Methanex - Developing Strategy in a Commodity Industry - Case Study Example

CASE ANALYSIS" Methanex: Developing strategy in a commodity industry EXECUTIVE SUMMARY Methanex is seeking to increase its market share and hedge itcompetitors. It is for this reason management should consider undertaking market differentiation and cost leadership. Differentiation will include market research and innovation where new sources and new uses of methanol will be identified. This will increase market demand and also reduce cost; further increasing its competitive advantage. Methanex Management wants to see the company carry out its operations efficiently into future periods. Therefore, board should consider re-investing the company’s revenues in other markets like China, which are considered to be viable. This strategy will be financed by retained earnings and new capital sources. The company can also roll out a strategy to control the raw materials in the industry. This is aimed at controlling the supply of natural gas, a raw material in manufacture of methane. New production plants will be built in new exploration sites as research will be intensified to increase demand and market share for Methanex. EXTERNAL ASSESSMENT The methanol industry is marked with price fluctuation due to various factors in the commodity market. First, there are shortages that occur from time to time due to the fact that methanol cannot be stored. Political and social factors are other causes of price fluctuation of methanol. Competition is among the factors that ensure market sustainability. Methanex is the largest player in the industry competing against Methanol Holdings Trinidad Limited, the biggest competitor. Other players in the industry include Sabic, Mitsubishi Gas Chemical and Malaysian Petronas. Entry into the industry is free although small firms find it difficult to join the industry due to domination by large firm firms in terms of market share and raw materials. From the case study description, the methanol industry market can be described as an oligopoly. There are few firms in the industry where some firms are price and quantity leaders. As depicted in the industry’s price curve, methanol’s production costs and price are directly related to those of crude oil. The external environment analysis has been summarized in Exhibit 1. Market leadership is one of the opportunities in the methanol industry that can be pursued by any firm to its advantage. Price is a major determinant in demand and supply of any commodity in the market. Being in a position to influence the market prices places a company in a good position in the industry as prices changes do not affects its operations. Being able to determine industry prices enables the company to protect itself against the effects of price volatility. Demand and supply can be determined with ease since the prices are often known to the company. The company is therefore able to project its revenues with certainty. Another area of opportunity in the industry is the continued innovation of the diversified uses of methanol. When some governments, for instance the USA government, face out the use of methanol fuels, others are encouraging the use. New uses of methanol are also being invented. As presented in the case, a new market is looming in China. This has been attributed to the new uses of methanol in fuel blending and domestic cooking. Continued research in the uses of methanol and its diversified uses present a growth opportunity in the methanol industry. Politics plays an important role in success of any business. The policies formulated by different governments impact business operations. The political status of the countries with potential market has always determined the success or failure of the companies. The foreign operations in politically instable have always presented threats to industry. For instance, the case study presents the effects of the political unrests in Egypt, where Methanex had to abandon Emethanex. This resulted in losses due to dormancy and reduced supply. The unforeseen occurrences in the political world present a threat to the industry. If the policies keep changing for the worse, more of methanol trading firms will be non-operational. Political unrests have also resulted in market loss and destruction of property. INTERNAL ASSESSMENT Methanex is one of the methanol industry’s largest players. The company was started with a sole aim of sourcing and supplying methanol to its customers across different parts of the world. The success achieved by Methanex is largely attributed to its specialization in a single product, methanol, that allows the management to concentrate and strategized with greater ease. Being the largest methanol supplier, Methanex enjoys various market privileges like price determination and a wide customer base. The company has acquired many smaller firms