You are on page 1of 9

Available online at www.sciencedirect.


Journal of Business Research 61 (2008) 669 677

Upstream or downstream in the value chain?

Marcos Singer , Patricio Donoso
Escuela de Administracin, Pontificia Universidad Catlica de Chile, Vicua Mackenna 4860, Macul, Santiago, Chile Received 1 February 2007; received in revised form 1 April 2007; accepted 1 June 2007

Abstract Companies in the natural resources industry (e.g., mining, timber, farming and fishery) face the dilemma of whether to focus upstream or downstream in the value chain. The literature provides arguments and empirical evidence for either position. This paper presents an analytical framework based on the neoclassical theory of the firm, for which the best competitive advantage is the one that maximizes production efficiency. It serves to formulate an optimization model for the sawmill industry, and draws the data from the largest sawmilling company in the southern hemisphere. Although one conclusion is that the company should concentrate on the upstream activities, such conclusion is not applicable to other firms, since the analysis of the upstreamdownstream dilemma must focus on the individual capabilities of each firm. 2007 Elsevier Inc. All rights reserved.
Keywords: Strategic planning and management; Production and inventory systems; Optimization modeling

1. Introduction Latin American countries have specialized in the production of commodities. In 2004, the main Chilean exports were copper (46%), timber products (6%) and fishery (5%). Argentina's main exports were agricultural products (62%) and petroleum (26%). Peru's main exports were mining and petroleum (65%) and fishery (10%). Uruguay's second main export was leather (8%) and Brazil's second and third main exports were agricultural products (22%) and raw materials (19%). Each firm participating in those industries faces the dilemma of whether to invest upstream or downstream in the value chain. Upstream activities are those close to the exploitation of natural resources, whose output is a primary commodity or virgin material (Van Beukering et al., 2000). Downstream activities add value to the products, through manufacturing or customization, which outflow is a final commodity. Several firms are vertically integrated, so each must decide where to focus their effort.
This research has been partially sponsored by FONDECYT project number 105/1021. The authors wish to thank the executives from Aserraderos Arauco S.A. Corresponding author. E-mail addresses: (M. Singer), (P. Donoso). 0148-2963/$ - see front matter 2007 Elsevier Inc. All rights reserved. doi:10.1016/j.jbusres.2007.06.043

The literature provides arguments in one direction or the other. The theory of comparative advantages explains international trade by relative differences in productivity of labor and capital (Keuschnigg, 1999). Productivity varies between countries due to technological knowledge and natural conditions such as climate, natural resources, soil conditions and geographical location. According to the author's argumentation, firms in Latin America should pursue upstream activities, given the relative abundance of natural resources in the region. Many countries can build a factory of copper wire, but very few can deploy a copper mine with the production yields observed in Chile or Peru, and with a relatively mild environmental impact. Consistently, several recent mining projects, such as BHPBilliton's Escondida, the largest copper mine in the world, focus on extraction and concentration (upstream activities), forfeiting the refinement (downstream activities) to plants in the northern hemisphere. Wooden furniture can be manufactured almost anywhere in the world, but while in the northern hemisphere trees reach maturity in half to one century, in southern Chile and Argentina trees mature in an average of just 25years. Thus, Latin America's comparative advantage is in the forest itself. By contrast, the comparative advantage of sawmills in the northern hemisphere is their closeness to the consumption centers. This situation justifies the empirical evidence obtained by Roos, et al. (2001) for the Swedish sawmilling industry,


