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Sustaining the recoveryErnst & Young global forestry, pulp and paper report 2011
4 Introduction
7 Competinginthenewenvironment
8 Performanceacrossdifferentindustries
10 Businesslogicofpulpandpaper
16 Businessinnovationinthepharmaceuticalindustry
20 Privateequity—excellenceinM&A
22 Cashinthebarrel—workingcapitalmanagementinoilandgas
26 Whatdoesthefuturelooklike?
26 Methodology
26 Main results
32 Conclusions — what does the future look like?
34 Sustainingtherecoveryinpulpandpaper
List of contents
2 SustainingtherecoveryErnst & Young’s global forestry, pulp and paper report 2011
3SustainingtherecoveryErnst & Young’s global forestry, pulp and paper report 2011
Thepasttwoyearscanformanyindustries,theirseniorexecutivesandshareholdersbedescribedasextraordinarilychallenging.Thefinancialcrashthatstartedin2008ledtomanyshockstotheworld’sfinancialsystemandcausedseismicshiftsbetweenthedevelopedeconomiesandtheemergingmarkets.Therippleeffectscanstillbefeltinmanywaysandthelatestandperhapsthemostdramaticofthesehasbeentheeurozonecrisis,whichhasevenledtothespeculationsinthemediaaboutthebreak-upoftheeuro.
Intheseconditions,onewouldexpectthatcompaniesareonthevergeofbankruptcyorattheveryleastaccumulatinghugelosses.Andsurelyatroubledindustrysuchaspulp,paperandpackagingwouldbedoingevenworsethanithassince2002whentheindustry’sprofitabilitystartedtorapidlydecline?Wrong—during2010,mostpulpandpapercompaniesproducedsolidandhealthyprofitsinverychallengingconditions.
Duringthepastdifficultfinancialcrisis,Ernst&Younghasworkedcloselyandintensivelywithitsclientsacrossmanyindustriesandregions.Asaresultofthatworkandextensiveresearch,wehaveproducedthreemajorprogramstoprovideinsightsforourclientsandtoassisttheminnavigatingthefinancialcrisis.ThesewerecalledOpportunities in adversity, Lessons from changeandCompeting for growth—allreflectingtheprogressionofthefinancialcrisis.Thelatestone—Competing for growth—includedover1,400executiveinterviewsandfocusedonhowtheleadingcompaniesindifferentindustriesarelookingforwaystoreturntoprofitablegrowth.
ThisErnst&Youngthoughtleadershipreportdrawsonourknowledgeofthepulpandpaperindustryandtheresultsoftheaboveprograms.WeinterviewedourclientsinthissectorduringFebruary2011,askingthem70questionsrangingfromfutureR&Dspendingandindustryconsolidationaswellaskeycompetencesofthefuture.Manyofourclientshavealsoindicatedthattheyareinterestedinalsootherindustriesandhowtheyhavetackledthechallengesofthefinancialcrisis.Wehavethereforeanalyzedthefinancialresultsbetween2006and2010ofsixotherindustriesandlookedathowtheycomparewithpulpandpaper.Morespecifically,wehavelookedathowleadingcompaniesinotherindustriesperformcertaincriticalfunctionsandhowtheymightbenefitthepulpandpaperindustry.
Thepulpandpaperindustryhasbeenundergoingadramaticrestructuringprocessduringthelastseveralyears.Theprofitabilityofmostcompanieshasbeenlow,overcapacityinmanypaperandboardgradeshasplaguedsupplyanddemand,severaluncompetitivemillshavebeenclosedandthousandsofjobshavebeenlost.Thefocusofmanycompaniesinthedevelopedeconomieshasbeenonsurvival,divestmentsofnon-coreassetsandintensecostreductions,whereastheindustryhascontinuedtothriveintheemergingeconomies.Manycompanieshavealsobeentryingtoexpandinrelatedbusinessessuchasbioenergyandspecialitymaterialsandreducetheirdependenceontraditionalpaperandboardproducts.
Itseemsthat,inlightofthefinancialresultsof2010andthepromisingnear-termoutlook,theworstisoverandthe
industryis“outofthewoods.”However,manystructuralchallengeshavenotdisappeared,andsupplyanddemandsituationinespeciallyprintingandwritinggradesisstilldifficult.Butitseemsthattheleadingcompanieshavelearnedtolivewiththatandtheyareadjustingcapacity—eitherpermanentlyorthroughmarket-relatedshutdowns—accordingtodemandandtheintensecostreductionsarealsobeginningtopayoff.Theriskisthatthecurrentrecoveryisnotsustainableandsupplyanddemandbalanceaswellasprofitabilitydeclinesduringorafter2011.
Howtosustainthisrecoveryandcreatetheplatformforlong-termsuccessisthemainthemeofthisreport.Whatarethekeylearningsfromotherindustries,whatcombinationoffactorshasthebiggestimpactonfutureprofitabilityandwhatarethekeycompetencesofthefuturearesomeofthequestionswehopetoshedlighton.Wewouldliketosincerelythankallthecontributorstothisreportandwehopeyouwillfinditinsightfulandusefulinimprovingyourcompany’sperformance.
