to rise, too. In order to maintain the competitiveness, Arauco may not rise its pulp price as much as the market price. However, if Arauco has its own paper business, it won’t be afraid of increasing its product price accordingly, because it will have its own channel to sell pulps and produce papers. It won’t need to rely on original buyers and also will increase bargaining power between Arauco and its buyers.
4. Vertical integration of main competitor: Arauco’s major competitor, CMPC, who started from paper manufacturing to forests and pulp in order to assure its supply. Besides, Not being affected by the fluctuation of supply also makes CMPC more competitive. Thus, Arauco can adapt the same way corresponding to CMPC’s strategy.

4、Would you suggest Arauco to move away from its traditional “pulp alone” strategy? Would you support building a new huge pulp plant in Itata project?