Crown Cork & Seal in 1989

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Suppliers xxx Who are the suppliers and who has leverage in the relationship?

Suppliers are the major aluminum and integrated steel companies. Since aluminum over time has come to dominate the industry (accounting for 71% of the cans produced), we first look at aluminum companies—Alcoa and Alcan combined represent 65% of the aluminum can stock market. Is it possible for can manufacturers to successfully trade one off against the other in a price negotiation? Perhaps to a certain extent in the short term, but basically the aluminum industry is a classic oligopoly with few suppliers and price leadership exercised by Alcoa and Alcan. (In the late 1980s, the deteriorating structure of the aluminum industry, driven by slowing growth, threats of substitutes, and exit barriers for marginal players, may have offset this historical pattern.)

Is it a problem that Reynolds is both a supplier and a competitor? It would be clearly incorrect to credit them with a raw material cost advantage simply because they are vertically integrated (aluminum sheet and aluminum can manufacture are clearly separate businesses). However, if by being vertically integrated, Reynolds is able to benefit from lowered transactions costs or research and development carried out elsewhere in the company, then they may have a competitive advantage. The case suggests that this may indeed be true since they are the leader in the technology for metal can manufacturing equipment. Not mentioned in the case is the fact that they are the leader in redesigning the tops (using spun aluminum) and bottoms of the can (shape) to make thinner walled cans resulting in raw material costs savings. Although this technology would ultimately disseminate to other can manufacturers, Reynolds would clearly gain first-mover advantages from introducing the technology.

Are integrated steel companies friends of the can manufacturing industry? To a certain extent they are as they have an incentive to defend steel’s market share in the metal container industry. There is some evidence that aluminum prices have not risen as much as they might have because of the steel industry’s pricing strategy. However, it is clear that this is a declining industry for steel, and their incentives are to maximize the cash generated over the decline. This means pricing as high as possible short of accelerating the can manufacturing industry’s change over to aluminum. Hence, they may help can manufacturers but they are not entirely incentive compatible.

Barriers xxx What are the barriers to entry? How difficult would it be for, say, Alcan, to forward integrate into the industry?

Historically, it was probably not that difficult to enter the industry and more than 100 competitors did (mostly on a regional basis). Transportation costs (7.5% of overall costs) limited efficient operations to 150 to 300 miles of a plant, and capital costs for three-piece lines were relatively low ($7 million in 1989 dollars).

In 1989, entry is more difficult, but certainly possible. Although used three-piece lines are available for $200,000, this does not help in North America due to the shift to two-piece cans. A new minimum efficient scale plant with one two-piece line would cost roughly $25 million in 1989. The capital costs are small relative to the size of the market ($12 billion in the United States), but it is necessary to capture market share in a particular region. The capital cost barrier is basically the return on investment which, in turn, is driven by (1) size of the market; (2) growth rate of the market; (3) market share that the investment will gain; and (4) margins the investment will sustain. If capital is to be a barrier, it must be either market share or margins. Given our analysis of buyers, a new entrant with an efficient low-cost plant will be able to capture the market share needed. The biggest barrier to capturing market share is competitor retaliation due to overcapacity in a region, but this is not very credible once a plant has been built. The major reason for lack of entry over the recent past is the low and deteriorating margins in the industry.

Rivalry xxx What is the nature of the rivalry in the industry? Is it possible to find profitable segments or differentiate oneself?

This is basically a low-growth, capital-intensive, somewhat cyclical, commodity product industry. Although aluminum had grown rapidly in the past at the expense of steel, this has played out as it represents 99% of the beer can segment and 94% of the soft drink segment. Margins have fallen significantly in the recent past as raw material prices rose and rivals were unable to pass on cost increases to customers. High capital costs relative to variable costs require volume to support high-capacity utilization; hence, pressure on prices.

Is there some way to differentiate yourself? Service may be possible and there is some evidence that Crown Cork provides superior service in the form of helping to solve customers problems. It does not appear, however, that a price premium can be obtained for this service. Customers buy primarily based on price. All suppliers provide just-in-time inventory, and product quality is a strategic necessity in the sense that customers will not pay extra for exceeding the standards. Buyers punish suppliers for poor delivery and service. Most of the rivalry discussion will have been covered in the discussion of buyers so it can be cut short here.

Bottom line xxx So what is the bottom line? Is this an attractive industry?

Clearly not! Buyers have a great deal of leverage which they exercise. (General Cinema said in the past that they would not backward integrate into can manufacturing because the can manufacturers are “practically giving away the cans”). There are many substitutes which limit price and limit or reduce long-term demand. The suppliers are few, relatively large, and members of oligopolies. Reynolds is both supplier and competitor and may have a competitive advantage as a result. There is a threat of possible further forward integration. Barriers are moderate, but intense price-driven rivalry in the industry makes it unattractive to potential new entrants as margins are squeezed.

So what is the conventional wisdom when faced with such an industry? Diversify away from the industry! This is exactly what major competitors did in the 1970s and 1980s. American Can first diversified into packaging more broadly and then, due to a lack of financial success, moved into financial services, divesting all of its packaging business and becoming Primerica under Sandy Weil. Continental Can diversified and became Continental