INDUSTRIAL AND

COMPETITIVE ANALYSIS
CEMENT INDUSTRY OF PAKISTAN

Submitted to: Ms. Zainab Dar

BBA 2K5-B
6/30/2007

TEAM MEMBERS:
SYED USMAN WAZIR (GL)

FATIMA SYED

QURAT-UL-AIN RAUF

ASIM REHMAN

ZEESHAN AHMED

1
Table of Contents

Introduction: ................................................................................................................................................. 3

Structure:..................................................................................................................................................... 4

Conduct ....................................................................................................................................................... 5

Performance ................................................................................................................................................. 5

Related governmental regulations .............................................................................................................. 6

Herfindahl Index .......................................................................................................................................... 7

Lerners Index: .............................................................................................................................................. 8

Advertisements: ........................................................................................................................................... 9

New Product Development: ....................................................................................................................... 9

Capacity Expansion cycle: ......................................................................................................................10

Capacity addition cycles in the industry ..................................................................................................11

Capacity expansions are targeted at domestic markets: ........................................................................11

Demand and growth:..................................................................................................................................12

Competition in export markets:.................................................................................................................19

Problems of overcapacity: .........................................................................................................................19

Oversupply situation in local markets:......................................................................................................20

Financial Obligations will determine price strategy:................................................................................21

Conclusion: ................................................................................................................................................23

2
INDUSTRY: - CEMENT INDUSTRY OF PAKISTAN

Introduction:
Cement industry is indeed a highly important segment of industrial sector that plays a pivotal role in

the socio-economic development. Though the cement industry in Pakistan has witnessed its lows

and highs in recent past, it has recovered during the last couple of years and is buoyant once again.

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Structure:
A market is a group of buyers and sellers exchanging goods that are highly substitutable for one

another. Markets are defined by demand conditions; they embody the zone of consumer choice for

the goods.

Now, market for Cement in Pakistan exists in two main dimensions:

1. Product type

2. Geographic area.

Product type:

Since cement is a specialized product, requiring sophisticated infrastructure and production location.

So, most of the cement industries in Pakistan are located near/within mountainous regions that are

rich in clay, iron and mineral capacity. Structure of Cement industry in Pakistan is as such that there

is not much substitutability to buyers. Which shows that the Cross elasticity of demand is negligible.

Geographical Area:

The other factor i.e. geographic location also doesn’t affects a lot considering the flexibility of

demand. Example can be taken from the fact that if DG cement in DG KHAN raises its price and

MAPLE LEAF CEMENT in DaudKhel will raise its price to match DG cement’s. This is due to

cartel of all of the cement manufacturers in Pakistan. Thus the customer has no choice at all to

switch between two brands of cement. As the cement market is moving from a virtual 'sellers'

market' to an over-supply situation, it is expected that when prices stagnate and profitability

becomes a function of volume and economies of scale, location advantage and proximity to markets

will become extremely important factors. At present the freight charges are a massive 20% of the

retail prices. The plants located very close to each other and tapping the same market will have to

expand their markets which will increase their freight expenses. Dandot, Pioneer, Maple Leaf and

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Garibwal are all located within a radius of 100 kilometers and are selling bulk of their production in

the same areas and will thus face serious competition from each other.

Market Share:

The market share if Cement industry is as such that since large number of manufacturers are in the

market and are targeting the entire market through the formation of Cartel. So the dominancy of

market share is yet to be analyzed by us. This dominancy can be attributed to two factors:

1. Brand name

2. Product quality.

Since pricing is similar so production capacity can provide a vague idea with regards to the market

share of all the players.

Conduct
Conduct
Cement industries in Pakistan are currently operating at their maximum capacity due to the boom in

commercial and industrial construction within Pakistan. Consumers face a tough decision with

regards to prefer which brand over which because of the similar pricing of cement industry. The

formation of cartel by the cement manufacturers have exploited local consumers a lot and this has

led to the concentrated degree of oligopoly, where the firms are acting as a single unit to perform

their monopoly. Their combined market power is simply a diluted version of the dominance that a

single firm with a monopoly market share can exert.

