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Horizontal Expansion Versus Vertical Integration Essay

1032 words - 5 pages

In reviewing the facts presented to me it is my opinion, along with those of my colleagues at WIF Consulting, that your recommendation to horizontally expand the production of market pulp is the better decision when weighing it against the prospect of forward integrating into paper production. After doing an initial calculation, the net present value of the Valdivia project is roughly $3.7 billion (see Exhibit A), which yields a gain of almost $2.6 billion. Below are the key points we’ve identified to support this figure.

Existing Competencies Within Arauco’s Contracted Workforce
Because Arauco already has over 10,000 employees aiding in forestry and transportation operations under ...view middle of the document...

The soil itself allows for more pines to be planted per hectare. Additionally, the climate allows pines to be harvested for pulp in only 16-18 years compared to the 18-45 years needed to accomplish the same results in North America. Because of this, Arauco’s backward integration into forestry proved essential because it not only lowered economies of scale through the elimination of transaction costs, but also through the strategic placement of mills, which cut down transportation costs. Furthermore, Arauco’s throughput time is already significantly faster than that of the North American producers and affecting the market. Investing in the Valdivia plant would allow Arauco take advantage of these factors and produce more pulp, more rapidly, at already lower prices than the competition.

The Paper and Pulp Industry
The paper industry has seen three consecutive years of no growth. The demand for paper, which is driven by consumer demand, has a direct correlation to pulp prices per ton, which makes both markets extremely volatile. This proves a benefit for Arauco when considering that four out of the five largest paper companies are vertically, integrated—if not fully integrated. These integrated paper manufacturers benefit from higher pulp prices because they are not forced to buy at these higher levels. When prices are low, however, integrated operations find themselves at a disadvantage because they have already made substantial investments in their own forestry plantations and pulp production mills and, thus cannot take advantage of lower market prices. When considering this, increasing Arauco’s operating capacity by 800,000 to 3.2mm tons of pulp will only drive marketed pulp prices down, which will further hurt these large, integrated paper companies.

Arauco’s Competitive Advantages in Market Pulp
Arauco is also to adapt to the potentially lower pulp prices that will result in its increased presence in the pulp market because it has been able to sustain an advantage over its competitors. By producing its own energy, Arauco is not only able to provide enough energy to sustain its operations; it also has an excess amount being generated which is sold to the Chilean electricity grid at an average of $100 million annually. This means that adding the Valdivia plant would not...

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