A company’s Strategic Business Unit (SBU) identification gives managers the ability to differentiate between different parts of an organization that are operating under different conditions in different markets. Since Rio Tinto operates in a multitude of locations globally, and extracts many different commodities and minerals, it is very important that there is clarity in the SBU analysis insofar as identifying the different parts of the organization and different challenges.
Rio Tinto’s activities can be categorized as follows; the energy sector, concerned with coal and uranium (for coal and nuclear power plants), the precious metals sector, including gold, silver as well as rocks such as diamonds, and the industrial mineral sector, including boron, salt, gypsum, talc, iron ore, copper and aluminum (Rio Tinto Company Profile, 2007). There are fifteen companies based in Australia and the USA under Rio Tinto that are currently extracting coal, and supplying both domestic and export markets.
The coal is aimed at coal power plants for energy production, for manufacturing iron and steel, as well as coal on its own for purposes of international trade. On the uranium platform, there are two major holdings based in Australia and Namibia (Southern Africa). The uranium here is produced only for nuclear power plants for energy production. These are significant operations, as the mine in Namibia supplies 7. 5% of global uranium demand, and the mine in Australia feeds a third of global demand (Rio Tinto Company Profile, 2007).
Regarding precious metals (gold, silver) and stones (diamonds), the company satisfies a significant proportion of global demand for small diamonds. There are several large firms operating under Rio Tinto around the world, and are mining these commodities. In the minerals sector, Rio Tinto supplies half of global demand for borates. It operates boron mines in South America, and in North America, has the largest boron mine, located in California. It operates talc mines in Australia, Europe, and North America. Finally, Rio Tinto’s aluminum platform is operated by its Aluminum Group.
Manufactured from the raw material bauxite (which is considered to be the most abundant mineral in the world), aluminum is a very useful commodity, since it is used for a variety of purposes. The Aluminum group is involved vertically in the industry and operates throughout the entire supply chain, including extraction, refining, and distribution, respectively. These include eight key companies, around the global, and recently acquired Alcan (in Canada) in an effort to expand operations, reduce long run average costs, and meet a significant portion of growing global demand.
Strategic Event As mentioned earlier, the objective of Rio Tinto’s acquisition of Alcan was to grow in size. The two main ways a company can achieve growth, is either through increased capitalization, by investing in new technology, research and development (finding new mines, or extracting from previously ‘unfriendly’ mines) and improved efficiency, or, through mergers, where output is increased not by discovering new mines, but buying new companies involved in the same sector (consolidation).
The mining sector globally is a relatively saturated industry and there are a few dominant (leader) firms that dominate the industry. Therefore, there is scope for oligopolistic behavior, and/or price leadership. This means the recent Alcan acquisition was not only important in meeting demand, but also crucial in maintaining and perhaps even expanding Rio Tinto’s industry power and voice. The acquisition was approved by the government of the United States of America, for the value of US$38 billion. Business Environment
Aluminum is a low cost commodity currently, and therefore, when compared to other options for investment (gold, copper, and so on), is more attractive. This also means that the opportunity costs of investing in Aluminum are currently quite low. Furthermore, projections of growth rates in the demand for Aluminum are very high, and perhaps the highest in history, due to sustained growth in economic development in China and India, not to mention emerging economies in Eastern Europe, as well as the strong Asian economies of Taiwan, Malaysia and South Korea.
In fact, Chinese growth in demand for aluminum is estimated to be 15% annually. Now, China consumes 12. 5 of the 70 tons of current global supply. Taking into account growth from other countries, the merger was a welcomed move by Rio Tinto’s management (. Since start-up costs, as well as marginal costs for Aluminum extraction and refining can be very high, these costs also act as a significant barrier to entry by other interested firms. This means that future competition is unlikely and Rio Tinto would only have to deal with existing competition (minus Alcan) (Austen, 2007).
Also, since Rio Tinto is in control of the entire supply chain, or in other words, is vertically integrated, this means that it takes advantage of significant economies of scale and scope, to bring about greater efficiency, supply abundance, and reduced costs (primarily by cutting out the middle-men). To further boost the attractiveness of expanding Aluminum production for Rio Tino is the fact that there is a shortage in supply and an excess in demand for the commodity.
This means that the price is pushed up to very profitable levels and with control of a greater portion of global supply, Rio Tinto can control its production rates in order to control how fast the price is pushed down. Alternatively, if other competitors are behaving as such, Rio Tinto can increase supply, and grasp a larger share of global demand. Furthermore, there is scope for improving Alcan’s operations even further by introducing new management and corporate strategy from the Rio Tinto side, and integrating this with Alcan’s existing infrastructure and manpower.
It is worth noting that this sort of consolidation and mergers are taking place all over the world in the Aluminum industry. RUSAL (the Russian Aluminum giant) was consolidated recently, combining Rusal, SUAL and Glencore. The new firm feeds 11. 7% of global Aluminum demand. The trends in consolodiation in the industry also warrant the Rio Tinto Alcan megrer. Relative Positioning Prior to the merger with Alcan, Rio Tinto’s share of global Aluminum supply was 2. 5% (one million tons), making it 8th in the ranks of the market’s producers.
The merger did much more strategically than first meets the eye. Since the returns of the mining and particularly the Aluminum industry is so high, firms have been using these increased returns to re-invest and expand to meet future projected demands. One way in which this was done was mergers, and Rio Tinto’s Aluminum company would have been a target for this. However, Rio Tinto foresaw this and took over Alcan, giving it a boost to 12. 6% of global market supply share (four billion tons). This puts it ahead of (in terms of output) RUSAL.
Therefore, Rio Tinto has moved from product development to actual market penetration, with one very smart merger. This is usually achieved by a firm over a long period of time, and over a series of mergers. Obviously, this shows that Rio Tinto’s management is very optimistic about Aluminum, and it wants to have a leading global position in the commodity. As mentioned, in terms of output, this has already come about. If the price of Aluminum does increase further and projected demands are realized, then, it is safe to say that Rio Tinto’s Aluminum positioning globally might possess even more gravity in the future.
Value Added by Event The Alcan merger gives Rio Tinto the opportunity (in addition to the positive points made above) to discover a new role as a possible price and output leader in the market. This means, that with greater output, maintained high Aluminum prices and demand levels, the share price of Rio Tinto should increase substantially. Not only does the company become more attractive for possible investors, but it becomes more attractive for skilled employees, which further increases the value added to the company.
This sort of move by Rio Tinto acts as an ‘unintended’ marketing gesture or vacuum that attracts employees from all over the world. There are of course also new production methods that were developed by Alcan (since it was a specialization for Alcan), that can be inherited by Rio Tinto. These methods can be shared in other existing pre-merger plants. Corporate culture can be shared between the two sides in not only merging financials, but also skills, methods, and quality of work.
As mentioned earlier, the movement down the long run average cost curve (closer to minimum efficient scale) resulting from the merger should result in high savings in input costs, greater revenues, due to increased output, and therefore larger profits. It is expected that the merger will save the company US$ 500-700 million in 2008 (Rio Tinto, 2007), with a corresponding 12% rise in earnings. Inevitable these provide echoes of higher dividends, which mean an increase in demand for Rio Tinto shares, and therefore a rise in their shares.