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Aluminum: Through the lens of Michael Porter

Mar 26, 2009

Backed by abundant and good quality bauxite reserves and cheap labour costs, Indian aluminum producers have emerged among the lowest cost aluminium producer in the world. India is home to the sixth largest bauxite deposit in the world which makes its world's 5th largest aluminium producer. Aluminum industry in India registered a phenomenal growth during the past few years on the back of robust growth in the economy. However, the current ongoing global crisis seems to have created some medium term hiccups. In this article, we have analysed the domestic aluminium industry through Michael Porter's five forces model so as to understand the competitiveness of the sector. Barriers to entry: We believe that the barriers to entry are medium. Following are the factors that vindicate our view.

  1. Economies of scale: As far as the sector forces go, scale of operation does matter. Benefits of economies of scale are derived in the form of lower costs and better bargaining power while sourcing raw materials. It may be noted that the minimum economic size of a fully integrated greenfield smelter is around 250,000 tonnes. The aluminium companies, which are integrated, have their own mines for key raw materials such as bauxite and coal and this protects them from the potential threat for new entrants to a significant extent. They also have their own power plants as it is a major cost driver.

  2. Capital intensive: Aluminium industry is a highly capital intensive business. It is estimated that a capital investment of around US$ 1.2 bn is required to setup a economically viable greenfield project.

  3. Higher gestation period: The gestation period for an economically viable green field plant is over 4 years while for a brownfield project, (modernization / capacity addition) the gestation period is relatively lower between 1.5 years to 2 years.

  4. Government policies: The government has a favorable policy towards aluminium manufacturers. In fact to protect the domestic industry, recently, the government has imposed duty on value added products like foils and rolled products from the Chinese markets. However, similar to other sectors, there are certain discrepancies involved in allocation of mines and land acquisitions. Furthermore, regulatory clearances and other issues are some of the major problems for the new entrants.

Bargaining power of suppliers: The bargaining power of suppliers is low for fully integrated aluminium smelters (upstream) as they have their own mines for key raw material like bauxite. Examples here could be Nalco and Hindalco. However, those who are non-integrated or semi integrated, (downstream) have to depend upon the upstream producers for alumina or primary metal. While the bargaining power is limited in case of power purchase as it is highly regulated sector and government is the sole supplier most of the times, increasing usage of captive power plants are helping the companies to rationalize their costs to certain extent.

Bargaining Power of Customers: Being a commodity, customers enjoy relatively high bargaining power as prices are determined on demand and supply.

Competition: Competition is primarily on quality and price, as being a commodity, differentiation is difficult. However, the recent spate of consolidation has reduced the competitive pressure in the industry. Further, increasing value addition to aluminium products has helped some companies protect themselves from the high volatility witnessed in the industry.

Threat of substitutes: On one side, the usage of aluminium is rising continuously in the automobile and construction sector but steel still remains a main substitute because of its relatively lower cost. On the other side, copper has been slowly substituting aluminum's usage in the power sector due to its higher conductivity. However, with properties like higher strength-to-weight ratio, durability, higher corrosion-resistance and relatively lower cost, aluminium is able to hold its own. Thus the usage of aluminium is likely to increase over a long term period.

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