dealing in methanol production and distribution. It has also entered into partnerships and agreements with various players in the industry, for instance, the Egyptian government. Methanex also runs a transport and logistics company, Waterfront Shipping Company, which supplies methanol to customers across various destinations. The services of the transport subsidiary can be contracted by other firms whenever they are idle. The internal analysis of methane is better summarized by exhibit 2. Value: As identified in the external assessment, the methanol industry exhibits potential growth opportunities due to the continued innovations leading to new uses of methanol. This has resulted to ever increasing demand for the product. This is a distinctive competence for the company as it can capitalize on this factor for profitability. Methanex solely focuses on production and distribution of methanol. This has enabled the company to maintain steady supply of methanol; thereby increasing consumer confidence in the company. It is for this reason than Methanex is able to sustain a wide customer base. Rarity: Methanol has high storage costs, but Methanex risks by storing some of the product so as to meet demand when shortages occur. This is the major factor that has contributed to the continued growth of the company. The factor has also enabled Methanex to be the price leader, a factor that has shielded the company from market shocks. Imitability: Although Methanex has control of the methanol market, unforeseen occurrences and market volatility are likely to slow down the growth of the company. Various players in the industry have diversified their operations to include other petroleum products. Any occurrence in the market, for instance, a ban on methanol by environmental authorities or invention of a better alternative to methanol uses, is likely to drive Methanex out of the market. This is an internal weakness (Exhibit 2) that the company has always used to its advantage. To ensure sustainability in its operations, the company has always invested in research and technology. This has allowed it to develop alternative uses of methanol and also to identify risky market factor and come up with solutions. Organization: as revealed in the case study, John Floren is the CEO and president of Methanex. He has been tasked with evaluating the current position of this company and develops long term solutions that will ensure the company grows in a profitable way. This shows that he has been delegated with the duty of running the company’s daily operation. The authority has been delegated to him by the board of directors. Floren has used his authority to assemble a development team to assist him achieve what the board required of him. From the evidence provided, the company uses a vertical organization structure. FINANCIAL ANALYSIS The company effectively utilizes its assets to generate sells. From the financial analysis in exhibit 1, the Asset turnover ratio for 2012 is 0.75 compared to 1.2 attained in 2011. This means that the company utilizes $0.75 to generate $1 worth of sales. This depicts a reduction in operation efficiency in the 2012. As depicted in the income statement issued, the company attained a loss in the 2012. This is mainly why there was a reduction in operation efficiency. This is also depicted by the profitability ratios that are negative. Return on equity was 0.14 in 2011 and dropped to -0.13 in 2013. The company manages its inventories and receivables effectively as shown by the high activity ratios. Since little profit is generated from the sales, the company has not been effective in meeting the interest payments. As explained in the case studies, the company offers cheap prices to customers owing to its price leadership. Low prices encourage debtors to clear their debts so as to continue enjoying the price discounts. Although the company has had high sales volume, operation and overhead costs are still high leading to low profitability as shown in exhibit 3. CURRENT STRATEGY Cost leadership Cost has been identified as impairment to the company’s profitability. High operation costs have resulted in reduced profits as depicted by Exhibit 4. Due to this the company is embarking on cost reduction mechanism. First, Methanex is seeking to secure cheaper sources of its raw materials, majorly natural gas. The company has ventured into research to identify natural gas locations that are easily accessible and with 20-25 year abundance of natural gas. The dormancy of many of its plants due to unfavorable environmental, political and economic conditions was also addressed in future operation of the country. Methanex seeks to invest of areas considered to possess good political, environmental and economic conditions. China has been acknowledged as the emerging market in the methanol business. According to the evidence presented in