The commodities and metals industries around the world have been experiencing a significant paradigm shift in the new millennium, in that the global demand for commodities is reaching dramatic heights, and this of course is pushing the price for commodities up to very profitable levels. As a result, the share prices of companies such as Rio Tinto, RUSAL, and BHP Billiton, have also been soaring. The paradigm shift itself is not so much the soaring demand, as much as it is where the demand is coming from.
A few key ‘Western’ countries are suffering from sub-prime mortgage and credit crises, and may undergo recession, such as USA and Japan. However, the soaring demand for these commodities is actually coming from China and India. With GDP growth rates averaging at about 10% a year, an unprecedented level, China’s economy is becoming the ‘world’s factory. ‘ Not only is labor here cheap, but the Chinese government also heavily subsidizes manufacturing industries to shield them from rising oil prices, and in effect, aids to sustain the competitiveness of these firms in the global market.
But the story is a bit more complicated. First, this soaring demand from China, meant that it was a net importer for many commodities, such as Aluminum. Secondly, due to low input costs, and subsidized industries, Chinese industries decided to heavily invest in Aluminum plants, to snatch yet some more global market share in a newly lucrative industry. However, although start-up costs were cheap, marginal costs ended up becoming too high to sustain any level of competitiveness.
This was because the production of Aluminum in terms of raw material was complicated and costly, and, the Chinese government, already faced with pressures of securing the country’s energy needs, no longer viewed the Chinese Aluminum industry as favorable, since it devoured stupendous megawatts of electricity in the production process. Consequently, the Chinese are slowly becoming importers again. This is relevant to a firm like Rio Tinto for two reasons.
Firstly, it has to satisfy huge demands for Aluminum, while simultaneously, be in competition with Chinese as well as other firms that are after the same market share, and highly competitive. Secondly, this commodity is only of many in which a firm like riot into is involved in extracting, and therefore, it has to think carefully about how it allocates its own resources to pursue a profit maximizing level of inputs and outputs, and realize sustainable profit levels.
Economic theory tells us that if a firm is already operating at (close to) maximum output, is faced with heavy competition, and wants to reduce costs through expanding output by becoming more efficient then it should merge with other firms. This is the equivalent of a firm moving down its long run average cost curve, and getting closer to minimum efficient scale (Varian, 2002). This is exactly what Rio Tinto was doing when it put in a high bid for Alcan (Aluminium Company of Canada), in offering it $38 billion in cash.
This report will be divided into several sections, exploring the Rio Tinto strategy in this case, covering historical perspectives, SBU Identification, strategic event, business environment, relative positioning, and value added. Historical Perspective Formed in 1943 as a copper mining company (in Spain), Rio Tinto ended up merging in 1962 with Zinc Coporation, consequently forming Rio Tinto-Zinc Corporation (RTZ Corp). Well into the 1990s, Rio Tinto expanded through further investment and merger around the world.
Between 1968 and 1985, Rio Tinto diversified into oil and gas, construction and vehicle manufacturing, cements well as chemicals. This ‘over-diversification’ resulted in the company’s losing focus of its core objective, specialization and area of competence that is mining (Rio Tinto Company Profile, 2007). Furthermore, low oil and gas prices throughout that period meant very low profits, and some losses. Therefore, in the late 1980s, following a strategic review, Rio Tinto made a decisive move to completely realign its focus only on mining, as well as related activities.
As a result, well into the late 1990s, Rio Tinto got rid of all of its non-mining assets, and tried to capture value adding mining investments. During this period, a significant merger, creating Rio Tinto US Holdings, was to be traded on the Australian, as well as the London stock exchanges (Rio Tinto Company Profile, 2007). This brings the company to its current state, of ‘smart’ mergers, closely following commodity areas that have promised demand for decades to come, since mining is a long term investment, and the industry has huge sunk costs at start-up.