Introduction
Timo UronenGlobal network leaderForestry, pulp and paper
4 SustainingtherecoveryErnst & Young’s global forestry, pulp and paper report 2011
5SustainingtherecoveryErnst & Young’s global forestry, pulp and paper report 2011
66 SustainingtherecoveryErnst & Young’s global forestry, pulp and paper report 2011
Competing in the new business environment
Thefinancialcrisisanditsaftermathhas—perhapspermanently—changedtheglobaleconomyandalso,inmanyways,thecompetitivearenaofmanyindustries.Itseemsthatthefinancialcrisisitselfmostlyservedasa“tippingpoint”andspeededuporhighlightedfactorswhichhaveactuallybeenunderwayformanyyears.
Forinstance,globalizationanddigitalizationaswellasmobilityofcapitalhavebeenunderwayformanyyears.Regardlessoftheunderlyingreasons,thebusinessenvironmenthassignificantlychanged.
Ernst&Young’sresearchintothefinancialcrisisanditsaftermathhasindicatedthattheleadingcompaniesarenowfocusingonprofitablegrowthaftertwoyearsofretrenchmentand“managingbybacktobasics.”Accordingtoourresults,thenewenvironmentcanbecharacterizedbythefollowingfactorscomparedwiththepre-crisisera:
Competitionhasincreased.Becauseof•lowgrowth,especiallyinthedevelopedeconomies,growthhastobewonfromcompetitors.Thedemandnolongerincreasessignificantlyandthereisoversupplyinthemarket.Marketvariationhasalsoincreased—emergingmarketscontinuetogrowbut,forinstance,ChinaandIndiaaregrowingfasterthanRussiaorBrazil.Similarly,somedevelopedcountriessuchasGermanyandtheNordicsaregrowingfasterthanothers.Figure1clearlyshowsthattherespondentsfeelcompetitionincreasing.
FIGURE1:Howcompetitivehasthemarketbeeninthepasttwoyears?Howdoyouseeitlookingoverthenexttwoyears?(aspercentageoftotalrespondents)
Asaresultofincreasedcompetition•andmarketvolatility,marginsareunderpressure.Figure2highlightstheresults,and,forinstance,29%oftherespondentsreportedthattheyexpectinputcoststoincrease.
Stakeholdersarenervous,asaresult•ofthebiggestrecessionsincethe1930s.Investorshavelostmoneyandgovernmentshavehadtomake
unpopulardecisionstobailoutfinancialinstitutionsinmanycountries—asaconsequence,thereareincreasingregulatorymeasuresdemandedandplanned.Sovereigndebtmarketsandmaincurrencies—especiallyeuro—havebeenturbulentandthedominantroleoftheUSdollarinworldfinanceshasbeenquestioned.
Itseemsclear,thatthegoodoldpre-crisisdaysareover,andcompaniesacrossdifferentindustriesandregionsneedtoadapt.Accordingtoourresearch,theleadingcompaniesareadaptingbyfocusingonenhancedcustomerreach,improvingoperationalagilityandcostcompetitivenessaswellasensuringstakeholderconfidence.Thesearethegenericresultsforallparticipantindustriesofourresearchandthefulldetailsofthe Competing for growthprogramareavailablethroughErnst&Younglocaloffices.Inthefollowingsections,weanalyzehowtheseapplytothepulpandpaperindustrycomparedwithotherkeyindustries.
Past 2 years Next 2 years
7086
7182
7483
High Medium Low
Source:Ernst&YoungCompetingforgrowth
Source:Ernst&YoungCompetingforgrowth
High performers
Priceerosion
Demand decline
Input costinflation
Exchange rate
fluctuation
Labor cost
inflation
Investor/stakeholder
pressure
Interest on/servicing
debt
4448 47
42
60
51
33
2629
32
23 24
30
24
31
16
9 1015 16 14
FIGURE2:Whichcostpressuresaremostsignificantforyourcompany? (aspercentageoftotalrespondents)
Medium Low
7SustainingtherecoveryErnst & Young’s global forestry, pulp and paper report 2011
8
Inouropinion,itisalwaysusefultostudytheneighborhoodandseewhatothersaredoing—notonlywithregardtothecompetitorsandcustomers,butalsoentirelydifferentbusinesses.Manyleadersofdifferentindustriestendtothink,that“wellyes,veryinterestingbutourbusinessisdifferent.”Pulp,paperandpackaginghastraditionallybeennoexceptiontothatlineofthinking.
Performance across different industries
However,wefeelthatthisattitudeisnowchanging.Manyofourpulpandpaperclientshaverecentlyaskedforanalysisandinformationaboutotherindustries.Someleadingcompanieshavealsoincreasinglyrecruitedtalentfromentirelydifferentbusinesses,withtheviewtobringinginexperienceandskillsfordoingthingsdifferently.Ofcourse,allindustrieshavemajordifferencesandtheirownearningslogic,andsimplytransferringorimitatingkeycompetencesandprocessesiscertainlynotalwayspossible.Butconsideringthelowlong–termfinancialperformanceofmanypulpandpapercompaniesbetween2003and2009,
itmakessensetoseewhattheothercompaniesinotherindustriesaredoingdifferentlyandseewhatmightbelearnedfromthem.