the case study, china alone is accountable for 37% of the global methanol demand. Research and innovation in china has resulted in new uses of methanol, thereby increasing its demand. Methanex has entered into an agreement with a Chinese firm, XinAo. Methanex will be a 20% shareholder in this venture. Methanex wants to participate in the Demethyl Ether (DME) project in China through this association. The company has realized an opportunity in the increased use of DME in China and the surrounding countries as heating and cooking fuel. This venture will see Methanex supply 30,000 tonnes of methanol per annum to XinAo. Differentiation strategy Methanex is seeking to maintain its position as the largest methanol supplier in the world. This is a strategy that was rolled out in the year 2000. The company is the largest methanol supplier supplying 7 million tonnes of methanol. This represents 16% of the world demand for methanol. Methanex is seeking to intensify its operations in Trinidad, where its largest production plant is. Methanex has received competition from the Trinidad based MHTL and is seeking to invest in plant expansion. The company signed long term contracts with various governments, including the Trinidad government. These contracts will run from 2012-2024, a fact that is likely to hedge MHTL. This is likely to KEY ISSUES The first issue facing Methanex is the political instability and government policies that have resulted in dormancy of its plants. Political in Egypt, a partner state in the Emethanex plant has resulted in losses due to unused capacity of the plant. The Argentinean policy banning export of raw materials has also led to a closure of two of Methanex’s plants in Chile. Another issue facing Methanex is the high cost of raw materials. As explained in the case study, high operation costs and raw material cost have resulted low profitability of the company. The growth and expansion of MHTL is becoming a threat to Methane’s market in Trinidad. As explained in the case study, Methanex’s contracts may be hijacked by MHTL if it grows to exceed Methanex. China is presenting an emerging methanol market. Methanex has identified this opportunity and is seeking to invest in this market. Methaniex has not yet looked into long term aspects new market and its sustainability. The market might just be short term making Methanex’s investments nonviable ALTERNATIVES Differentiation: Methanex should focus on increasing its competitive advantage by outdoing its competitors. Customer acquisition and satisfaction is a strategy that will see Methanex increase its market share over time as shown in exhibit 5. This can be achieved by: Expanding operations to Asia, which has recently proved to be a viable market Cost leadership: Methanex can hedge its competitors through a cost reduction strategy as shown in Exhibit 5 alternative 2. This is attainable through: Closing down and disposing the dormant facilities Moving operations to low cost and resource abundant region Focused innovation: Methanex should invest in scientific research as it has proved to result in demand increasing innovation. As shown in exhibit 5 alternative 3, it is attainable through: The company should intensify scientific research into the production and use of methanol. In this way, it can establish new ways of producing methanol and also new uses. Market research should also be undertaken so as to identify new markets. CRETERIA OF EVALUATION Assumptions and justification The discount rate used in this analysis was 8%. The sales revenues attained were projected to increase at an average rate of 3% per annum in the initial 5 year of operation in the new markets. The sales have been projected to hit more than 8 million dollars by 2017. The Pessimistic scenario depicted in exhibit 7 shows a negative value of NPV. This can be explained by unseen market occurrences such as hidden operation costs and unfavorable economic conditions. Optimistic scenario presented in exhibit 6 shows high sales that are increasing per year. This can be explained by correct prediction of the market conditions. There may also be prevailing conditions which were not identified in the assumptions that are likely to favor operations. Expenses are likely to reduce leading high cash flows. The most likely scenario shown in exhibit 8 shows sales increasing at an average rate of 2%. The expenses are also decreasing due to reduced operation costs. Net present value Any investment is undertaken with the sole aim of increasing future revenues of a company. Expansion into the Asian market is an investment that is viable as the future cash flows of Methanex are projected to increase. From exhibit 6,7 and 8, the assumptions stated will determine the viability of the alternative strategies. If the assumptions fail to hold, then the strategy might not be attainable. If the factors hold, then the