Performance
The demand of Pakistani cement is expected to continue to grow at the rate of 20 per cent for about

four years to come. It may then follow traditional growth rate of seven per cent per year.

Announcement of major dams will dramatically increase this demand. Deregulation after accession

of Pakistan to WTO is expected to open the window of competition from cheaper markets. There

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may be no tariff after this deregulation on import of cement allowing its entry into Pakistan from

cheaper market at lower rate. Cement from cheaper markets may also block Pakistan’s export of

cement to its neighboring countries. Global market has vigorously taken up the advantage of

economy of scales and multinational giants now control more than 40 per cent of world

production—(China not included). The recent acquisition of Chakwal Cement by an Egyptian giant,

Orascom may be a beginning of such an entry in Pakistan by multinationals. New avenues for

export of cement are opening up for the indigenous industry as Sri Lanka has recently shown

interest to import 30,000 tons cement from Pakistan every month. If the industry is able for avail the

opportunity offered, it may secure a significant share of Sri Lanka market by supplying 360,000 tons

of cement annually.

Related governmental regulations

The policy of the Government is to keep a balance between rapid economic development, on the

one hand, and social justice and consumer’s protection, on the other. There is a traditional conflict

between these two aims. It is, therefore, necessary to regulate trade, commerce or industry in the

interest of free competition therein. The Ordinance was promulgated to provide for measures

against un-due concentration of economic power, growth of un-reasonable monopoly power and

un-reasonably restrictive trade practices. Thus cement industry too is monitored and answerable to

rules and regulations developed by the monopoly control authority of Pakistan.

The government is considering allowing further concessions and additional incentives for cement

export, with a view to increase overall export volume. These measures will immensely help in

promoting and protecting high investments made in cement sector in recent years. In the wake of its

huge surplus production as a result of massive capacity expansion undertaken it rather seems

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imperative for Pakistani cement industry, on one hand, to sustain existing export markets and, on

the other, explore new markets.

Herfindahl Index
In Pakistan there are 27 cement manufacturers that are playing a vital role in the build up of country’s

economy and contribution towards growth and prosperity. For the calculation of Herfindahl index we have

chosen 5 dominant industries of Pakistan, on the basis of their production capacity. The market share of

these firms is as follows:

• Askari cement (NZP) 7.6%

• DG cement 9.8%

• Lucky cement 12.7%

• Maple leaf 7.1%

• Pioneer cement 5.5%

Where si is the market share of firm i in the market and n is the number of firms.

(0.127^2)+ (0.098^2) + (0.076^2) + (0.071^2) + (0.055^2) = 0.395

Since the Hirfindahl index is above the standard set of (0.18) for an unequally distributed market share

industry. This indicates that there is a high concentration in the cement industry.

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 Market share

Askari cement
(NZP)
DG cement

Lucky cement

Maple leaf

Pioneer
cement
Others

Lerners Index:
Average industry price of cement bag/50Kg = Rs.235

Average industry cost of cement bag/50Kg = Rs.192.5

L = (P-C)/P

Where L is the Lerners index and is also = H/EoP for the whole industry.

Now L = (235-192.5)/235

= 0.181

And

EoP = .395/.181

= 2.18

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Advertisements:
The firm’s optimal level of advertising intensity (Advertisement/Revenue) is equal to the ratio of its elasticity

of demand to the price elasticity of demand that it faces. The important implication of this demonstration is

that the level of advertising is chosen simultaneously with the level of price, there is no cause and effect

relationship between these two variables.

For oligopolistic competition as in cement industry, the firms have to make decisions taking into account the

decision of their rivals. So advertising decisions are measured to the extent on which amount of reaction it

would generate from the rival firms. In brief we can conclude that advertising is an instrument of an

oligopolistic competition.

