Pulp, paper,
and packaging in the next decade: Transformational change
If you thought the paper industry was going to
disappear, think again. Graphic papers are being squeezed, but the industry
overall has major changes in store and exciting prospects for new growth.
From what you read in the
press and hear on the street, you might be excused for believing the paper and
forest-products industry is disappearing fast in the wake of digitization. The
year 2015 saw worldwide demand for graphic paper decline for the first time
ever, and the fall in demand for these products in Europe and North America
over the past five years has been more pronounced than even the most
pessimistic forecasts.
But the paper and forest-products industry as a whole is
growing, albeit at a slower pace than before, as other products are filling the
gap left by the shrinking graphic-paper market. Packaging is growing all over
the world, along with tissue papers, and pulp for hygiene products. Although a
relatively small market as yet, pulp for textile applications is growing. And a
broad search for new applications and uses for wood and its components is
taking place in numerous labs and development centers. The paper and
forest-products industry is not disappearing—far from it. But it is changing,
morphing, and developing. We would argue that the industry is going through the
most substantial transformation it has seen in many decades.
In this article, we outline the changes we see happening
across the industry, and we identify the challenges CEOs and their leadership
teams will need to manage over the next decade.
Changing industry
structure
The structure of the industry landscape is changing. The
changes are not dramatic individually, but the accumulation of changes over the
long term has now reached a point where they are making a difference.
Consolidation has been a major factor in many segments of the industry. The big
have become bigger in their chosen areas of focus. At the aggregate level, the
world’s largest paper and forest-products companies have not grown much, if at
all, and several of them have reduced in size. What they have done is focus
their efforts on fewer segments. As a result, concentration levels in specific
segments have generally, if not universally, increased . In some segments, such
as North American containerboard and coated fine paper, ownership
concentration, as defined by traditional approaches to drawing segment
boundaries, may be reaching levels where it would be difficult for companies to
find further acquisition opportunities that could be approved by competition
authorities.
A grouping of companies has emerged that is not
identical to but partly overlaps with the group of largest companies, and it is
drawn from various geographies and market segments. Companies in this group
have positioned themselves for further growth through high margins and low debt.
Our analysis suggests the financial resources available to some members of this
group for strategic capital expenditure (capex) could be five to ten times
greater than other top players in the industry. This potentially represents a
powerful force for change in the industry, and over the next few years it will
be interesting to see how these companies choose to spend their resources. Some
of these companies, with large war chests and sizable annual cash flow
deployable for strategic capex, might even face a challenge to find
opportunities on a scale that matches these resources.
Where there are leaders, there are also laggards. We
believe the pronounced differences in performance among companies across the
industry continues to pique the interest of investors and private-equity
players in an industry that is already undergoing substantial restructuring and
M&A.
Changing market
segments
Whether companies are well positioned for further growth
or still needing to earn the right to grow, they can expect demand to grow for
paper and board products over the next decade. The graphic-paper market will
continue to face declining demand worldwide, and our research has yet to find
credible arguments for a specific floor for future demand. But this decline
should be balanced by the increase in demand for packaging—industrial as well
as consumer—and tissue products. All in all, demand for fiber-based products is
set to increase globally, with some segments growing faster than others. The
one hazy spot in demand might be concerns over how fast it will grow in China.
Expectations of growth from only a few years ago have proven a bit too
optimistic, not only in graphic papers but also in tissue papers and packaging.
Given China’s weight in the global paper and board market, even relatively
modest slowdowns can have significant impact.
How these demand trends will translate into industry
profitability will of course be heavily influenced by the industry’s supply
actions. Supply movements are notoriously difficult to forecast more than a few
years out, but we believe the following observations are relevant to this
discussion:
·
Graphic papers, particularly
newsprint and coated papers but also uncoated papers, will continue to face a
severe decline in demand and significant pressure to restructure production
capacity. We are likely to see continuing machine conversions into packaging
and specialty papers, as well as more innovative structural moves that include
innovations in distribution and the supply chain. Such structural changes are
already having an impact, and the profitability of graphic-paper companies is
currently reemerging from several years in the doldrums. The turbulence in
graphic papers has meanwhile spilled over to packaging and tissue segments,
with capacity increases in segments that don’t really need it.