strategies named above are likely to generate a positive NPV of $123,271.30. This is because the above identified strategies will increase sales revenue for the company and reduce costs. Generally, costs and other expenses are predicted to decrease as the year progress. Market share Methanex is currently serving 16 percent of the entire market. Its operations into Asia, which is responsible for more than 50% of the entire methanol demand, will assist the company raise its market share significantly. China alone demands 38% of the world’ methanol; by supplying an additional 30,000 tonnes, Methanex will see its market share increase from 16% to 20% in the first 3 year of expansion. Quality of services Being the largest supplier of methanol, Methanex will work to ensure its customers are retained. The company has ensured continued supply of methanol to its customers, a factor that has increased customer confidence. Timely reviews will be conducted to ensure that the current customers are not affected by the increased demand. The alternative strategies will be undertaken while ensuring the current customer base remains unchanged. RECOMMENDATIONS Methanex should focus on new market acquisition as it will increase the current market share and the company’s revenues. New markets are only attainable through market research and development. Methanex should invest in new markets as they show potential in helping the company attain its goal of remaining the world and market leader. Long term contracts should be entered into the new markets so as to secure the new customers and also to ensure sustainability of the markets. Research and innovation should be promoted by the company so as to come up with new sources of methanol and also new uses. This is likely to reduce raw material costs and also increase demand. Methane should also focus on leadership. As identified in the case study, the company has often invested a lot in production plants that turn to be dormant due to various reasons. The current operation costs and raw material costs are also high leading to lesser profits. The company should invest in areas where raw materials cost cheaper. The company should also invest in areas with political stability and favorable economic policies. Once the analysis is complete, it will be brought to the board for approval. After the recommendations have been approved, implementation will be commenced as shown in exhibit 9. First, the company has to source and make available the required finance. Research on the Asian markets to ascertain the sources of raw materials and identification of potential partners for contraction will follow. Internal restructuring will then be done to cut unnecessary costs. CRITIQUE My major concern for the identified strategies to be undertaken by Methanex is the ability for the company to meet the investment demands. The income statement presents a loss in the current financial year. Investors may be reluctant in approving the investment endeavors. These changes may also over stretch the current resources of the company, reducing the quality of services since the company will be serving a wider customer base. Factors Description Opportunity/Threat Economic Condition Recession and unfavorable economic policies Threat Competitive Rivalry Low competition Market leader and spot price determiner opportunity Location Across Americas, Europe and Asia Strategic positions to attract new customers Strategic locations; near raw materials Opportunity Government and political environment Unfavorable in some location Hostility due to political instability Threat Exhibit 1: External analysis The external environment poses is out of the company’s control. Therefore, internal care should be exercised with dealing with external factor. Research on the factors should be undertaken so as to capitalize on opportunities and hedge the threats. Exhibit 2: VRO analysis Methanex decided to specialize in methanol extraction and supply, a factor that has been considered as strength as it has led to growth and development of the company. Continuous supply of methanol throughout various seasons has increased customer confidence and increased Methanex’s competitive advantage. EXHIBIT 3: FINANCIAL RATIO ANALYSIS Financial Ratio Analysis 2011 2012 Profitability Ratio Return in sales 0.14 -0.13 Poor management of investor funds Return on equity 0.04 -0.003 Liquidity Ratios Current Ratio 4.0 3.30 The company is able to meet its short term obligations with ease Acid test(quick ratio) 3.10 2.73 Activity ratios Inventory turnover 9.8 8.64 Good inventory management Accounts receivable turnover 7.0 6.22 The company exhibits good debt collection techniques Total asset turnover 1.2 0.75 This ratio depicts good utilization of assets by the company. Leverage ratios Debt to equity ratio 1.8 1.40 The company is in a good position since it operates on a