To Compute Quasi-Rents

Group Assignment Question: 1. Compute the quasi-rents, that is the additional profit for both parties of the relationship between the pulp mill and its closely located plantations (50% of pulp mill capacity) for the Alto Paraná operations over what the pulp mill and the closely located plantations could achieve in terms of profits if they did not trade with each other and instead each party had to trade with its respective second-best option. You may ignore loading costs and assume that there are no quality differences from using different suppliers. 2. How is each party’s profit in the relationship affected by their outside options? Should Arauco own both forests and pulp production facilities? How would you graphically communicate the result to an audience?

UPDATED QUESTION: Should Arauco forward integrate into paper manufacturing in 2004? As part of your answer, evaluate Arauco's acquisition of Alto Parana in Argentina. As stated in the case, Alto Parana sources 50% of its wood from third-party plantations, and 50% from its own plantations. Evaluate the relationship between Alto Parana and its third-party plantations. Specifically, calculate the quasi-rents that accrue to Alto Parana and the third-party plantations due to the relationship. Based on your calculations and your analysis of the relationship, should Alto Parana continue to source half of its wood from outside plantations? Or should it choose to source only from inhouse forests (or outside plantations), by buying out third-party plantations (or selling off its Alto Parana forest holdings)? Finally, what does your analysis suggest for Arauco's decision about whether to forward integrate into paper manufacturing, vs. increasing the size of its pulp milling capacity?

To compute quasi-rents, there are two main aspects to consider when looking at the additional profit for both parties of the relationship, between the pulp mill and the plantations. The first is the cost savings of transportation. Since the capacity of the mill is 350,000 tons with 50% going to third-parties we can estimate the total cost savings.  There is an estimated cost savings of $2.5 million based on the possible savings on transportation costs, as seen below:

Next, there has to be an evaluation of whether the plantation is selling a price intercompany for wood comparable to what it would sell in the open market. We can estimate the profit margin the plantation gives up by comparing the production cost of pulp within Arauco versus other producers. This will give an idea of the value the plantation gives up when selling within the firm. We used the average production costs across regions because external factors such as overall market demand relative to regions producing pulp can affect where and for how much the plantation can sell its products for. As listed below the estimated profit margin surrendered by the plantation is approximately 13.2 million.