Ernst&Youngisinanexellentpositiontoassistourclientsinthis.Becauseofourextensivepulpandpaperexperienceandglobalnetwork,weknowthekeyissuesandhowleadingcompaniesinthisindustrycurrentlyoperate.Andinadditiontopulpandpaper,weserveaverywiderangeofotherindustries—fromretailandrealestatetotelecommunicationsandmining.Combiningtheknowledgefrombothpulpandpaperandotherindustriesiswhatisneeded.
FIGURE3:Top10companies’averageturnoverbydifferentindustries
Source:Fortune500,2010
8 SustainingtherecoveryErnst & Young’s global forestry, pulp and paper report 2011
9
InFigures3and4,wehaveanalyzedthefinancialperformancebetween2006and2010ofthe10biggestcompaniesinconsumerproducts,automobiles,oilandgas,mining,pharmaceuticalandchemicals,aswellaspulpandpaper.Wehaveselectedtheseindustriesbecausetheyrepresentcapitalintensiveindustriesorbecausetheyarecloselylinkedtothepaperandboardvaluechain.
Itmustbenotedthattheresultsincludeonlythe10biggestcompaniesineachindustry—itislikelythatthereareothersmallerfirmsineachindustrywhoseprofitabilityfiguresaredifferent.But
consideringthattheaboveindustriesarehighlyconsolidatedandthetop10representcloseto60%ormoreoftotalindustrysales—withtheexceptionofpulpandpaper—onecanassumethattheyprovideareasonablyaccurateviewofeachindustry’soverallperformance.Afurtherpointtonoteisthatpulpandpaperconsistsofanumberofverydifferentbusinesses—however,moststakeholderssuchasinvestorstendtobundlethesetogetherandforpracticalreasonsitisverydifficulttoanalyze,forinstance,tissueandnewsprintseparately.
Figures3and4warrantthefollowingconclusions:
Totalsalesofstudiedindustrieshavenot•increasedsignificantlybetween2006and2010.Despitethechallengesinthepulpandpapersector,otherindustrieshavenotbeenabletosignificantlygroweitherinthatperiod.
Acleargapintheprofitabilitybetween•pulpandpaperandotherindustrieshasexistedbetween2006and2010.Duetothefinancialcrisis,thisgapnarrowedin2009and,in2010,pulpandpapernarrowedthisfurther.Basedonthe2010financialresults,theprofitabilityofpulpandpaperismoreinlinewiththeotherindustriesstudied.
However,consideringthatthefinancialresultsofoneyeararehardlysufficienttoinspirelong-terminvestorandstake-holderconfidence,itisclearthatinthispeergrouppulpandpaperisclearlytheunderdog.Persistentlong-termlowprofitabilitycanultimatelybedisastroustoanybusiness,andtheencouragingtrendof2010needstobecontinued.Itseemsthatitwouldstillbeaworthwhilepursuittostudywhytheotherindustriesperformbetter.Butpriortoanalyzingthat,thespecialcharacteristicsandearningslogicofpulpandpapermustbestudiedfurther.
FIGURE4:Top10earningsbeforedepreciation,interestandtaxes(percentageofturnover)
Source:Fortune500,2010
9SustainingtherecoveryErnst & Young’s global forestry, pulp and paper report 2011
Business logic of pulp and paper
Pulp,paperandfiber-basedpackagingcomprisesawiderangeofdifferentsub-businesses.Tissue,newsprintorliquidpackagingboardhaveverylittleincommon—exceptrawmaterials,productiontechnologyandinsomecasesalsoownership.However,therearemoreextensivesimilaritieswithinthemainproductgroups—forinstance,withinprintingandwritingpapersandpackagingboards.
NorthAmericaMature/decliningmarket•Restructuring•
LatinAmericaFibersourcing•Pulpsuppliesandinvestments•
Throughouttheseproductgroups,thefollowingfactorsarecommon:
Capitalintensity—biginvestments(for•instance,agreenfieldpulpmilltodaycostsaroundUS$1.2billiontobuild)areneededandthereforetheplanninghorizonislong.
R&Dandinnovationhasfocused•onincrementalratherthanradicalinnovation.Theemphasishasbeenonoperationalefficiencyandincrementalqualityimprovements,ratherthandevelopmentofentirelynewproductsandservices.
Typically,theseareintermediate•productsthatarefurtherconvertedorprinted—tissueandhygieneproductsaretheexception.
Lowlevelofconsolidation—thetop10•papercompaniescontrolonly25%ofglobalmarketshare.AlthoughthereareregionallyquiteconcentratedproductsegmentssuchasLWCinWesternEurope,manyotherindustriessuchasbeveragesortelecommunicationsarefarmoreconsolidated.
Cyclicality—duetothebiginvestments•required,productioncapacityisaddedinbigsurgesratherthanincrementallyandthisoftenleadstoimbalancesindemandandsupply.
Maturephaseoftheproductlifecycle,•meaninglowermarketgrowththanaverageGDPgrowth.Thisappliesmainlytodevelopedeconomies—thedemandgrowshealthilyinemergingmarkets.Thismeans,thatthemainproductgroupshavebecomecommoditized.
Regionalnatureofthebusiness—there•isrelativelylittleinter-regionaltrade,forinstance,betweenNorthAmericaandEurope.
Lowlevelofglobalization—veryfew•ofeventhebiggestcompanieshaveahighersharethan15%–20%ofsalesderivedfromoperationsoutsidetheirhomeregion.