New Product Development:

Assume two firms A and B who want to decide whether they should attempt to produce a new product with

marginal cost c. The demand for the good is P = a-bQ and as for the R&D effort, the costs of setting up a

research lab are K and the probability that the lab will successfully develop the product is %. If both firms

successfully develop the product they will be a Cournot duopoly. While, if one of them develops a new

product then the first mover advantage would embark rewarding the developer to maintain a monopoly.

Everybody’s doing it, so why shouldn’t we? This is probably the thought reverberating through every cement

magnate’s mind these days. The current expansion spree now seems to be a bandwagon effect. Cement

manufacturers, especially the larger ones, are sitting on the horns of a dilemma where the only way to

maintain market share is to expand capacity, but only at the expense of increasing future unutilized capacity.

It does tend to seem as if the industry may be gradually, albeit inadvertently, digging its own grave.

A proverbial David vs. Goliath scenario seems to be developing where the larger players like Lucky, DG

Khan, Bestway, Pakistan Cement, etc. may cause a few smaller (especially those not expanding) cement

9
manufacturers to struggle for existence, or eventually sell out operations to one of these large producers.

However, within the group of large producers, we could have an interesting scenario in itself, where the local

cement industry’s big boys, Lucky and DG Khan, are likely to be given a tough time by the international

veterans like Orascom and Bestway.

Capacity Expansion cycle:

The capacity expansion cycle in cement industry is governed by following factors:

• Cement industry being a commodity industry provides very few barriers to entry.

• Positive demand and profitability outlook attract new entrants until profitability is affected.

• Industry went through two such capacity addition cycles during 90’s.

• However, current capacity addition cycles is the largest as industry capacity will be increased from

20.045mn tpa in FY05 to 43.9mn tpa by FY08.

• These factors indicate that although it is considerably easier for a new entrant to enter into the

business with regards to the conditions. But the staggering amount of investment required makes in

quite a difficult task.

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 Capacity addition cycles in the industry

Mn Tpa
45 45%

40 40%

35 35%

30 30%

25 25%

20 20%

15 15%

10 10%

5 5%

0 0%
FY92
FY93
FY94
FY95
FY96
FY97
FY98
FY99
FY00
FY01
FY02
FY03
FY04
FY05
FY06E
FY07E
FY08E
FY09E
FY10E
Capactiy Increase in Capacity (RHS)

Capacity expansions are targeted at domestic markets:

The research made on our part has shown following indications with regards to capacity expansion in cement

industry of Pakistan:

• Capacity expansions are largely concentrated in the northern zone

• Capacity in the northern zone will grow from 14.7mn tpa in FY05 to 33.8mn tpa by FY08.

• Concentration of expansion projects away from sea routes indicates these projects are targeted at

domestic markets.

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Further more, we have also researched on the region wise industrial capacity so that to present a conclusive

picture of cement concentration in Pakistan.

Northern Region Southern Region

Industry Market y-o-y Market y-o-y

Capacity Share Industry Share

Capacity

FY05 14.336 74% 8% 5.086 26% 1%

FY06E 18.006 80% 26% 4.388 20% -14%

FY07E 28.215 77% 57% 8.227 23% 87%

FY08E 32.363 77% 15% 9.663 23% 17%

FY09E 34.243 78% 6% 9.663 22% 0%

Demand and growth:

We expect domestic demand to grow at 13% Capacity growth rate (CAGR) during next five years. But certain

other factors will also affect the growth of cement industry as well. These are as follows:

• Backlog in development activities

• Strong DGP growth

• Housing sector growth

• Government Development Expenditures

• Earthquake Rehabilitation

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 • Announcement of large dams

Backlog in developmental activities will help in such a way as the Cement demand remained stagnated during

90’s owing to lack of development activities. And if we conduct a comparison of per capita consumption

between Pakistan and India we can find out that demand of cement in Pakistan with respect to its geographic

size has stagnated. Per capita consumption was 73kg during FY97 in both countries. Consumption in India

during FY05 was 115kg/capita whereas ours was 95kg/capita. Our consumption is low compared to region

countries and world average and so our per capita consumption may well remain below world average in the

medium run.

