Arauco (A): Forward Integration or Horizontal Expansion?

Topics: Paper, Pulp and paper industry, Kraft process Pages: 115 (10988 words) Published: October 27, 2013
9-705-474
REV: MARCH 25, 2009

RAMON CASADESUS-MASANELL
JORGE TARZIJAN
JORDAN MITCHELL

Arauco (A): Forward Integration or Horizontal
Expansion?
In early March 2004, Alejandro Pérez, president and CEO of Chilean forestry company, Arauco, was about to present his recommendations to the board of directors as to whether the company should invest US$1 billion to construct a new state-of-the-art chemical pulp plant. The plant, part of a multiphase project called Nueva Aldea, would increase Arauco’s capacity by approximately 800,000 tons to 3.2 million tons, placing the company as the largest producer of market pulp, just ahead of Aracruz in Brazil. Two years earlier, Arauco’s board approved the first phase of the Nueva Aldea project for US$150 million, which consisted of building a sawmill, plywood mill, and energy complex. The second phase involved constructing a pulp mill following the inauguration of the new Valdivia plant on January 30, 2004. The Valdivia plant had a designed production capacity of 700,000 tons of pulp, with an operating life between 30 and 40 years and expected sales of USD $350 million per year.1 Pérez was concerned about the downward trend in market pulp prices over the last three years. In addition, major paper companies, the sole buyers of market pulp, were typically backwardintegrated into the production of pulp. Pérez was confident, however, that the board would trust his judgment given Arauco’s tremendous success in recent ventures into remanufactured wood products (such as cut stock, blanks, clear rips, and decking balusters), plywood, and fiberboard panels. Pérez anticipated the toughest question the board would pose: would shareholders be better served by a strong-willed forward integration move into paper manufacturing rather than the horizontal growth plan he was proposing? Furthermore, was a large resource commitment a good strategic move at this point?

History of Arauco and COPEC
Arauco was formed through a merger between Industrias Arauco and Celulosa Constitución in 1979. Both companies had been created 20 years earlier by the Chilean government to develop forest resources, improve soil quality, and promote employment. In the late 1970s, the Chilean government had initiated an aggressive privatization program, which resulted in the sale of Industrias Arauco in 1977 to Companía de Petróleos de Chile (COPEC), a conglomerate involved in oil and gas, fishing, ________________________________________________________________________________________________________________ Professors Ramon Casadesus-Masanell and Jorge Tarziján (Universidad Católica de Chile) and Research Associate Jordan Mitchell prepared this case. HBS cases are developed solely as the basis for class discussion. Cases are not intended to serve as endorsements, sources of primary data, or illustrations of effective or ineffective management.

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Arauco (A): Forward Integration or Horizontal Expansion?

forest management, and pulp. Two years later in 1979, COPEC purchased Celulosa Constitución, merging the two entities to create Celulosa Arauco y Constitución SA (referred to as Arauco). Arauco began its expansion plan in the 1980s, which involved purchasing land and plantations and installing new technology equipment to improve efficiencies to compete effectively in the world market pulp arena. The expansion plan paid off as the company’s total holdings in hectares2 grew from 170,000 in 1980 to...
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