TheforestindustryoverallhasaglobalturnoverofcaUS�500billion(includingsawngoods,whichmostoftheleadingcompaniesalsoproduce)—thisisabig,basicindustrywhoseproductsareusedbybillionsofpeopleintheireverydaylives.SomeoftheabovekeyfeaturesoftheindustryarehighlightedinFigures5and6.
Figure5showsperhapsthemaintrendthathasamajorimpactontheindus-try.MarketsinWesternEuropeandNorthAmericaarematureandundergoingheavyrestructuring,whereasespeciallyChinabutalsootheremergingmarketssuchasIndia,RussiaandEasternEuropearegrowing.
Fibersourcingisanotherkeydeterminant—SouthAmericancountriessuchasBrazil,ChileandUruguayareincreasinglytheworld’sfibersuppliersforhardwoodpulp,andsourcingoffiberisthemainlimitingfactorforgrowthandinvestmentsinChinaandIndia.Nordiccountriesstillretaintheedgeintechnology,duetosomeoftheworld’sleadingchemicals,machinery,automationandlogisticssuppliersaswellasmanypulpandpapercompaniesbasedintheNordics.
10 SustainingtherecoveryErnst & Young’s global forestry, pulp and paper report 2011
FIGURE5:Regionaldevelopmentphasesofthepulpandpaperindustry
Western/NordicEuropeMaturemarket•Restructuringunderway•Technologyleadership•
RussiaHugeconiferousfibersources•Sizablemarketpotential•Poorinfrastructure•Investmentsneeded•
ChinaHugegrowth•Limitedfibersources•Aggressiveinvestments•
IndiaBigpotential•Limitedowncapacity•Limitedfibersources•
Source:Ernst&Younganalysis
11SustainingtherecoveryErnst & Young’s global forestry, pulp and paper report 2011
Themarketsformostoftheindustry’sproductscontinuetogrowgloballyatahealthyrate,butthegrowthisunevenlydistributedbetweendifferentregions.Thisglobalpicture—withthegrowthinChinaandotheremergingmarkets,fiberfromSouthAmericaandtechnologyfromdevelopedeconomies—shapestheindustry’sfutureandcompaniesneedtothinkhowthisimpactstheirstrategies.However,thisdoesnotmeanthatallcompaniesshould,forinstance,trytoinvestinChinaorbuildapulpmillinSouthAmerica—theWesternmarketsarematurebutlargeandtheystillofferplentyofopportunities.
Tosummarizeabovekeyfeaturesofpulpandpaperindustry,Figure6showstheunderlyingfactorsthathaveledtotheunsatisfactoryfinancialperformanceofrecentyears.
AscanbeseenfromFigure6,lowprofitabilityisthecombinationofdecliningreal-termpriceswhichareinsufficienttooffsetrisingunitcostsandhighcapitalintensity.Decliningreal-termpricesareduetoovercapacity,commoditizationofproductsandcompetingsubstitution(especiallyelectronicmedia).Becauseofthecoststructureofpaperandboardproduction,onlyafractionofthecostsaredirectlyundermanagement’scontrol—forinstance,oil,chemicalsandfiberare
commoditiestradedaccordingtoworldprices.Highinvestmentrequirementsandlongsupplychainleadtohighamountofcapitaltiedupinensuringmodernandefficientproductionfacilitiesandworkingcapital.
Inouropinion,thewayoutofthisviciouscycleisbasedonacombinationoffactors,themostimportantofwhicharetheurgencyinthedevelopmentofnewproductsandservicesandincreasedconsolidationandgrowthinemergingmarkets,whilecontinuingthepursuitofcost-efficiencythroughoutalloperations.Obviously,thisisnoteasyanditrequirestime.
FIGURE6:Theunderlyingcausesofindustry’sprofitability
Profitability2002–09
ROCE -0%–5%• EBIT ~4%–5%•
Decliningrealprizes
Growth<GDP%
Printmedialosesmarketshare
Lowproductandserviceinnovation
Newpaperandpulpmills
Debottlenecking
Changingtradeflows
Strongunions
Traditionalmanagement
Persistingovercapacity
Electronicmedia
Productcommoditization
Consolidationincomplete
Inflexiblelabormarkets
Energy,fiber,chemicalsandtransport
Emergingmarkets
HighcapitalexpenditureandM&A
Lackofacultureofchange
Highnetworkingcapital
Oil,carbontrading
Focusonproductioneconomics
Focusongrowthandmarketshare
Longdistributionchainandforecastingdifficulties
Negotiatingpowerofcustomersandsuppliers
Increasingcosts
Capitalintensity
Source:Ernst&Younganalysis
12 SustainingtherecoveryErnst & Young’s global forestry, pulp and paper report 2011
13
“ToomuchfocusofR&Donproductionefficiencyandcostshaveledtothecommoditizationofproductsandservices.Newandinnovativeproductsareurgentlyneeded.”
13SustainingtherecoveryErnst & Young’s global forestry, pulp and paper report 2011
Becausetheindustryhas,toalargeextent,focuseditsR&Deffortsonprocessefficiency(ineffect,outsourcingR&Dtosuppliers)ratherthandevelopmentofentirelynewproductsandservices,itsmainproductshavebecomecom-moditized.ThisisshowninFigure7,andmostofthetraditionalpaperandboardproductsareinthematurelowerright-handquadrant,characterizedbylowentrybarriersandoversupply.