Kg/Capita
130
Pakistan India
120
110
100
90
80
70
60
50
FY97

FY98

FY99

FY00

FY01

FY02

FY03

FY04

FY05

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 Kg/Capita
600
Per capita cement consumption 625 1095
500 560
530
470
400
World Average 300 375
300

200

100
95 115
0 50

M ala ysi a

Chi na
Pak ista n

Iran
Ind ia
Ban gla des h

UA E
USA

EU
Effect of GDP:
Following effects of GDP will govern the growth of cement industry in Pakistan:

• Higher GDP growth has positive impact on cement demand

• Cement demand growth rate was double the GDP growth rate in last three years

• GDP growth is expected to continue to have same positive impact on demand growth

FY02 FY03 FY04 FY05 FY06E

Real GDP Growth 3.1% 4.8% 6.4% 8.4% 6.5%

Domestic Demand Growth -1.1% 11.8% 14.2% 18.2% 15%

Cement/GDP growth -0.36 2.46 2.22 2.16 2.30

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Housing demand to grow:
grow:
Following indications have showed a considerable demand of cement in Pakistan:

• Housing projects consume roughly 40% of cement demand

• Currently 0.3mn houses are built annually against demand of 0.5mn

• Low interest rates, post 9/11 remittances’ inflow, and real estate boom have helped housing sector

growth

• Easy mortgage availability and announcement of low cost housing schemes will determine housing

sector growth in the long-run.

Government’s development spending shall continue to rise due to:

• Government development expenditures count for one third of total cement consumption

• Increase in development expenditures has helped cement demand to grow at very high rates

• Increase in PSDP- as announced in Medium Term Development Framework 2005-10 - will help

cement demand to grow in the country

• Infrastructure development in a region triggers private development projects having even positive

impact on cement demand

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Govt.’s
Govt.’s development spending:
spending:
Mn PKR Bn PKR

35 700

30 600

25 500

20 400

15 300

10 200

5 100

- -

FY06E

FY07E

FY08E

FY09E

FY10E
FY00

FY01

FY02

FY03

FY04

FY05

Domestic Demand Development Expenditures (RHS)

Earthquake rehabilitation to boost demand:

demand:
After the earthquake of October 8th, the demand for cement rose tenfold due to the rehabilitation and

developmental programs. The conditions that constitute this growth due to earthquake are as follows:

• Earthquake losses are estimated at USD 5.2bn

• Reconstruction work will boost construction material demand

• Some portion of development expenditures will be allocated to this project

• Reconstruction work is expected to generate cement demand of 4mn tons over next 3-4 years

• Positive impact on demand will be much more evident from 2HFY07 onwards.

• Cement manufacturers in northern zone will be the main beneficiaries of this demand growth

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Demand generation from large dams:
dams:
The demand for cement will also increase due to following observations:

• Construction of four large dams will generate demand of 3.7mn tons as construction activities start

• Our estimate does not include demand generation from Skardu-Katzarah dam as its feasibility study

in not yet completed.

• Extent of demand generation will depend on size of dam, type of dam, and extent of

relocation/resettlement activities required.

• Bhasha dam will generate maximum demand as it is RCC concrete dam whereas other dams being

Earthfill/Rockfill dams will require less cement for their construction.

• Resettlement activities for Kalabagh dam will generate maximum demand as it is located in a highly

populated area.

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Cement demand generation from large dams:
dams:
Dams Munda Bhasha Kuram Kalabagh Akhori Katzarah

Tangi

Capacity MAF 1.3 7.3 0.9 6.1 6 -

Dam Type Rockfill RCC Earthfill Rockfill Rockfill -

Relocation Persons 1,000 23,700 11,000 120,000 49,300 160,000

Households1 101 2,833 1,111 16,667 6,847 19,753

Cost2 USD Bn 1.2 6.5 0.22 6.1 5 -

Estimated Cement Usage

-Construction Mn Tons 0.30 1.35 0.25 0.99 0.30

-Resettlement Mn Tons 0.002 0.055 0.022 0.325 0.134 0.385

1. Number of households except for Bhasha is calculated based on average persons/household as

mentioned by Population Census Organization

2. Cost of Kuram Tangi dam is converted to USD based on PKR 60/USD parity. (Original cost PKR

13.241bn)