M. Singer, P. Donoso / Journal of Business Research 61 (2008) 669677

which shows that customization is the most successful strategy to increase profits. In summary, if the firm's advantage is in the availability of natural resources, its competitive strategy should focus on how to exploit them. Challenging the above, there is empirical evidence showing that those countries that have pursued downstream activities have grown much faster than those that have specialized in the exploitation of natural resources (Sachs and Warner, 1995). Japan and Korea have become world-class steel producers despite their lack of iron ore, while some of the main iron ore exporters like Brazil and the Russian Federation show a much slower economic development. The apparent contradiction that having fewer natural resources leads to stronger economic growth can be explained by the absence of positive externalities coming from natural resource sectors. Industrialization, as opposed to natural resource exploitation, entails a more complex division of labor. This condition translates into a higher capability of knowledge creation, which is essential for sustaining the firm's competitive advantage (Powell and Snellman, 2004). Manufacturing skills are flexible, which allows companies to adapt to changes in the markets with innovative products (Anand and Ward, 2004). Commodity production is extremely specific, and has little room to react to volatile world prices. In a nutshell, companies that engage in downstream activities increase rents by developing their core competences for adding higher value to their products and adapting to the market's fluctuations. Since the debate in the aggregate is inconclusive, managers facing the upstreamdownstream dilemma must look for answers at the firm level. No related academic literature exists, with the exception of Gaudet, van Long and Soubeyran (1999). These authors model a partially integrated industry in order to illustrate the separate effects of strategic interaction and the upstream cost, in the determination of the integrated firm's net sales to the nonintegrated sector. This paper proposes a methodology based on the neoclassical theory of the firm, for which markets progressively approach perfect competition (Stoelhorst and van Raaij, 2004). Companies are price takers, there is no room for product differentiation, resources are divisible and mobile, and market entry and exit are frictionless. There is also perfect information, sellers maximize their profit, and transactions are costless. Some decades ago, most of these assumptions sounded overly simplistic. Today, the globalization of markets, the free-trade agreements, the international freeflow of capital and the development of the Internet have driven several industries close to perfect competition (Van Beukering et al., 2000). Some of the assumptions of the neoclassical theory of the firm are especially valid for primary commodities or virgin materials. These are non-differentiable products by definition, traded on efficient and well-informed global markets (see Wrell, 2005 for the case of the coking coal). Several studies on commodity trade assume that firms face perfect competition (Hens, 1997; Schwarz, 2006), especially in the case of natural resources. According to McLaren (1999) the overwhelming majority of existing studies [about primary commodities] assume perfect competition.

Recent studies have acknowledged that in some industries there exist producers with market power (Gellert, 2003). In such a case, firms may engage in strategic behavior to reduce competition and increase prices. Johnsen (1991) reports the case of major oil companies that were buying above their own marginal cost at the upstream market, in order to harm their downstream competitors. In addition, when commodities come from non-renewable resources, firms may foresee a future monopoly status and decide not to maximize current profits as assumed by the perfect competition model. Such may be the case of oil and natural gas, where reserves will last for around 41 and 67 years more, respectively (Egging and Gabriel, 2006). As Kolstad and Wolak (1983) assert, the markets of primary commodities lie somewhere between the two extremes of perfect and imperfect competition. The closer the market to the perfect competition extreme, the more valid this approach. Such is the case with the timber, fruit and salmon industries, which have hundreds of producers worldwide, and depend on renewable resources. This paper also considers copper, for which mild market power exists: the largest five producers account for less than 40% of the global supply. Under perfect competition, the best competitive strategy is the set of actions that maximize the firm's efficiency, which implies generating the maximum economic value consuming the least amount of resources (Grifell-Tatj and Lovell, 1999). To do so, firms must offer the most valuable mix of products and services, given current prices. Firms must do so at minimum costs, which is achievable by transforming and mobilizing inputs and resources in an optimal manner. From its origin, mathematical programming has focused on the decision-making problems that intend to reach the firm's efficiency (Dantzig, 2002). Most of those problems have the necessary structure to allow mathematical tools to solve them and describe them formally. That is how mathematical programming has been gaining relevance for strategic decision-making, as Schwarz (2003) reports for the aluminum industry and Singer and Donoso (2005) do for the steel industry. The conclusion from the above is that mathematical programming should be a practical tool for assisting strategic decision-making for the natural resource industries in Latin America. In particular, programming can solve the upstreamdownstream dilemma in terms of the specific features of each firm. The objective of this paper is to assist managers in solving the above strategic decision. Section 2 shows how the decision applies to mining, timber, fruit farming and fishery. Section 3 describes some general principles regarding how to translate the strategic decision-making process, as understood by the neoclassical theory of the firm, into a mathematical program. Section 4 applies those principles to the sawmilling industry, and Section 5 presents a case study. Section 6 explains the paper's conclusions, limitations and some possible extensions. 2. The exploitation of natural resources The copper industry produces three main products: concentrate, anodes and cathodes. Copper concentrate is a sort of dust with a 33% content of copper. Such concentrate may be

M. Singer, P. Donoso / Journal of Business Research 61 (2008) 669677


Fig. 1. Chilean production of copper at three stages.

