Containing costs at Codelco Chile

Ever since Jos Pablo Arellano became executive president of Codelco Chile two years ago, getting a handle on costs has been his biggest challenge. A key strategy in this battle was the recent creation of a new vicepresidency with the job of designing and implementing a total cost-containment project. It’s a tall order, coming at a time when Arellano and his team have had to grapple with falling production, violent conflicts with contract workers and a spate of accidents unprecedented in company annals, such as the collapse of a tunnel last July at Codelco’s Northern

Division. So far, however, the recent trend toward higher production costs has been offset by recordbreaking copper prices in international markets, which peaked at an annual average of US$3.05/lb in 2006 (or US$3.24/lb over 2005-06) and an historical high investment figure of almost US$2 billion in 2007.

The cost of production at Codelco, which as recently as 2001 was in the range of US$0.61/lb of copper, almost doubled by 2006 to US$1.13/lb, a jump of more than $0.51 in just five years. Total production costs have risen no less than 83% over the same period, and by 2006 had reached levels never before experienced.

Explanations for these increases are both internal and external. Among the internal factors are the escalation in energy expenditures and a higher-cost employee base, while the external ones include rising prices of important inputs such as oil. Wage hikes combined with an enlarged workforce are the main reasons behind the greater labour costs.

Also on the employment front, an agreement negotiated with the unions at Northern Division in December 2006 has helped focus attention on the state-owned producer’s cost situation. The contract called for a wage raise of 3.8% and an 8-million-peso bonus for each worker, benefits that will mean an outlay of close to US$100 million. Then, just last December, the supervisors’ union won a bonus of 11 million pesos for each of its members. Meanwhile, the aging Salvador mine continues to be Codelco’s highest cost division, the decline in its ore grade posing a growing threat to the profitability of the deposit.

But rising costs have affected the entire copper industry. The impact of more expensive energy, for example, has hit operators hard in both the northern and central regions of Chile. Furthermore, restrictions on natural gas from Argentina have driven electricity companies to renegotiate their supply contracts. In an attempt to neutralize these effects and reduce the cost burden, various copper producers have decided to index electricity purchases to the price of diesel, whose availability (unlike natural gas) is not at risk.

Taking measures

To face the challenge of cost containment, Arellano has transformed the former vicepresident position for strategy and business. Now titled ‘vice-president of management control and operational excellence’, the new post’s mission is to implant effective cost-containment measures. Top executives at the revamped vice-presidency all have technical backgrounds, and specialists have been added to the divisional management committees with the task of making monthly reports to the executive president on progress in cost-containment. The incorporation of these experts should accelerate advances in the following lines of action:

• optimization of outsourced services

• improvement of contract management

• efficient use of energy and hydro resources

• better personnel planning

Although work on these policies had been underway for some time, there is now a real need to develop them as part of a costcontainment project for securing integral, rapid and effective improvements in the short term. The critical aspects of the project are as follows:

1. cost reductions in the company’s functional units obtained through a business process perspective that interrelates and integrates them;

2. rapid results and concentrated action on high-cost and potentially improvable processes in the short term;

3. direct supervision of the results by top management; and

4. recognition of the important role played by information technology.

An approach built around these features would effectively channel the different costcontainment efforts undertaken in various areas of the company. Measures to be co-ordinated under this integrative project include quality management, and the introduction of ISO standards and risk management systems. Expressing wholehearted confidence in this initiative, executive president Arellano has made available all the necessary technical and human resources to reach the established objectives.

Jorge Candia is a member of Board of Codelco Chile; Dr. Roberto de la Vega and Dr. Sigifredo Laengle (sigifredo.laengle@gmail.com) are professors at Universidad de Chile.