Inthissituation,onlycostsmatterandcustomersenjoyhighbargainingpowerwhichleadstodecliningprices,intensecompetitionandlowprofitability.Accordingtotheory,thereareonlytwowaysoutofthis—thedevelopmentofentirelynewproductsandrelaunchingthemoraradicallyre-engineeredcoststructure.Bothareverydifficultandtime-consumingtodointhisindustry.
TheIndustryhassincewokenuptothisreality,anditisactivelydevelopingnewproductssuchasbiofuelsandnano-fibers.Buttheircommercializationwillstilltakemanyyearsduetothepiloting,investmentsandotherrequirementsinaprocessindustrysuchasthis.Itmayseemsurprising,buttherecentdevelopmentsandcertainfeaturesofthepharmaceuticalindustryhavesomeinterestinganalogiestoR&Dinpulpandpaper—therefore,wedecidedtotakeacloserlookatbusinessinnovationintheglobalpharmaceuticalsector.
Insufficientconsolidationisoftencitedasoneofthemainreasonsfortheindustry’sproblems.Itistruethatmanyotherindustriesarefarmoreconsolidated,andbiggersizebringsmanybenefits—suchasmoreefficientproductioncontrol,lowerfixedcostsandbargainingpowertowardsuppliersandcustomers.However,manydistinctproductsegments,suchascoatedmagazinepapersinEuropehavebeenhighlyconcentratedformanyyears—yetthepricingpowerandprofitabilityhasbeenlow.Itremainstobeseenwhetherconsolidationcansubstantiallyincreasepricing,buttheaboveindirectbenefitsofhigherconsolidationaresignificantandtheindustryshouldcontinuetostriveforit.
FIGURE7:Commoditizationdegreeofmainpaperandboardproductgroups
Themostrecentexamples(aftermanyyearsofsloweractivity)oflargeM&AdealsareUPM-Kymmene’sacquisitionofMyllykoskiinEuropeandRock-Tenn’sacquisitionofSmurfit-StoneintheUnitedStates–bothdealsarestillpendingapprovalfromthecompetitionauthorities.Muchmoreneedstobedone,anditisawell-knownfactthatmostM&Adealsarenotsuccessfulingeneratingvalue.Also,inthepast,manylargeM&Adealsinthepulpandpaperindustryhavebeenunsuccessful.
Therefore,wedecidedtoanalyzewhatprivateequity(PE)firmsdodifferentlyincreatingvalue,acquiringanddivestinghundredsoffirmsannuallyandwhatcouldbelearnedfromthem.Contrarytopopularbelief,PEfirmsusuallyleavethecompanyinbetterconditionandcreatemorevaluebythetimeofexitthanatthetimeoftheactualdeal.
Duringrecentyears,thepaperindustryhasmadegreatstridesincost-efficiencyimprovements,and,inouropinion,this
isalsooneofthecriticalelementsinsustainingthepresentrecovery.Howeverpainfulthecostreductionsare,theymustbecontinuedinordertomaintainlong-termcompetitiveness.Despitethefactthatagreatdealhasalreadybeendone,therearestillareasthatcouldstillofferfurthercostreductionpotential,andsomeofthesearefacilitiesmanagement,supplychainmanagementandworkingcapital.Therefore,wedecidedtolookatthechallengesofimprovingworkingcapitalintheoilandgasindustry,aswellashowtoimprovefacilitiesmanagement.
Inouropinion,theareasthataremostcriticalforsustainingthepresentrecoveryareenhancedR&D,successfulgrowthandrestructuringthroughM&Aaswellascontinuedcostreductionsthroughoutoperations.Toassisttheindustryindevelopingtheseareasfurtherandtogainfurtherinsights,wethereforetakealookinthenextsectionsatthepharmaceuticalindustry,privateequity,oilandgasaswellasfacilitiesmanagement.
Growth
Maturity
Smartpackaging
NanofibersSecond-generationbiofuels
TissueFBB
LPB
WLC
WFCLWC WFU
KLB TLB
NBSKBHKP
Newsprint
Growingimportanceofcost-efficiency
FBB: Folding boxboardLPB: Liquid packaging boardWLC: White-lined chipboardWFC: Woodfree coatedWFU: Woodfree uncoated
Decline
Introduction
Growingimportanceofproductqualityandservice
KLB: Kraftliner brownTLB: Testliner brownNBSK: Northern bleached softwood kraft pulpBHKP: Bleached hardwood kraft pulpLWC: Light-weight coated paper
Source:Ernst&Younganalysis
14 SustainingtherecoveryErnst & Young’s global forestry, pulp and paper report 2011
15SustainingtherecoveryErnst & Young’s global forestry, pulp and paper report 2011
Business innovation in the pharmaceutical industry
Thepharmaceuticalindustryhastraditionallybeenoneofthemostprofitableindustriesintheworld.The“bigpharma”companieshaveexcelledinproducinghigherthanaveragereturnstotheirshareholders—manyofthemhaveglobalbrandsandtheyhaveenjoyedanexcellentreputationforcuringtheillnessesoftheworld.However,inrecentyears,allofthathasbeenchangingduetomajorchangesintheirbusinessenvironment.