Fig. 3. Chilean production of timber.

refined at high temperatures by smelters, supplying blister copper and other products 99% pure, known as anodes. Anodes may be electro-refined at high voltages, delivering 99.9999%pure cathodes. Cathodes can also be obtained directly by bleaching copper oxide ore with sulfuric acid, which is a byproduct from the smelters. Fig. 1 ( shows the Chilean production measured in tons of copper content, from 1997 to 2005. Although the volume of concentrates and cathodes is larger than the volume as anodes, the three production stages show a similar growth rate, so from the country's viewpoint, the upstream, the downstream and the intermediate strategies seem all profitable. Firms in the copper industry face the decision of how far into the value chain to invest. Those that are vertically integrated that have already invested in the infrastructure to perform the entire refining processstill have to decide whether to sell

intermediate goods along with final products. Consider the case of the Chilean Copper Corporation Codelco, the largest producer of copper and molybdenum in the world. Fig. 2 summarizes the outbound logistics of its products, as well as the internal transfers among its five productive divisions. As the divisions are hundreds of kilometers apart, it is sometimes more convenient to export the product before being refined as a cathode. For instance, the Andina division may transfer concentrate for refining to the smelter at the El Teniente division, export the product through the port of Ventanas. El Teniente may transfer its production to be refined as cathodes by the Ventanas division, or may export it through the port of Valparaso. Sawed timber may be exported as a green product, or further processed at drying and sanding plants. Fig. 3 (www. shows the Chilean production of timber at both stages, measured in millions of dollars free on board (FOB).

Fig. 2. Main product flows at Codelco.


M. Singer, P. Donoso / Journal of Business Research 61 (2008) 669677

Fig. 4. The value chain of a fruit- (timber-) exporting firm.

The fruit industry may freeze and export its production without further processing, or may prepare and export the fruit as canned food. The salmon and trout farming industries sell their produce at two main stages of the value chain. Exporters may sell the fish as is when harvested, or without head and tail. The data on the above charts, and from the fruit and the salmon industry, show a similar growth rate for the upstream and the downstream production, suggesting that there is not one single strategy to follow. According to Gaudet, van Long and Soubeyran (1999), this situation occurs because upstreamdownstream specialization decision depends on the firm's cost advantage, and there are persistent cost differences amongst firms in natural resource industries, exogenously determined by nature. Because of those differences, in 1993 the ratio between the refining capacity and the extraction capacity of the main state-owned Latin American oil producers was diverse: 48% for Pemex (Mexico), 80% for PDV (Venezuela), 193% for Petrobras (Brazil), 118% for YPF (Argentina), 123% for Petroecuador (Ecuador). Therefore, a solution to the upstreamdownstream dilemma at an aggregated level is unlikely. Different firms may be better suited to execute different strategies, as a result of both the country's comparative advantages and the firm's individual infrastructure. 3. Modeling the value chain This paper models the activity of the firm as a value chain, which obtains its raw material from its providers, and generates products and services for its clients (Porter, 1985). Fig. 4 shows the value chain of a firm that exports agricultural products, such as fruit or timber. The departments or units upstream in the chain deliver to the next downstream unit, until the product reaches the final client. The logistics unit is transversal, interacting with all the echelons in the value chain. Each unit has a specific value-adding function, which it performs by managing the key resources of the firm (Peteraf, 1993). The remaining of this section takes as an example a fruitexporting company (Lowe and Preckel, 2004), and in parenthesis shows the example of a timber-exporting company (Carlsson and Rnnqvist, 2005), as the two work in a similar manner. The Sales unit is in charge of marketing the products by using its sales force and other commercial channels. In the short term, this unit must decide how much to sell of each product at each market. In the long run, it must develop new markets, that is, find new clients and fruit varieties (timber products) to sell. The Shipping unit must move the products between packing (production) plants and cooling (storage) facilities and from there to the port, using a transportation fleet. This unit must also schedule and supervise loading of the vessels. In its

