Once again, analysing business problems is no easy task. It tests one’s resolve to think critically. The Alusaf case was no different, an interesting but tricky one to analyse. Alusaf is an aluminium manufacturing company with a capacity of 170,000 tons per year (tpy), located at Bayside in Richard’s Bay in Kwa-Zulu Natal, South Africa. Despite historical fluctuations in the global price of aluminium, Alusaf was a profitable company. An idea to expand was conceptualised as what is known as the Alusaf Hillside project.
The Alusaf Hillside project
Alusaf Hillside project was to be the world’s largest greenfield primary aluminium smelter with a capacity of 466,000tpy- more than twice that of the Bayside facility. It was to be located at Richard’s Bay. The total estimated project cost was $2.0b. Feasibility studies were done, and the political scene was set by Nelson Mandela. He had appealed for sanctions to be lifted against South Africa and several countries responded positively. Economic relations were to be restored. All was set for Alusaf Hillside to take off by early 1994. But there was an aluminium glut from Russia which drove the global price of aluminium to an all-time low of $1,110 per ton (pt) compared to $1,300pt in 1991. Here was the dilemma, Alusaf needed to decide if this was the right time to embark on this massive and capital-intensive project.
Aluminium production in South Africa was predominantly secondary in nature, with Alusaf being the sole primary producer. Alumina was the main raw material needed, in addition to constant electricity supply. To produce one ton of aluminium, two tons of alumina and 15,000kilowatt hours of electricity is needed.
Rob Barbour, Managing Director of Alusaf was at crossroads. The Hillside project looked promising. Contracts for power and alumina (main cost drivers) had been favourably negotiated and equipment suppliers were offering 20 to 30% discounts reducing the total projected cost to $1.6b. Several investors had shown interest to partner with Alusaf. Scheduled meetings of aluminium producing countries were expected to address the world gut issue, but it was still uncertain that the prices would recover. Did it make sense to go ahead?
Well, putting oneself in the place of the protagonist, one would need to tread carefully. When analysing this case, the viability of the Hillside project under the current market realities is a top priority. To that effect, the financial implication, as well as demand for aluminium was taken into consideration. Based on the analysis done, the operating costs of the Hillside project was much lower than an average smelter. Demand was also expected to increase with global aluminium production cuts. The break-even analysis for the project revealed it would take about 11years to start becoming profitable. More so, with such a massive investment we concluded that the Hillside project is placed on hold for now.
What could have been done differently?
The cost structure should have been broken into fixed and variable costs and the information used to compare with costs of the already operating smelters. Also, it is important to calculate the Net Present Value (NPV), where a positive value will indicate that the project should go on. Finally, the expected price of aluminium should have been forecasted.
The Alusaf Hillside project went on as planned and was opened in 1996 by President Nelson Mandela. The project was delivered on budget and exceeded its original capacity of 466,000tpy to 510,000tpy.