lesser debt proportion. Debt to total assets 0.76 0.58 Times interest coverage ratio 0.98 0.47 Less profit is made to cover the interest expense. Shareholders ratio(could be termed as part of profitability ratios) Earnings per share 8.1 7.22 P/E ratio 0.14 0.13 Dividend per share 7.9 7.74 Dividend payout ratio 2.45 2.24 Return on assets 0.02 0.01 Operating cycle(could be termed as part of the activity ratio) Number of days inventory 2.19 3.17 The current financial performance of the company is poor compared to the previous periods. For better performance in the future, costs ought to be reduced and revenues maximized. EXHIBIT 4 CURRENT STRATEGIES AND THEIR IMPLEMENTATION Name of the Business Strategies: Cost leadership and Differentiation strategy Customer Needs: Affordability and constant supply of methanol Customer Groups: service to customers across the world majorly in China and Asia that present an upcoming potential market. Basis for Competition: Increased demand due to new uses being invented in the identified potential markets. Corporate Strategies: long term contracts with potential stakeholders in the industry to ensure sustainability of the market and the raw material. Placement in the value system: Methanex is the only company with ability to supply large amounts of methanol continuously to its customer. The company has ability to stock methanol so as to meet shortages. Global Strategies: Methanex competes on a global platform with production plants across different regions of the world. It has a sole aim of hedging its competitors by increasing customer confidence and reliability to supply methanol at all times. Major Functional Strategies: high quality methanol low production and distribution costs increasing productivity Implementation: Structure, Control Systems, and Culture centralization of authority distinct organizational culture Adherence to ethical standards EXHIBIT: 5 COMPREHENSIVE STRUCTURE OF A STRATEGIC ALTERNATIVE Name of alternative strategy: differentiation Customer needs: High quality and constant supply of methanol. Customer group: Extending operations to effectively cover the Chinese market and the whole of Asia. Basis of competition: Availability of cheap and readily available natural gas among the Asian countries. Research and innovations leading to new markets identification and the Perceived potential of the new market. Corporate strategies: Partnerships, alliances and contracts with various stakeholders in the methanol industry. Placement in the Value System: this will increase the company’s command in the market and also increase its competitive advantage. Issues addressed by these strategies: high cost of raw materials and competition. FEASIBILITY JUSTIFICATION FOR THIS STRATEGIC ALTERNATIVE Environmental Opportunity: political stability in China and long term Contracts with the Chinese firms demanding high amounts of methanol. Environmental Threats, Risks: low priced Chinese currency and interest rate volatility are likely to be an economic impediment. Fixed term contracts will be used where the current interest rate and currency value will be used till the end of the contracts. Present Corporate Attributes relevant and sufficient to this alternative: The desire to remain the market leader and also the urge to increase the size of the company in terms of production and market share. Missing and/or insufficient Corporate Attributes: a concrete development plan for new market acquisition ALTERNATIVE 2 Name of alternative strategies: cost leadership Customer needs: High quality and affordable methanol Customer group: Asian market mainly China. Basis of competition: Availability of cheap and readily available natural gas among the Asian countries. Research and innovations leading to new markets identification and the Perceived potential of the new market. Corporate strategies: Partnerships, alliances and contracts with various stakeholders in the methanol industry. Placement in the Value System: this will increase the company’s command in the market and also increase its competitive advantage. Issues addressed by these strategies: high cost of raw materials and competition. FEASIBILITY JUSTIFICATION FOR THIS STRATEGIC ALTERNATIVE Environmental Opportunity: political stability in China and long term Contracts with the Chinese firms demanding high amounts of methanol. Environmental Threats, Risks: low priced Chinese currency and interest rate volatility are likely to be an economic impediment. Fixed term contracts will be used where the current interest rate and currency value will be used till the end of the contracts. Present Corporate Attributes relevant and sufficient to this alternative: The desire to remain the market leader and also the urge to increase the size of the company in terms of production and market share. Missing and/or insufficient Corporate Attributes: a concrete