daily operation, it decides the origin and destination of the shipments. Its strategic decisions are about what size and type of truck fleet to have, and what type of vessels to contract. The Operations unit is in charge of the packing (sawing) plants, where the raw material is processed according to the clients' requirements. The operational decisions are the production goals at both the upstream and the downstream level. The strategic decisions define investments in production plants, personnel and technology. The Acquisitions unit is in charge of purchasing the fruit (timber) from the farmers (forestry providers). The fruit acquisition process starts long before the fruit is delivered in the packing plant, since farming is a capital-intensive activity, and farmers must be financed throughout the season. Banks and other sources of capital are inefficient, given the strong information asymmetry and the moral hazard problem that may arise (Rasmusen, 2001). Fruitexporting firms are a more knowledgeableand therefore more efficientlender. Their operational decisions focus on which crops to purchase, and at which packing plants to deliver them. Their strategic decisions are about what longterm deals should be worked out with which farmers, in order to guarantee the provision of fruit. The Logistics unit, sometimes regarded as the management department of the supply chain, is in charge of coordinating the value chain. The tasks include monitoring inventories, to guarantee that goods are available as an input to the productive tasks, delivered on-time and in-full for the clients. Inventories are stored in warehouses and distribution centers. In the case of a fruit-exporting firm, warehouses are especially costly, because of expensive cooling systems that help preserve products for a long time. Some varieties of apples and pears are stored in Chilean cooling chambers almost a full year before being exported to the northern hemisphere. Table 1 summarizes the function, key resource, operational decisions and strategic decisions of the five units depicted by Fig. 4.
Table 1 Main features of the units of a fruit- (timber-) exporting firm Unit Sales Function Marketing products Moving products Key resource Sales force Operational decisions Strategic decisions Market development Fleet configuration Production infrastructure Long-term provision deals Storage development

Sales targets in each market Shipping Transportation Originfleet destination of shipments Operations Packing fruit Packing plants Production goals (processing (sawmills) at different stages timber) Acquisitions Purchasing Capital Purchases and fruit (timber) delivery points Logistics Monitoring inventory Warehouses Where to store products

M. Singer, P. Donoso / Journal of Business Research 61 (2008) 669677


Fig. 5. Sawmill model.

As the actions performed at each unit influence other units, in theory operational and strategic decisions should be made in a coordinated fashion. Defining sales targets at the operational level that exceed product availability given by current inventories, raw material purchases and production capacity makes no sense. At the strategic level, it is convenient to align fleet configuration with markets and production infrastructure. Consistently, whether the operations unit decides to focus on upstream or on downstream activities depends on all the units. This dilemma generalizes the approach by Gaudet et al. (1999), which considers production cost only. Besides cost, this paper considers business constraints at all the stages of the value chain. 4. Mapping the sawmill value chain into a model Mathematical programming can coordinate the operational and strategic decisions within the firm, as it makes explicit the

interactions among its internal units. This paper models the internal process of the sawmill in terms of two transformation stages: sawing and drying-sanding (finishing). There are also two stock stages: green inventory (after sawing) and dried inventory (after drying and sanding). Fig. 5 is a simplified representation of the products' flow and stocks within a sawmill. The first stage begins with the purchase of raw material, that is, logs from both thinned and regular (unthinned) stands. Thinning is a treatment usually carried out at year 6 in the life of a stand, which includes cutting branches in order to yield better quality timber. Regular and thinned logs go to different categories based on diameter and according to the characteristics of the forest that supplies each sawmill. The productivity of the sawing process, measured in terms of the volume of logs processed per hour, is different for each log type and diameter. Depending on the type of cut made, three kinds of primary or green products result: G1, G2 and G3 (GR1, GR2 and GR3

Fig. 6. Actual sales and suggested optimal sales of green and dried timber.


