The copper industry has been changing during the decades leading up to 1984. The
market had transformed from one in which demand drove prices and production to
one in which supply seemed insensitive to demand and price. A prolonged decline in
copper prices prompts Phelps Dodge, founded in 1885, one of the worlds leading
copper producer in North American to consider corporate strategy to fight out the
income loss. According to the industry information and corporate structures of
Phelps Dodges rivals, the core problem could be concluded as following:
External analysis
Copper price was declined due to bigger amount of suppliers and lower demand on
the market. In order to gain profits and get competitive advantage, five forces
analysis of environment will be used for external threat analysis.
1. Rivals
Rivals were the main threat of Phelps and their profit shrinking. There are
three types of rivals.
I.
40% of the world copper supply was controlled by governments.
Governments had more political and resource advantages to
achieve larger economies of scale than any other independent
firm. Due to that they have a competitive advantage in the
market with a lower cost of production. State-owned Codelco
(Chile) could lower their cost to 45 cent per pound while Phelps
Dodges lowest cost was 70 cents a pound. Phelps had limited chance
to win the competition with governments.
II.
35% of world copper supply was controlled by non-copper companies.
Most of those non-copper companies were oil companies and able to
financially support copper companies to continue producing even while
prices were temporarily below the cost. As an experienced leading
copper company, Phelps has future opportunities to gain more market
share in the copper industry with acquiring other struggling
competitors.
III.
Other independent copper rivals like Asarco and Newmont used
diversification strategy to compensate the loss in copper business.
2. Suppliers
The threat from suppliers is relatively low for Phelps Dodge. As a leading
copper producer in North America, the bargain power of Phelps Dodge is
strong. According to Phelpss financial statements analysis, days payable
outstanding are 74 days while days sales outstanding count as 54 days. This
is an advantage for Phelps to pursuit its competitive advantage. The loss of
income did not come from the pressure of suppliers, but was the result of the
market price pressure.
3. Bargaining power of buyers
The buyers always choose the best combination of price and quantity for
their product. One way to keep some customers detached to your company is
Internal analysis
Because of the decline of copper price, Phelps had negative Net income in both
1982 and 1983, which indicates that the operational costs are higher than the
actual sales (1.044.789.000>977.383.000). It was urgent that Phelps needed to
reduce the cost of goods sold to compensate the decrease of the revenue.
Although with a negative Net income, Phelps still has a positive cash flow statement
with a cash conversion cycle of 19 days in 1983. It was improved by 15 days from
1983. Asset turnover of Phelps was 0.51, slightly lower than Asarco (0.67) and
higher than Newmont (0.34), which means Phelps was more efficient than Newmont
by the conversion of assets into revenue.
Strategies suggestion
Basically, in order to thrive from current financial and operation difficulty, Phelps
should either like state-owned firms operate with lower costs, meaning that their
surplus is higher, or like Asarco and Newmont introduce diversification strategy.
Another way is to use the model of non-copper firms that use extra cash flow to
Hedging
There are two ways of hedging. One is hedging with future. Another is hedging risks
by using diversified portfolio. Treasure risk could be hedged by using financial
instruments such as forward or future contract. Future contract for 1984 is to sell at
Yao Zhang, Ivan Jajic, Xuan Zhang
Conclusion
Restructuring plan is a sufficient risk management method for Phelps which creates
values due to volatility reduction and positive future cash flow if hedged by future
contract. However, diversification strategy is necessary for Phelps long term run in
order to minimize its weakness to treasure risk and strategic risk.