Alusaf Hillside Project: Case Study

Alusaf Hillside Project: Case Study Alusaf Hillside Project refers to the case of rapidly declining aluminum prices in South Africa in the first half of 1990s which made Alusaf reconsider its plan to invest in a new smelter at Richard's Bay. When the feasibility study was conducted two years prior to the actually decline in prices, everything looked positive for Alusaf. It was clear that Alusaf could gain a lot from developing a new facility at Richard's Bay since it had been the only large producer of aluminum in SA.

The company had been raking in huge profits in early 1990s as they reached $220.2 million, up 1% from two years ago. However they had failed to foresee the future which resulted in a huge setback when in 1994 Russia entered the aluminum market and suddenly everything went awry. For one, Russia had aluminum in excess after its break up from the Soviet Union. This meant that now Russia needed to discard off its excess production stock as quickly and as cheaply as possible.

Since SA was a good market, Russia entered this market with full force and quickly took over as people preferred the cheaper prices and equally good quality as they had previously been getter from Alusaf. But that also meant that Alusaf had to suffer since it had been producing aluminum at a much higher cost compared to the prices it was now forced to compete with. Preparation of aluminum required huge electricity reserves and hence Alusaf had been contracting with electricity providers at a huge cost.

But the main problem with the development of a smelter was that it was an unstoppable process. This meant that once a project had been started it was not easy to close it off or end it abruptly as this could lead to serious electricity loss along with serious leak of unwanted substances in the air. Hence Alusaf was now in a fix.

It had to decide quickly if it would go ahead with the plan or if it would stop the entire project because it may never be able to recover the costs that it had once hope to recover quickly. With the entrance of Russia in the market, it had become clear that Alusaf was no longer the only large producer and now it was easier to get aluminum at a much cheaper rate from Russia producers.

Alusaf could suffer a major setback if its smelter plan was withdrawn and it could also suffer if they went ahead with it and were unable to rake in the profits to at least cover the operating costs. Alusaf thus had to decide what it would do and for this reason, we shall conduct pros cons analysis and see what would work for Alusaf in the light of the available information.

PROS Alusaf needs to understand that despite the presence of Russia, it was still the market leader in SA because buyers were aware of its reputation as against the Russian producers who were only new suppliers in the market. Alusaf had the capacity to produce much more than what Russia could offer. This meant that even if they failed to cover the domestic region, they could easily export the excess.

The smelter plan was already half done which means that most of the resources required for it to work had already been in place and hence it is better to proceed with the project than stop it now.

Alusaf also must not forget that if it continues with the smelter plan, there is a likelihood of long tern benefits because once the Russian aluminum runs out and there is no more supply, Alusaf would again dominate the market and the smelter project would keep producing aluminum for a long time thus serving and meeting the needs and demands of the people of SA long after Russians have left. CONS: The one major setback that Alusaf can face is short-term profits decline.

We understand that with the presence of cheaper aluminum in the market, it is more than possible than Alusaf's aluminum would not find the same reception it did before. This means lower profits as demand for expensive aluminum declines. The short-term decline in profits would be aggravated due to the fact that Alusaf had already invested a huge sum of money in the development of this smelter. In other words, the operating costs would initially be much higher than what Alusaf would ideally aim for.

For this reason, initially at least for the first few years, Alusaf will either make no profits or its profit margins would shrink significantly. The drastically low prices of aluminum i.e. $1,100 per ton has significantly shrunk the profit margin as previously the prices had been $2,500 per ton. The consistently declining prices due to the presence of cheap aluminum gives Alusaf even lesser dominance in an otherwise perfectly competitive market.

The fact that aluminum industry is perfectly competitively in SA means there are many competing firms and thus even the leader has only 4.1% share of the total demand. This doesn't work in Alusaf's favor now that cheaper aluminum has taken over the market. ANALYSIS The analysis of situation suggests that Alusaf will definitely face serious shrinkage in profits in the short-term. However it still must continue with the project because there is a likelihood of an increase in profits in the long-term.

If Alusaf is focusing on the long-term which it must, then it should not stop the project because it will lose.