M. Singer, P. Donoso / Journal of Business Research 61 (2008) 669677

denote the products obtained from regular logs; GT1, GT2 and GT3 refer to those from thinned logs). There are maximum proportions for the utilization of the raw material that result from arranging rectangular sections in the cylindrical logs. In addition, the cutting process loses raw material in the form of sawdust. Once the sawing process finishes, products G1, G2 and G3 go either to the drying and sanding stage, for sale in the market or to storage. The second stage (kiln-drying and sanding) converts the green products into finished products F1 and F2 in certain established proportions that depend on the type of green and finished products and on the sawmill. For example, for each cubic meter of thinned G1 logs cut in sawmill A2, a total of 0.8m3 is allotted for the production of F1 and the remaining 0.2m3 for the production of F2. There is a loss of product yield during the drying and sanding process of the green material due to cracking, splitting and chipping off. For this reason, it is necessary to assume a certain percentage of loss of material during the process of drying and sanding. The productivity of the drying and sanding process, measured in cubic meters per hour, depends on the green product utilized in each sawmill. The parameters are related to the input, without considering the associated volume losses. The capacity of the milling, drying and sanding stages depends on each sawmill and on the given time period. Production cost is expressed in terms of output. Transportation cost to the port is constant for each plant. Storage cost depends on the sawmill, the product and the period (being higher in the winter season because of humidity). Minimum sales also depend on the sawmill, the product and the period, while prices depend exclusively on the product and the period. Once the drying and sanding process has finalized, the plant may either sell the production or store the products. Transferring green products among plants optimizes the production capacity utilization. Transferring final products optimizes the use of the storage capacity. Transferring logs, the raw material, may also be advantageous if technology at one mill is more productive than at another due to the characteristics of the raw material. An extension of the model by Singer and Donoso (2006) (see Appendix) permits to model the sawmill operation with a linear program. The range of the decision variables is in months, so both the location of the facilities and the production capacities are given. The assumptions include unlimited availability of raw material, following Troncoso and Garrido (2005), and that the raw material markets are integrated (Toivonen et al., 2002), so log prices are given. Since most of the production is for the global market, prices for final products are given. The above suppositions are crucial; otherwise, there is no perfect competition and one should consider strategic behavior to reduce competition and gain market power in one or more stages of the value chain (Johnsen, 1991). Parameter classification depends on which unit is in charge of providing the data to calculate its value. The variables correspond to the operational decisions in Table 1. The objective function maximizes revenues minus production cost, minus inventory costs, minus costs of raw material and minus transfer costs. This study groups constraints according to which unit is more directly related to them. Some constraints affect the unit's

performance directly, such as the sawing, drying and sanding capacity constraints that limit the production throughput of the Operations unit (Gupta, 2001). Other constraints require supervision by the unit. For instance, the Sales unit must verify the minimum sales constraint, and the Logistics unit must supervise that the inventory equation holds, that is, that products do not disappear. The sensitivity analysis guides the strategic decisions. The marginal benefit of relaxing the maximum sales constraint shows which markets need to be developed. The marginal benefit of relaxing the sawing, drying and sanding capacity constraints shows the type of infrastructure in which the firm must invest. 5. The case of a Chilean sawmill holding Aserraderos Arauco Sociedad Annima (AASA) is the largest sawmilling corporation in the southern hemisphere. As of 2004, AASA consisted of twelve companies, each one managing a production plant (eleven in Chile and one in Argentina) with an aggregate annual processing capacity of 4.3million cubic meters of saw logs. The above translates into an aggregate production capacity of 2.5million cubic meters of lumber. The sawn timber's markets cover packaging, pallets, construction, and decorative products for the furniture and design industries. AASA also has five companies for remanufactured wood products (e.g., window moldings, clear rips, decking balusters) as well as several facilities for manufacturing plywood and fiber panels (CasadesusMasanell, Tarzijn and Mitchell, 2005). High-level planning consists of assigning customer orders to the different plants. In addition to capacity and productivity, planners at headquarters must take into account a fairness criterion. One can adapt the mathematical model described in Section 4 and Appendix to the specific conditions of each of AASA's eleven plants. Instead of two diameter categories, plants may have four or five. Plants may produce about seven types of green products and 21 final products. Assuming only one time period simplifies the problem to a static model. In total, there are 453 decision variables and 483 constraints, not including nonnegativity. Approximately 50 constraints account for specific assignments and other considerations that are not included in the general model, which ensures that the solution arrived at is a realistic one. Implementing the optimization model in a Microsoft Excel spreadsheet using a Frontline System Solver permits to solve the problem in a few seconds using a Pentium III processor. A comparison of the actual monthly sales for September, October and November 2003 with the model's optimal solutionomitting results for other periods for reasons of confidentialityyields similar conclusions. Fig. 6 compares the average actual sales with the sales suggested by the model for both green and dried timber. Note that eight of the eleven plants are equipped for drying and sanding timber, while the others must subcontract these tasks. The aggregate quantities turned out to be similar: 158,533m3 for the real-life situation and 164,244m3 for the model's solution. Total cost was also similar: US$18,578,777 actual and US$18,436,626 for the model. Revenues, on the other hand, displayed an increase from US$21,500,529 actual to US$21,804,388 for the model, which

