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Cyclicality dominates the fine paper sector, but there is an alternative to all the ups and downs
Kimmo Alajoutsijärvi, Mats B Klint and Henrikki Tikkanen
Putting a smooth edge on a fine business
During the last decade, pulp and paper companies have had to face up to increasing cyclicality in their industry. In general though, these cycles are not caused by fluctuations in end-user consumption. For example, the average annual increase in fine paper consumption has remained steady at 4% over the past 20 years, despite widespread speculation about the possible negative effects of recycling and paper-free offices.
Fluctuations in price and demand create a no-win situation for the various players in the global fine paper sector. The most significant impact of business cycles can be seen in the inconsistent use of production capacity, the threat of substitution from electronic media and the industry's unreliable image in the eyes of financiers and investors. Added to that, the variations in turnover, which can be caused by business cycles, are of vital importance as the financial sector uses these as a key indicator in measuring investment risk.
Understanding and coping with business cycles is one of the main challenges faced by paper industry managers. Surprisingly, business cycles have so far attracted only scant attention among marketing and management researchers. One exception is Haslett's well-known Pulp Time Loop, which takes an ironic look at the typical behavior of pulp players throughout a business cycle (PPI April 1983, pg 31).
Current research tends to focus on business cycles as a basis for decision making from a governmental or "macro" perspective, but it would be more beneficial to look at them from a managerial or "micro" angle. In this way, companies could understand and even attempt to manage the cycles that affect their operations in different industries.
When developing a general managerial or corporate view of business cycles, the emphasis needs to be put on the management of customer relationships. In current management thinking, business cycles are typically characterized as being "natural" in the fine paper industry. As a result, it is crucial that managers are able to forecast the turning points and adjust marketing/purchasing activities appropriately. But companies could take a more dynamic approach, based on an understanding of the logic of business relationships.
Figure 1 - A Vicious Time Loop for the Global Fine Paper Industry
Note: the inner circle depicts events and actions in the pulp industry, the text in bold represents the fine paper industry, and the outer circle is for merchanting
Out of the loop
The key players in the fine paper industry consist of pulp producers, papermakers, merchants and other organizations that buy fine paper. Our reconstruction of Haslett's Pulp Time Loop (Figure 1) depicts a time loop for structuring key events and actions during a business cycle. It can also be seen as a summary of typical behavior within buyer-seller relationships, or the so-called "vicious time loop".
Over the time loop, the ability of managers to successfully learn the rules of the game has created a fundamental flaw in terms of smoothing the business cycles. Ironically, the more successful the managers are in taking advantage of the business cycle, the more cyclical their business actually becomes. In other words, the ability to learn from direct experience, eg in anticipating the turning points of business cycles, has led to a situation in which the entire industry tends to conform to the same opportunistic logic.
A closer look at the key players and their relationships in the fine paper industry will identify the issues that underpin the vicious circle. Firstly, pulp producers, papermakers and merchants have extensive inventory capacities. When pulp and/or fine paper prices begin to increase at the beginning of a boom, key players perceive it as profitable to build up inventories, which creates additional pressure on price increases. This inventory game continues from the beginning until the end of the boom period. When the players eventually start running down their high inventory levels, prices begin to fall which, in turn, puts additional pressure on the companies to get rid of their inventories as soon as possible.
Price expectations among key players in the fine paper industry centrally affect the turning points of the business cycles. At the beginning of a bust period, inventory levels are considered too high. Consequently, price expectations quickly turn negative and companies begin to run down inventories. Simultaneous de-stocking in many organizations gradually leads to considerable price cuts in both pulp and fine paper.
Secondly, the time perspective regarding prices and volumes within a typical buyer-seller relationship is short, ranging from between three months to a year. Buyers and sellers agree loosely on future deliveries in advance, usually a maximum of one year ahead. However, eventual price levels are normally defined on a quarterly basis in accordance with global market prices. Consequently, managers are responsible for ensuring the highest possible operational profit on an annual or even quarterly basis, which makes the managerial time span rather short in the context of such a capital intensive industry.
Delay tactics
Thirdly, the short managerial time perspective in the industry tends to lead to a no-win situation in which a gain for one side means a loss for the other. This in turn, often results in a "circle of revenge" between the buyer and seller. Given their strict quarterly budget responsibility, sales managers are often forced to dictate their latest price increases to the buyer even at the threshold of an expected downturn. Consequently, when the market price is at its lowest, the buyer often demands additional price cuts.
Throughout the business cycle, the profitability of each organization in the fine paper value creating system varies to a considerable extent. During a boom, producers' earnings grow quickly in accordance with price increases and merchants' profits fall sharply. The situation is reversed in a bust period. All this naturally reinforces opportunistic behavior in the fine paper industry.
A fourth point is that business cycles are reinforced by delivery and investment delays. During a boom period, deliveries may take several weeks, leading to excess or overlapping orders from different sources. On the other hand, investment projects in new production lines require several years. This means that paper companies do not have the flexibility to respond to increased demand on a short term basis. Fierce competition also leads manufacturers to introduce new machines to the market at approximately the same time, causing excess capacity.
Lastly, paper companies have very high fixed costs, which forces and/or tempts them to keep producing even at the lowest prices. Despite new investments in more efficient paper machines, old production capacity is not shut down because of accounting practices that make paid investments profitable. Moreover, in the absence of clearly dominant global corporations or an OPEC type of regulatory organization, no player can control the industry network even as far as basic capacity regulation is concerned.
Power games
As Figure 1 clearly shows, business cycles in the global fine paper industry strongly shift the power balance within buyer-seller relationships. This balance can move from extreme customer dominance during a bust period to extreme supplier dominance during a boom period.
Paper industry managers need to have a major rethink regarding relationship strategies in the different phases of business cycles. During a boom, the paper supplier should aim at a more flexible and cooperative relationship strategy, whereas a bust period would call for a more competitive and dominant mode of behavior. Through these types of relationship strategies, managers in the global fine paper industry could attempt to escape the trap of the vicious time loop illustrated in Figure 1. In the long run, genuinely cooperative customer relationships could also be created.
There are four courses of action which managers should take to reach the objective of a more stable business environment in the fine paper industry. Firstly, there should be a considerable decrease in inventory capacity and the adoption of just-in-time delivery policies, especially in order to shorten unnecessary delays between orders and deliveries. The latest developments in ICT (information communication technology) can contribute to more cooperative buyer-seller relationships if a just-in-time delivery system with no stocks and direct supply is developed along the chain of buyers and sellers.
Secondly, companies need to focus on product development so that customers can differentiate between the range of services on offer. This development is already visible in the magazine paper business, in which sellers now often combine several magazine paper grades from different paper mills to offer a complete solution to printers.
Thirdly, there should be increased focus on end-user consumption in the consumer market rather than the concentration on incoming factory orders (or apparent consumption) from wholesalers. The adoption of the latest ICT tools will make it possible for producers to focus on real end-user consumption more precisely and with fewer delays.
Lastly, large forest products companies need to focus on developing stronger market positions to coordinate investments on a global scale. There were several major mergers among global forest industry corporations during the 1990s, which should make this objective easier to implement.
If all these steps are taken, managers may be able to iron out some of the creases in the cyclical fine paper industry and look forward to a more stable environment in the future
Kimmo Alajoutsijärvi and Henrikki Tikkanen are professors of marketing at the University of Oulu in Finland. Mats B Klint is associate professor at the Mid Sweden University in Sundsvall, Sweden
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