·
Consumer packaging and tissue will
be driven largely by demographic shifts and consumer trends such as the demand
for convenience and sustainability. It will grow roughly on par with GDP. We
expect innovation to be a critical success factor, but we are uncertain how far
packaging players can drive innovation by themselves. Clearly they can take the
lead on materials development, but they may need to follow the lead of
retailers and consumer-goods companies in areas such as formats, use, and
technology. At the same time, the sudden inflow of capacity from the
graphic-paper segment will need to be managed.
·
Industrial packaging will
also see opportunities for innovation and a certain amount of value-creating
disruption, for example, in online shopping, last-mile delivery, product
safety, and counterfeiting measures. But demand growth is still likely to be
somewhat below GDP.
·
Hardwood fiber is
likely to face some challenging times near term, despite healthy demand growth.
Recent and ongoing expansions are creating an oversupply that is likely to
exert downward pressure on prices for a few years. Until the industry as a
whole learns to adopt a more long-term view on demand cycles and capacity
expansions, this cyclical performance is likely to continue.
·
Softwood fiber could
be looking forward to some prosperous years. In the medium term, requirements
for stronger, lighter-weight packaging and the need to balance out the
deteriorating quality of recycled fiber could increase demand. Although
demand-growth rates are lower than for hardwood, so are the industry’s capacity
additions, and this should help profitability. Challenges in expanding
softwood-forest supply are constraining new supply, as well as the fact that
much of the industry’s softwood-production assets are aging and need complete
renewal or substantial upgrades. But the scale of the investments required is a
potential roadblock to them being made, which could further contribute to
scarcity. The lingering question is whether such supply-side challenges can
trigger an accelerated development of hardwood applications as a substitute,
rendering softwood fibers partly obsolete.
Challenges for the
next decade
In such an environment, what are the key challenges
senior executives will need to address? What are the key battles they will have
to fight? The paper and forest-products industry is often labeled a
“traditional” industry. Yet given the confluence of technological changes,
demographic changes, and resource concerns that we anticipate over the next
decade, we believe the industry will have to embrace change that is, in
character, as well as pace, vastly different from what we have seen before—and
anything but traditional. This will pose significant challenges for CEOs
regarding how they manage their companies.
We argue that there are three broad themes that paper
and forest-products CEOs will have to address through 2020 and beyond:
·
managing short-to-medium-term “grade turbulence”
·
finding the next level of cost optimization
·
finding value-creating growth roles for forest products
in a fundamentally changing business landscape
Managing short-to-medium-term
‘grade turbulence’
The past couple of years have seen increased instability
in some forest-products segments. The negative impact of digital communications
on graphic paper has led many companies to steer away from the segment and into
higher-growth areas, either through conversion of machines or through
redirection of investment funds. This is leading to a higher level of
uncertainty and overcapacity in, for example, packaging grades. The instability
has also been exacerbated by the capacity additions that primarily Asian
producers have made in spite of the slowing demand growth in that region.
An increased interest in swing capacity that can move
production between grades has added to the uncertainty in certain grades. A
case in point is virgin-fiber cartonboard. Several producers in Europe have
converted machines away from graphic paper and into this segment, creating
further oversupply in Europe, and leading producers to redouble their efforts
to sell to export markets. This is happening just as increasing capacity in
Asia, and particularly in China, looks set to displace imports that have
traditionally come into the region, mainly from Europe and North America. Some
of the new Asian capacity could even find its way into export markets.
This development is likely to persist for several years
until markets again find more of an equilibrium, and it poses challenging
questions for companies. What, if any, safe havens exist for my products? How
do I protect home-market volumes? How do I protect my export volumes? What is
the appropriate pricing strategy to use in the different regions?
For CEOs looking to move into a new market segment, it
will be equally important to make the right assessment of which segments to
enter as they shift their footing. Where will I be the most competitive? How
will my entry change market dynamics, and will this matter to me?
