ARAUCO: Forward Integra3on or horizontal expansion?

Aude Andrawis

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Individual Assignment

Strategy – Individual case write-­‐up – 28mar12 – Aude Andrawis

In 2004, Alejandro Pérez, CEO of Arauco, and its shareholders are discussing whether to integrate into the paper industry or to increase the company capacity in the pulp market Arauco is the world’s largest single producer of unbleached soKwood kraK pulp Very instable market: price swings Arauco has four business segments: pulp, panels, sawn Nmber and forestry Athe pulp acNviNes account for 50% of Arauco’s revenues Market pulp is the only globally traded commodity in the enNre paper business Most of the most prominent producers of market pulp come from North America, but they are losing power as growth in the market is driven by short-­‐fiber like eucalyptus ü Market trend is changing from a supply driven market to a demand driven market ü The industry is highly fragmented and marked by a lot of mergers (Arauco is one of them) ü Necessity for compeNtors to maintain high producNon efficiencies to measure up to the fierce compeNNon on price ü ü ü ü ü ü

Strategy – Individual case write-­‐up – 28mar12 – Aude Andrawis

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ü High produc3on efficiencies thanks to tangible assets investments à economies of scale àFor instance, Arauco produce BSKP for less than $300/ton compared to more than $400 for its compeNtors ü Plants exploited in order to minimise the total costs and reach the “minimum efficient plant size” ü Use of advanced forest techniques thanks to high R&D investments à beKer product quality and increase of margins à GeneNcs, pest controls, soil ferNlity à Findings of Arauco R&D department are not disclosed publicly ü Arauco is Chile’s largest radiata pine owner (most producNve species in the world) + rich natural resources of Chilean soil (external factors) à high yield per hectare ü Use of « log merchandising » à beKer and faster cut of logs à Saved millions of dollars per year ü Arauco’s mills built strategically close to plantaNons à cut down on transporta3on costs Strategy – Individual case write-­‐up – 28mar12 – Aude Andrawis

Arauco’s compeNNve advantage is essenNally a cost advantage, due to external factors and intern organisaNon of the firm

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But Arauco’s leading posiNon on the market is also based on external factors and intern organisaNon of the firm ü ü ü ü ü Diversified products and cash flows A large amount of revenues come from exports: 80% of its total revenues Solid cash flows and balance sheet throughout pulp price cycle Long-­‐term relaNonships with other nonintegrated paper manufacturers A diversified poreolio of customers

Strategy – Individual case write-­‐up – 28mar12 – Aude Andrawis

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Arauco’s business model is as it is differently verNcally integrated

ü In the paper industry, most of actors have a completely integrated structure from the ownership of forests, through pulp mills and paper manufactories to the distribuNon and converNng capabiliNes à beKer nego3a3on leverage ü Arauco is only present on the ownership of forests and pulp mills ü Diversified porWolio of products: saw mills and panels à value-­‐added produsts ü Arauco also ensure distribu3on trough its network of subcontractors CF Exhibit 1 ü The panels business is a natural complement to the company’s pulp and sawmills operaNons because it uses the fiber wasted during these two processes

Strategy – Individual case write-­‐up – 28mar12 – Aude Andrawis

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Arauco should integrate forward into the paper business in Chile but focus its internaNonal expansion on its core acNvity ü Arauco’s acquisiNon of Alto Parana in 1996: desire of expansion abroad à more efficient and more legi3mate to start with the pulp acNvity as Arauco is a leader on this market ü Arauco should focus on its core acNvity and not verNcally integrate its structure ü Cannot verNcally integrate without compromising its margins: high iniNal investments à Increase of costs ü Arauco is not a top-­‐of-­‐mind company in this very compeNNve market ü Doesn’t have the R&D knowledge nor the producNon capabiliNes to achieve economies of scale

Strategy – Individual case write-­‐up – 28mar12 – Aude Andrawis

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Arauco should build the Nueva Aldea project as it is the most profitable soluNon for the firm ü Very profitable market where companies can make up to 30% of margins à Opportunity for Arauco to become leader on this market ü Due to the strong demand for pulp worldwide, plus the company’s strong balance sheet and cash flows, the board of directors should go on wit the Nueva Aldea project

Strategy – Individual case write-­‐up – 28mar12 – Aude Andrawis

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