M. Singer, P. Donoso / Journal of Business Research 61 (2008) 669677


implies a 15.3% increment in profits, from US$2,921,752 to US $3,367,762. This result derives from shifting the production focus upstream the value chain. The aggregate production of green products should grow by 48.5%, while the aggregate production of final products should fall by 21.6%. The sensitivity analysis confirms that increasing the upstream capacity of sawmilling is highly profitable, especially in Horcones I and Colorado. A similar analysis shows a limited benefit of investing in downstream capacity. 6. Conclusions This paper has dealt with the question of whether companies in the natural resources industries should focus on activities upstream or downstream in the value chain. The macroeconomic argumentation and the country-level empirical evidence are inconclusive, so managers can derive little help. This study proposes to examine the upstreamdownstream dilemma from the point of view of the neoclassical theory of the firm, which assumes that companies are price takers, there is no room for product differentiation and there is perfect information. Due to the globalization of markets and Internet, most of these assumptions are becoming realistic, leading markets to approach perfect competition. In such a scenario, the best competitive advantage is the one that maximizes productivity, subject to the constraints facing the firm. In the above decision-making setup, mathematical programming can provide crucial insight. By identifying the main parameters, decision variables and constraints of each unit in the value chain, it was possible to map the operational and strategic decisions into a lineal program and test the model at AASA, a corporation consisting of eleven sawmilling plants located in southern Chile. To evaluate how close the company was to a global optimum, it was necessary to simulate the conditions in September, October and November 2003 to derive the optimal operating plan. Interestingly, there is an opportunity to increase profits by more than 15% if the firm orients its production upstream the value chain. While conclusions for AASA are robust for a relatively wide range of values, the same should not be directly applied to other companies. The timber industry in Chile is the aggregation of individualities, and there is doubt that there could be a one-size-fits-all strategy for all the firms. Whether the competitive advantages theory prevails over the benefits of the higher-value-adding activities depends on a caseby-case analysis. The results will most likely be mixed, as the strengths of different firms are diverse. This upstreamdownstream dilemma is not only relevant for the competitive strategy of the firm; it is also crucial in the development strategy of countries based on the exploitation of natural resources, as are in most countries in Latin America. As several governments have been following a more proactive attitude, where to invest the resources becomes a matter of public policy. Just like the managers of individual companies, the authority will face the contradicting prescriptions. To avoid such confusion, it seems convenient to study each industry at the firm level and, in the case of the sawmilling industry, to replicate the method to several companies. This process will

reveal the exact place in the value chain where the country must invest to increase its worldwide competitiveness. Appendix Index definition: r {regular, thinned} Type of raw material d {1618, 2022} Diameter of logs g {G1, G2, G3} Green products f {F1, F2} Finished products (kiln-dried and sanded) t {1, 2, 3,} Time periods p {P1, P2} Plants Parameter classification reflects which unit is in charge of providing the data to calculate its value. The following six parameters relate to the Sales unit: MGg,t MFf,t QGg,t QFf,t Gg,t Ff,t maximum quantity of green product g for period t maximum quantity of finished product f for period t minimum quantity of green product g for period t minimum quantity of finished product f for period t sale price of green product g at time t sale price of finished product f at time t sale in sale in sale in sale in

The following parameters relate to the Shipping unit: TRp Tp,q transportation cost to the port from plant p transportation cost from plant p to plant q, with Tp,p =