Finding the next
level of cost optimization
Even though we see new ways of creating value in the
forest-products industry, low cost is, and will remain, a critical factor for
high financial performance. One of the characteristics shared by companies with
high margins and high returns is that they have access to low-cost raw
materials, primarily fiber. This will continue to be a high-priority area,
albeit with some twists compared with today.
In recycled fiber, availability and quality—and
therefore cost—will be increasingly challenged. Fresh fiber is facing other
cost issues. It is unclear whether plantation land in the southern hemisphere
(primarily for short-fiber wood) will continue to be available at current low
prices. And as companies go to more remote areas to acquire inexpensive land,
such as in Brazil, their infrastructure and logistics costs increase. Will
higher productivity and yield allow the global industry to add ever more
low-cost capacity, or are we going to see a gradual increase in raw-material
costs? For long-fiber products, the difficulties involved to expand long-fiber
pulp capacity will make such assets very valuable over the next several years.
But at what point will development of the material properties of short-fiber
pulps make them rival more expensive long-fiber pulps in a number of major
applications?
Operating costs for paper and board production are
another area where companies need to get a tighter grip. Despite the fact that
this area receives continual focus from management, our experience suggests
there is still significant potential for cost reduction by using conventional
approaches to work smarter and reduce waste in the production chain. This is
particularly the case in areas that are less the focus of management attention,
such as converting.
Many companies need to go beyond the conventional
approaches to a next level of cost optimization—and many are ready to take this
step. Most, if not all, paper and forest-products companies have completed
large fixed-cost reduction programs. But there are often broader systemic
issues that companies still need to address to be able to build sustainable
operating models. In addition, in some segments many companies fail to reduce
fixed costs as quickly as capacity disappears. By radically rethinking the
operating model, companies can significantly shift their fixed-cost structure.
By doing so, they can set a very different starting point with respect to
flexibility and agility for when market volumes go through their normal
cyclical swings.
The paper and forest-products industry has much to gain
from embracing digital
manufacturing: according to our estimates, this could reduce the
total cost base of a producer by as much as 15 percent. New applications, such
as forestry monitoring using drones or remote mill automation, present
tremendous opportunities for increased efficiency and cost reductions. This is
also the case in areas where big data can be applied, for instance, to solve
variability and throughput-related issues in each step of the integrated
production flow. The industry is well placed to join the digital revolution, as
paper and pulp producers typically start from a strong position in regard to
collected or collectable data.
At the customer-facing end, the opportunity for
innovation is huge and has the potential to transform existing industries and
create new ones, especially in packaging segments. Digital developments will
also help disrupt previous B2B2C value chains, paving the way for direct B2C
relationships between paper-product makers and end consumers, for example, in
tissue products.
The digital
world is unfamiliar territory to most paper-industry
CEOs. To avoid too much doodling with small uncoordinated efforts, it is
necessary to undertake a thought-through program, preferably guided by
digitally experienced people either on the top management team or board.
Finding
value-creating growth roles for forest products
For any paper-company CEO who looks out ten years, the
really different challenges will not be around cost containment. Global trends
are moving the industry into a new landscape, where the challenges and
opportunities for finding value-creating growth roles for forest products are
changing radically. For example, the industry’s historic linear value chains
are giving way to more collaborative structures with players in and outside the
industry. We believe examples will include new producer and distributor
collaborations; pulp players collaborating more innovatively with nonintegrated
players; paper and packaging companies collaborating more intensively with
retailers, consumer-goods companies, and technological experts; and new
products such as biorefinery products requiring novel go-to-market
partnerships. Here are some interesting examples of how these and other trends
could play out.
Staying relevant (and increasing relevancy) in a
fast-changing packaging world. The
packaging market is multifaceted and continuously morphing. Digital
developments influence it both by stimulating demand for packaging used in
e-commerce and by enabling the integration into packaging of sensors and other
technology. E-commerce has highlighted new packaging topics such as improved
product safety, the unboxing experience, counterfeiting measures, and
optimizing for last-mile delivery. At the same time, the industry has to deal
with increasing pressures around cost, resource conservancy, and
sustainability, while plastic packaging continues to grow at a faster pace than
fiber-based packaging.