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Competition in export markets:
markets:
With regards to the competition in export markets, we have observed following behaviors of cement industry

in Pakistan:

• Cement exports started in FY02 to Afghanistan that is still a major market

• Iraqi market can become a potential target after peace is restored

• India and Iran are the major competitors for Pakistan in the Middle Eastern region

• Upcoming capacity expansions in Iran and other GCC countries will create tough competition for

Pakistan

• Export prices are presently touching USD 75/ton in the exports market, however they are likely to

come down as new capacities comes online

Problems of overcapacity:
overcapacity:
Overcapacity situation in local market is due to:

• Cement industry has grown at 31% CAGR from capacity of 20mn tpa to 43.9mn tpa by FY08

• Current wave of new capacity expansions have reduced capacity utilization rates despite demand

growth of 13% CAGR

• We expect capacity utilization levels to decline to 60% in FY07 and 56% during FY08.

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Oversupply situation in local markets:
markets:
Mn tons
50 90%
45 85%
40
80%
35
30 75%

25 70%
20 65%
15
60%
10
5 55%

0 50%
FY01

FY02

FY03

FY04

FY05

FY06E

FY07E

FY08E

FY09E

FY10E
Sales Capactiy Capacity Utilization (RHS)

Problems of oversupply situation:

situation:
Following problems might arise with the oversupply situation in cement industry:

• Lower capacity utilization will reduce benefits of economies of scale. High leverage will also

adversely affect profitability of new plants

• New plants will gain market share at the cost of older players which are not undergoing expansion

• Large idle capacity is will create panic in players

• This may result in price wars in the coming years

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Idle Capacity of various players:
players:
FY06 FY07 FY08

DG Khan 10% 39% 39%

Fauji 12% 27% 30%

Lucky 12% 39% 43%

Maple Leaf 10% 37% 42%

Pioneer 10% 38% 40%

Attock 6% 37% 42%

Industry Average 17% 41% 45%

Financial Obligations will determine price strategy:

strategy:
Level of financial obligations will play key role in determining pricing strategy for manufacturers. Players with

higher debt obligations will have greater incentive to cheat from current cartel arrangements and as the

Financial and depreciation costs were PKR690/ton in FY04 that will increase to PKR1260/ton during FY07.

Similarly, at 60% capacity utilization level, financial obligations/ton (current maturity + interest expenses) will

be PKR 298/ton for Pioneer and PKR 1158/ton for Maple Leaf cement during FY07. And an increase of

10% in capacity utilization level declines financial obligations per ton by 14%. And if capacity utilization

levels are increased to 70%, financial obligations will decline to PKR 256/ton for Pioneer and PKR 998/ton

for Maple Leaf cement

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Price reductions are likely in the coming years:
years:
This observation is mainly due to following factors:

• Cement industry is currently enjoying historically high prices, margins and utilization rates

• Historically, lower capacity utilization rates have resulted in price wars among manufacturers

• Effect of capacity utilization levels will start to decline from 1QFY07

• Lower sales volume and high leverage due to expansion will create problems for players to meet debt

obligations

• This is likely to trigger price wars as players will try to gain market share

• Price wars will lower margins creating further problems for players

• We expect price reduction of 10% in FY07 and 5% in FY08

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Conclusion:
Consolidation is needed for industry stability because of following observations that we as a group have

made:

• Cartels are unstable by their nature.

• Industry needs one or two dominant players for long-term sustainability in prices and profits

• Top four players command 35% of market share in the industry that will be increased to 46% in

FY08.

• World norm is that top four players have more than 60% market share

• Consolidation process will be needed to increase market share of larger players rather than going for

capacity expansions

• We may see acquisitions in the industry as the industry goes through overcapacity cycle

• Acquisitions were made at EV/ton of USD100-130/ton in India excluding GACL acquisition that at

EV of USD193/ton.

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