The following parameters relate to the Operations unit: MHt,p DHt,p SHt,p MPr,d,p DPr,g,p SPr,g,p Mr,d,g,p Mr,d,+,p Mr,d,p Yr,g,f Af,p MCp DCp SCp sawmilling hours available during period t at plant p kiln-drying hours available during period t at plant p sanding hours available during period t at plant p sawmilling productivity of type r logs of diameter d at plant p kiln-drying productivity of type r logs of product g at plant p sanding productivity of type r logs of product g at plant p maximum proportion of type r logs of diameter d converted into g at plant p maximum proportion of type r logs of diameter d converted into G1 + G2 at plant p maximum proportion of type r logs of diameter d for converting into green product at plant p indicating (1 = yes; 0 = no) if green product g from type r logs must go for drying and sanding to make product f volume loss of product f at plant p sawmilling cost for product g obtained at plant p kiln-drying cost for product f obtained at plant p sanding cost for product f obtained at plant p


M. Singer, P. Donoso / Journal of Business Research 61 (2008) 669677

The following parameters relate to the Acquisitions unit: Cr,p Pr,d,p cost of type r logs at plant p proportion of type r logs of diameter d at plant p

Constraint classification reflects which unit constraints relate more directly to. The maximum sales constraints directly affect the performance of the Sales unit. The Sales unit is in charge of supervising the minimum sales constraints.

The following parameters relate to the Logistics unit: ICf,t,p IGr,g,p IFf,p inventory cost of final product f at time t at plant p initial inventory of green product g from type r logs at plant p initial inventory of final product f at plant p

gsr;g;t;p VMGg;t

8 g, t

Max. sales of g


fsf ;t;p VMFf ;t

8 f, t

Max. sales of f

The following variables relate to the Sales unit: gsr,g,t,p green product sales of type g from logs type r in period t from plant p fsf,t,p finished product sales of type f in time period t from plant p The variables related to the Shipping unit are: tgr,g,t,p,q green product g from logs r transferred from plant p to q at time t tff,t,p,q final product f transferred from plant p to plant q at time t The variables related to the Operations unit are: or,d,g,t,p product g obtained from type r logs of diameter d in period t at plant p mr,g,t,p product g from type r logs moved to drying and sanding in period t at plant p The variables related to the Acquisitions unit are: ar,t,p acquisitions of type r logs at time t at plant p

gsr;g;t;p zQGg;t

8 g, t

Min. sales of g



fsf ;t;p zQFf ;t

8 f, t

Min. sales of f

The following constraints affect the Operations unit:

X or;d;g;t;p



8 t, p

Sawing capacity

X mr;g;t;p



8 t, p

Drying capacity

X mr;g;t;p



8 t, p

Sanding capacity

or;d;g;t;p VPr;d;p ar;t;p Mr;d;g;p or;d;G1;t;p or;d;G2;t;p VPr;d;p ar;t;p Mr;d;;p or;d;G1;t;p or;d;G2;t;p or;d;G3;t;p VPr;d;p ar;t;p Mr;d;p

8 r, d, g, t, p 8 r, d, t, p

Max. prop.

Max. prop.

8 r, d, t, p,

Max. prop.

The variables related to the Logistics unit are: igr,g,t,p iff,t,p inventory of green product g from type r logs at time t at plant p inventory of final product f at time period t at plant p

The linear program considers the following objective function: Maximize revenues discounting the transportation cost sawmilling, draying and sanding costs inventory costs costs of raw material transfer costs P

The following constraints relate to the Logistics unit, because this unit is in charge of detecting any deviation.
igr;g;t1;p X



8 r, g, t, p

Inventory of g

tgr;g;t;q;p igr;g;t;p gsr;g;t;p X


P Gg;t TR gsr;g;t Ff ;t TR fsf ;t

f ;t


tgr;g;t;p;q 8 r, g, p 8 f, t, p Initial inventory of g Inventory of f

f ;t


or;d;g;t DC SC P

r;f ;g;t

mr;g;t Yr;g;f 1 Af Tp;q tgr;g;t;p;q

igr;g;0;p IGr;g;p

ICf ;t if f ;t

Cr ar;t

if f ;t1;p

X mr;g;t;p Yr;g;f ;p 1 Af ;p tf f ;t;q;p X

q q


if f ;t;p fsf ;t;p

tf f ;t;p;q

f ;t;p;q

T p;q tf f ;t;p;q ;