Contrarytopulpandpaper,themostcriticalcorecompetencesofthepharma-ceuticalindustryhavebeenR&Dandbranding,whereas,inpulpandpaper,productionandlowcostshaveperhapsbeenconsideredmostimportant.Pharmaceuticalcompaniesspendbetween10%and15%oftheirturnoveronresearch,whereasthecorrespondingfigureinpulpandpaperis0.7%(notincludingthe2.5%–3.0%thechemicalsandmachinerysuppliersspend).Withtheexceptionoftissue,consumerbrandingisnotreallyimportantbecauseofthebusiness-to-businessnatureofmostpaperandboardgrades.Atfirstglanceitseemsthereisverylittleincommonbetweenthesetwoindustries.
However,theworldisconvergingandtherearestrikingsimilaritiesaswellasdifferencesinthebusinesschallengesbetweenthesetwoindustries.Firstofall,bothindustriescoverawiderangeofdifferentbusinesses:undertheumbrellaofpharmaceuticalindustrytherearethetraditionalblockbusterprescriptiondrugsfordiseasessuchasdiabetesandcancer,butalsopainrelief,skincare,animalhealth,vitamins,bandagesand
otherproductsthatresembleconsumerproducts—i.e.,anythingthatistypicallysoldinapharmacyshop.Similarly,pulp,paperandpackagingcomprisesmanydifferentsub-businesses.
Secondly,thecommercializationofnewproductstakesalongtimeinbothbusinesses—albeitfordifferentreasons.Regulatoryapprovalandtestingtakesseveralyearsbeforeanewdrugcanbesold,whereasinpulpandpaperanewproducttypicallyfirstneedstobepilotedtoensurethattechnologicalandcommercialrisksareminimizedpriortocommittingtoabilliondollarinvestmentinalarge-scaleplant—thisprocessalsotakesseveralyears.Forinstance,thedevelop-mentofsecond-generationbiofuelsisanexampleofpilotingrequirements.
Thirdly,bothbusinessesfaceconsiderableregulatoryscrutiny—pharmaforpatientsafety,pulpandpaperforenvironmentalandproductsafetyreasons.Forinstance,packagesthatareincontactwithfoodaresubjecttostringenthygienerequirementsandanewpaperorpulpmillmustcarryoutextensiveenvironmentalauditspriortogainingthenecessarypermits.
Lastly,andmostimportantly,thebusinessenvironmentsofbothindustriesareundergoingadramaticchange.Inpharma,thepatentsofmanywell-knownblock-busterdrugshaveexpired,andthishasopenedthedoorformanycheaperproducersbothinemerginganddevelopedmarkets.Pharmaceuticalcompanieshaverespondedbyaggressivelycuttingcostsandseekinggrowthintheemergingmarkets,wheretheyfaceconsiderablechallengesduetodifferencesinregulation,distribution,piracyetc.Atthesametime,theyareurgentlytryingtodiversifyanddevelopnewproductsthatwouldfillthenewdrugs’pipelinevacuumandbeprotectedunderpatentrights.Inother
words,thestaplecashcowproductshavenowbecomecommoditized.
HealthcaresystemsareunderintensepressureforreducedcostsanddifferentreformsareinitiatedbygovernmentsbothintheUSandothercountries.TheUShealthcarereformisthemostextensiveinthecountryfordecades,anditchangesthetraditionalrolesthathealthinsuranceandpharmacompanieshaveplayedinthepast.InGermany,theparliamentpassedabillinNovember2010,whichpermitspharmacompaniestofreelypricetheirnewpatent-protectedproductsonlyforthefirstyearafterlaunch—afterthattheywillhavetonegotiatepriceswiththehealthinsurancefunds.Similarinitiatives—allaimedatreducinghealthcarecostsandimprovingpatientoutcomes—havebeenlaunchedinItaly,theUK,FranceandJapan.
Atthesametime,newplayersareencroachingonthetraditionalterritoryofthepharmacompanies.Bigretailchainsandconsumerproductscompaniesarealsoincreasinglysellinghealthcareproductsandchallengingthetraditionaldistributionviapharmacychains.Newtechnologysuchaselectronichealthrecordsandmedicaladviceviainternetservicesarechangingthetraditionalbusinessmodels.Newmobileservicessuchasremindingpatientsviatextmessagestotaketheirdiabetesmedicineandvaccinationsattheprescribedtimesarebecomingavailable.Manytechnologyandtelecommunicationsfirmsarein-creasinglyinvestinginmedicaltechnologyandservices.Allofthismeansthatthetraditionalbusinessmodelofpharmaisrapidlychangingandbecomingfarmorecomplex.Previously,themaincustomerandfocusofmarketingwasthephysician—thishasnowshiftedtowardthepatient.Figure8outlinesthenewbusinessenvi-ronmentofthepharmaceuticalindustry.