development plan for new market acquisition ALTERNATIVE 3 Name of alternative strategies: focused innovation Customer needs: High quality and constant supply of methanol. Customer group: Extending operations to effectively cover the Chinese market and the whole of Asia. Basis of competition: Availability of cheap and readily available natural gas among the Asian countries. Research and innovations leading to new markets identification and the Perceived potential of the new market. Corporate strategies: Partneships, alliancies and contracts with various stakehlders in the methanol industry. Placement in the Value System: this will increase the company’s command in the market and also increase its competitive advantage. Issues addressed by these strategies: high cost of raw materials and demand in new markets. FEASIBILITY JUSTIFICATION FOR THIS STRATEGIC ALTERNATIVE Environmental Opportunity: political stability in China and long term Contracts with the Chinese firms demanding high amounts of methanol. Environmental Threats, Risks: inability for the market to adapt the new uses of methanol. This can be hedge by increasing awareness and marketing campaigns. Present Corporate Attributes relevant and sufficient to this alternative: Investment in market and scientific research Missing and/or insufficient Corporate Attributes: a concrete development plan for new market acquisition EXHIBIT 6: NPV The following assumptions will be used to ascertain the net present value of Methanex: The conditions identified to be favorable in the new markets, such as China will prevail. The sales volume will increase in the identified markets as time progresses The investment costs be incurred as estimated There are no hidden factors limiting entry into the new markets. Changes in Methanex’s financial and capital structure will not affect operations in the new markets. Interest rates and discount rates will not differ significantly from those used in this estimation Methanex will remain the market leader in the methanol industry The discount rate that will be suitable for both investors and the company will be the market interest rate of 8% p.a. Sales are assumed to increase by an average of 2% Costs are assumed to decrease by an average 0.1% Cash flows are also assumed to increase at an average rate of 2% (Values presented in the tables below are in millions) Optimistic 2013 2014 2015 2016 sales 600000 650000 710000 790000 total expenses 400000 380000 320000 325,000 operating income 200000 250000 390000 440000 interest 55000 60000 61000 63000 net income 255000 310000 451000 503000 Cash flows operating income 110000 120000 144000 115000 depreciation 40000 40000 40000 40000 total 150000 160000 184000 155000 cash outflows increase in working capital 20000 25000 30000 40000 capital expenditure 10000 2000 20000 350000 Total 10000 5000 10000 50000 cash flows 140000 155000 174000 15000 discount factor 1.08 1.167 1.26 1.36 NPV $123,271.30 EXHIBIT 7 Sales are assumed to increase by an average of 2% Costs are assumed to decrease by an average 0.1% Cash flows are also assumed to increase at an average rate of 2% after 2013 (Values presented in the tables below are in millions) pessimistic 2013 2014 2015 2016 sales 500000 550000 610000 690000 total expenses 400000 380000 320000 25,000 operating income 200000 250000 390000 440000 interest 55000 60000 61000 63000 net income 255000 310000 451000 503000 Cash flows operating income 110000 120000 144000 115000 depreciation 40000 40000 40000 40000 total 150000 160000 184000 155000 cash outflows increase in working capital 20000 25000 30000 40000 capital expenditure 10000 2000 20000 350000 Total 10000 5000 10000 50000 cash flows -140000 165000 174000 177000 discount factor 1.08 1.167 1.26 1.36 NPV ($11,344.09) EXHIBIT 8 Sales are assumed to increase by an average of 2% Costs are assumed to decrease by an average 0.1% Cash flows are also assumed to increase at an average rate of 1% . (Values presented in the tables below are in millions) most likely 2013 2014 2015 2016 sales 610000 630000 700000 750000 total expenses 3800000 350000 320000 300,000 operating income 200000 250000 390000 440000 interest 55000 60000 61000 63000 net income 255000 310000 451000 503000 Cash flows operating income 110000 120000 144000 115000 depreciation 40000 40000 40000 40000 total 150000 160000 184000 155000 cash outflows increase in working capital 20000 25000 30000 40000 capital expenditure 10000 2000 20000 350000 Total 10000 5000 10000 50000 cash flows 100000 155000 170000 19000 discount factor 1.08 1.167 1.26 1.36 NPV $56,444.37 EXHIBIT 9: IMPLEMENTATION SCHEDULE Approval by the board Differentiation: this strategy will be implemented first, following the current financial year, 2012. Source and make available the required finance. Retained earnings and external borrowings will be used in new acquisition of the Chinese market Read More