if f ;0;p IFf ;p

8 f, p

Initial inventory of f

M. Singer, P. Donoso / Journal of Business Research 61 (2008) 669677


Finally, the non-negativity constraints follow. ar;t;p ;or;d;g;t;p ;gsr;g;t;p ;fsf ;t;p ;mr;g;t;p ; igr;g;t;p ;if f ;t;p ;tgr;g;t;p;q ;tf f ;t;p;q z0; 8r; d; g; f ; t; p; q References
Anand G, Ward PT. Fit, flexibility and performance in manufacturing: coping with dynamic environments. Prod Oper Manag 2004;13:36985. Carlsson D, Rnnqvist M. Supply chain management in forestrycase studies at Sdra Cell AB. Eur J Oper Res 2005;163:589616. Casadesus-Masanell R, Tarzijn J, Mitchell J. Celulosa Arauco: forward integration or horizontal expansion? Harvard Business School, teaching case N9-705-474; 2005. Dantzig GB. Linear programming. Oper Res 2002;50:427. Egging RG, Gabriel SA. Examining market power in the European natural gas market. Energy Policy 2006;34:276278. Gaudet G, van Long N, Soubeyran A. Upstreamdownstream specialization by integrated firms in a partially integrated industry. Rev Ind Organ 1999;14: 32135. Gellert PK. Renegotiating a timber commodity chain: lessons from Indonesia on the political construction of global commodity chains. Sociolo Forum 2003;18:5384. Grifell-Tatj E, Lovell CAK. Profits and productivity. Manag Sci 1999;45: 117793. Gupta M. Activity-based throughput management in a manufacturing company. Int J Prod Res 2001;39:116382. Hens T. Exchange rates and perfect competition. J Econ 1997;65:15161. Johnsen DB. Property rights to cartel rents: the SoconyVacuum story. J Law Econ 1991;34:177203. Keuschnigg M. Comparative advantage in international trade: theory and evidence. Studies in empirical economies. Springer-Verlag Company; 1999. Kolstad CD, Wolak Jr FA. Competition in interregional taxation: the case of western coal. J Polit Econ 1983;91:44360. Lowe TJ, Preckel PV. Decision technologies for agribusiness problems: a brief review of selected literature and a call for research. Manuf Serv Oper Manag 2004;6:2018.

McLaren J. Speculation on primary commodities: the effects of restricted entry. Rev Econ Stud 1999;66:85371. Peteraf MA. The cornerstones of competitive advantage: a resource-based view. Strateg Manag J 1993;14:17991. Powell WW, Snellman K. The knowledge economy. Annu Rev Sociol 2004;30:199220. Porter ME. Competitive advantage. New York, NY: Free Press; 1985. Rasmusen E. Games and information. Cambridge: Blackwell Publishing; 2001. Roos A, Flinkman M, Jppinen A, Lnner G, Warensj M. Production strategies in the Swedish softwood sawmilling industry. For Policy Econ 2001;3: 18997. Sachs JD, Warner AM. Natural resource abundance and economic growth. National Bureau of Economic Research Working paper, vol. 5398. Cambridge, MA: National Bureau of Economic Research; 1995. Singer M, Donoso P. Strategic decision-making at a Chilean integrated steel manufacturer aided by an activity-based optimization system. J Bus Res 2005;59:38790. Singer M, Donoso P. Internal supply chain management in the Chilean sawmill industry. Forthcoming in International Journal of Operations & Production Management; 2006. Schwarz HG. Modelling investment and implementation of technological progress in metal industries. Theory and application to the German primary aluminium industry. Resour Policy 2003;29:99109. Schwarz H-G. Economic materials-product chain models: current status, further development and an illustrative example. Ecol Econ 2006;58:37392. Stoelhorst JW, van Raaij EM. On explaining performance differentials: marketing and the managerial theory of the firm. J Bus Res 2004;57:46277. Toivonen R, Toppinen A, Tilli T. Integration of roundwood markets in Austria, Finland and Sweden. For Policy Econ 2002;4:3342. Troncoso JJ, Garrido RA. Forestry production and logistics planning: an analysis using mixed-integer programming. For Policy Econ 2005;7: 62533. Van Beukering, P.J.H., van den Bergh, J.C.J.M., Janssen, M.A., Verbruggen, H., 2000. International material-product chains: an alternative perspective on international trade and trade theories. Tinbergen Institute Discussion Papers 00-034/3, Tinbergen Institute. Wrell L. Dening geographic coal markets using price data and shipments data. Energy Policy 2005;33:221630.