16 SustainingtherecoveryErnst & Young’s global forestry, pulp and paper report 2011
FIGURE8:Thechallengesandimpactsofchangesinthepharmabusinessenvironment
Thescience
R&Dproductivity
Personalizedmedicine
The customer
Globalization
Customerredefinition
The offer
Productsvs.services
Buildingbrand
Thepeople
Talentpipeline
Celebratingdiversity
The
organizationEnterprisevs.extraprise
Alternativebusinessmodels
The
value createdReturnvs.revenue
Financialstrategy
Riskmanagement
Impactofchange
PatentsPricingpressureCompliancecommitments
R&DproductivityCommercialstructureCustomerrelationships
ReducedgrowthMarginssqueezedReputationindecline
Source:Ernst&Younganalysis
17SustainingtherecoveryErnst & Young’s global forestry, pulp and paper report 2011
Thebusinesssituationsofbothpharmaandthepulpandpaperareinrealityquitesimilar.Pulpandpaperindustryhasalsobeenforcedtoaggressivelycutcostsanditisincreasinglyinvestingintheemergingmarkets.Theindustryisalsofacingachallengefromcompaniesoperatingintheemergingmarkets,whichareinvestingheavilyespeciallyinChina.Newtechnologysuchastabletcomputersanddigitalmediaareencroachingonthetraditionalstapleproductssuchasnewsprintandprintingandwritingpapers.Andjustaspharma,theindustryisveryactivelytryingtodevelopnewproductssuchasbiofuelsandnanofiberstofillthegapandreducecommoditization.
However,therearesignificantdifferencesintheresponsesthetwoindustries
aretaking.Theevolutionofthepharmaceuticalindustry—fromtraditionalso-calledPharma1.0tothecurrentPharma3.0isshowninFigure9.
Althoughthechallengesthetwoindustriesfaceareandhavebeenquitesimilarformanyyears,theyareindifferentphasesofdevelopment.ThepharmaceuticalindustryisrapidlymovingtowardPharma3.0byadaptingtothenewenvironmentandembracingnewbusinessmodelsandtechnology.AccordingtoErnst&Young’sanalysis,between2006and2010,pharmaceuticalcompanieslaunchedatotalof220Pharma3.0relatedinitiativesand97ofthosewerelaunchedin2010.Theseincludedsmartphoneapplications,socialmediapromotion,useofelectronichealthrecords,technologypartnerships,
acquisitions,openinnovationconceptsandredesignedorganizationalstructuresandbusinessmodels.Atthesametime,pharmacompaniesaredevelopingnewtraditionaldrugsandimprovingcost-efficiency.
Itseemsthat,whereasthepharmaceuticalindustryisrapidlyembracingPharma3.0,thepaperindustryisstillundergoingthephasethatbetterresemblesPharma2.0.Despitethesubstantialdifferencesintheactualbusinesses,consideringthatthechallengesofthetwoindustriesareverysimilar,adeeperstudyofwhatthepharmacompaniesaredoingwouldbeworthwhile.Themainquestionis:aretherenewwaystoconfigurethebusinessandmovetowardtheenduser?
FIGURE9:TheevolutiontowardPharma3.0
Drivers of change
Business modelsValue proposition
Customer
R&Dproductivity•Patentcliff•Globalization•Demographics•Pricing&reimbursement•
Healthcarereform•HealthIT•Consumerism•Valuemining•
Pharma 1.0Blockbusterdrugs
Pharma 2.0Diversifieddrugportfolios
Pharma 3.0Healthyoutcomes
PhysicianPayor
Patient
Source:Ernst&Younganalysis
18 SustainingtherecoveryErnst & Young’s global forestry, pulp and paper report 2011
Learningsfrompharma
Challengethecurrentbusiness•modelsandtheirrelevanceinthenewenvironment
ReviewcurrentR&Dandtechnology•strategiesandinvestmentlevels
Considershiftingthefocusincreasingly•totheenduser,ratherthanthecurrentintermediaries—merchants,printers,publishersandpackagingfirms
Useofnewtechnologytoaccess•theconsumer—thewebcanalsobeanopportunity
Collaborationandpartnershipswith•printersandpublisherstodefendagainstelectronicmedia
19SustainingtherecoveryErnst & Young’s global forestry, pulp and paper report 2011
SincethedevelopmentofthePEbusinessmodelinthe1980s,PEfirmshavecarriedoutthousandsoftransactions,manyofthemsuccessfully.Mostlikely,thePEindustryhasaccumulatedfarmoreexperienceandknowledgeoftransactionsthananyotherindustry—buying,increasingvalueoftheacquiredcompanythroughimprovedoperationsandthensellingit,istheircorecompetence.Figure10showshowtheglobalM&Amarketin2010wastoalargeextentdrivenbyPEfirms.
Contrarytopopularbelief,PEfirmsusuallyleavethebusinessinbetterconditionwhentheyeventuallyexit.
WhatisitthenthatPEfirmsdodifferentlycomparedtopubliccompanies?AccordingtoErnst&Young’sresearch,PEfirmscarryouttransactionsaccordingtothefollowingcornerstones:
Veryextensivebackgroundresearch•insectorandtargetselection
Private equity — excellence in M&A
Thoroughduediligenceandriskanalysis•
Carefulselectionofthemanagement•team
Attractiveincentiveschemestoensure•thebesttalentforrunningthebusiness
Highemphasisonpost-merger•integrationandoperationalimprovements
Carefulplanningoftheexit,whichis•oftenconsideredpriortotheacquisition
Accordingtoourexperience,themaindifferencesintheM&AapproachesbetweenPEfirmsandpublicfirmsisthatPEfirmsemphasizeandputalotmoretimeandeffortinboththepre-studyandpost-mergerphasesofthetransaction.Forinstance,accordingtoErnst&Young’sanalysisofexitsdealsin2009inEurope,60%ofthetargetshadbeenanalyzedindepthbeforethestartoftheformaltransactionprocess,and75%ofthemostsuccessfuldealshad
beenthoroughlyanalyzedmorethansixmonthsinadvance.Asaresult,thefirmshadthetimetocarefullyanalyzetheindustry,thetarget,itsmanagementandimprovementpotentialwellaheadoftheactualnegotiations.ThereisnothingreallymysticalorextraordinaryaboutthesuccessofPEfirmsintransactions—theyaresimplymorethorough.ThisisillustratedinFigure11.