The opportunity to develop a differentiated and distinct
customer value proposition in this landscape has never been greater. Packaging
CEOs will have to address a number of choices and trade-offs as they seek the
appropriate strategic posture. Should you be a pure upstream player or a
packaging-solutions provider? Should you focus on fiber-based packaging only or
on providing multisubstrate solutions? Should you be at the forefront of technology
integration and application development in packaging or focus on materials
development?
To stay relevant, many companies in packaging are trying
to move closer to the brand owner or end user. Only a few companies are
positioned to successfully make this move, however, and even they should be
cautious. We are already seeing brand owners and leading customers challenging
the benefits of packaging companies coming with consumer-facing ideas, such as
complete packaging concepts. Some of these players would prefer packaging
companies to focus instead on core competencies, such as materials development,
or interfaces with other substrates, such as plastics.
Finding the right path in next-generation bioproducts. Wood
is a biomaterial with exciting properties, from the log on down to the fibers,
micro- and nano-fibers, and sugar molecules. A healthy niche industry making
bioproducts has existed for many years alongside large-volume pulp, paper, and
board products. We are in the midst of an explosion of research activity to
develop new bioproducts, ranging from applications for nanofibers to
lignin-based carbon fiber. New processes are
being designed to extract hemicellulose as feedstock for sugars and chemical
production while still keeping the cellulose parts of the wood chip for pulp
products.
We believe wood-based products will find new ways to
enlarge their footprint in a more sustainable global economy. But the
challenges are legion, particularly for finding cost-effective production
methods that can withstand competition not only from oil-based materials but
also from other biomaterials. Finding the right balance between developing the
“new” and safeguarding the “old” will be a crucial undertaking for executives
running companies with access to fresh fiber.
Finding growth in adjacent areas. Over
the past decade or two we have seen the larger forest-products companies
performing a focus adjustment. Most companies have moved from being fairly
broad conglomerates present in various forest-products segments to focusing on
a few core businesses. To find value-creating growth in the next two decades,
we expect companies to start broadening their corporate portfolio again, but
broadening it around the core businesses they have been working on, so as to
create differentiated customer value propositions. Finding value-creating
adjacencies to the core business will be a challenging exercise in creativity
and business acumen for executive teams.
Finding new value-creating growth for forest products
will also put the spotlight on a number of functional executive topics. We
believe the following will be most important:
·
Innovation: The
forest-products industry has not been known for a fast-paced innovation agenda.
By and large it hasn’t been necessary, as markets and demand characteristics
have changed relatively slowly. In the future, however, innovation in products,
processes, organizational set-up, and business models will be imperative. For
many companies, getting efficient innovation practices and the organization up
to speed will be an important challenge.
·
Talent management: The
different skills required over the next 10 to 15 years will put particular onus
on the talent pool of forest-products companies. Installing an executive team
that is able to understand new demands across customer businesses, digital,
bioproducts that cater to completely different value chains, and cross-industry
collaboration will be a major task for CEOs and boards.
·
Commercial excellence: Paper
and forest-products companies will need to transform their commercial interface
to stay relevant, particularly in packaging and downstream paper. They will need
to put in place a more professionalized and skilled organization that focuses
on value creation, instead of focusing primarily on sales volumes.
We believe the paper and forest-products industry is
moving into an interesting decade, one that will see nothing less than a
transformation of large parts of the industry. There will be many barriers to
overcome and metaphorical cliffs to fall off. But the companies that are able
to navigate through successfully can look forward to an industry that has a new
sense of purpose and an increasingly vital role to play.
By
Peter Berg and Oskar Lingqvist
http://www.mckinsey.com/industries/paper-and-forest-products/our-insights/pulp-paper-and-packaging-in-the-next-decade-transformational-change?cid=other-eml-alt-mip-mck-oth-1706&hlkid=f28803c5bba94082a5c173c559e3c697&hctky=1627601&hdpid=d3359c71-be5f-4386-ae88-fb95d49375c4
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