Publicfirms—forwhomM&Aisnotacorecompetence—focusonrunningtheexistingbusiness.However,consideringthatM&Aislikelytobetheprimarygrowthvehicleinpulpandpaper,andespeciallyinthematureNorthAmericanandEuropeanmarketswhereorganicgrowthismorelimited,companiescouldlearnfromthepracticesofPEinordertomakemoresuccessfulacquisitionsanddisposals.
FIGURE10:Globaltransactions
GlobalM&Aactivity1 200
1 000
800
600
400
200
0
1,000
2,000
3,000
4,000
5,000
6,000
7,000
8,000
9,000
10,000
2003 2004 2005 2006 2007 2008 2009 2010
0
Value (€b) Number of deals
GlobalPEdeals300
250
200
150
100
50
0
100
200
300
400
500
600
700
800
900
2003 2004 2005 2006 2007 2008 2009 2010
0
Value (€b) Number of deals
Source:Bloomberg
20 SustainingtherecoveryErnst & Young’s global forestry, pulp and paper report 2011
FIGURE11:DifferentapproachesinM&Atransactions
Resources
Illustrative
- 6 months Acquisition + 6 monthsPre-studyandtargetselection
Exitplanning
PE
Public
DuediligenceValuation&offer
IntegrationActiveownership
Source:Ernst&Younganalysis
21SustainingtherecoveryErnst & Young’s global forestry, pulp and paper report 2011
Thepulpandpaperindustryisinmanywayssimilartotheoilandgasindustry.Botharebig,basicindustriesbasedonusingnaturalresources—ofteninremoteandchallenginglocations—andonconvertingtheseresourcestomeetultimateconsumerneeds.Bothindustriesarealsoverycapitalintensiveandhighlycyclical—oilandpulppricesareveryvolatile.
Also,bothindustrieshavealongsupplychaintoservetheultimateconsumer,andthistiesupalotofworkingcapital.Thetwoindustriesarealsoconverging,asmoreandmorepulpandpapercompaniesinvestinsecond-generationbiofuelsandmanyofthemhavesetupjointventuresandstrategicpartnershipswithoilcompanies.Therefore,wedecidedtocomparethetwoindustriesandinparticulartheirworkingcapitalperformanceandpractices.
Oilandgasisalsoahighlydiverseindustry.Somecompaniesfocusonlyon
Cash in the barrel — working capital management in oil and gas
refiningandmarketing(R&M),othersinexplorationandproduction(E&P)andsomearefullyintegratedproducers.Somecompaniesareonlynaturalgasproducersoroilfiedservicesproviders,whereasthebiggestcompaniesareusuallyfullyintegratedproducersofbothoilandgas.Criticalsuccessfactorsareaccesstooilandgasreserves,useofhightechnologyindrillingandmarketinganddistribution.
AccordingtoarecentErnst&Youngstudy(Cash in the barrel,2010),manyoilandgascompaniesarenowrealizingtheimprovementpotentialthatmoreefficientmanagementofworkingcapitaloffers.Table1showstheindustry’saverageperformanceininventories(DIO),accountsreceivable(DSO)andaccountspayable(DPO)andthecash-to-cashcycle(C2C).
ThetotalC2Cdaysvariessignificantlybetweendifferentsegments,withtheindustryaveragebeing32days.Oilfieldservicessegmenttypicallyoperatesonlong-termcontractbasis,andthisisreflectedinthehigherC2Cdays.Theintegratedproducers—whichareperhapsmostcomparablewithpulpandpaper—haveonaverage30daysofworking
TABLE1:Workingcapitalvariationsbysegment
capitaltiedupintheirsupplychain.Thisissignificantlybetterthaninpulpandpaperwhich,basedonanErnst&Youngstudy(Managing the bullwhip effect,2010),averaged50daysin2009.Figure12showstheresultsofthepulpandpaperindustry.
Thebigdifference—30daysvs.50days—seemssurprising,consideringthesimilaritiesbetweenthetwoindustriesdiscussedearlier.ThemaindifferenceisinDSO,whichaverages36daysfortheintegratedoilproducersand50daysforpulpandpaperindustry.Thisismostlikelyattributabletoretaildistribution,throughwhichoilcompanieshavedirectaccesstotheultimateconsumer.However,thebetterpaymenttermsviadistributionaretoalargeextentcompensatedbyhigherinventoryrequirements.
Despitethebetterperformance,manyoilandgascompanieshavenowrealizedthatworkingcapitalstilloffersasubstantialimprovementpotentialofseveralbilliondollars.Theoldcultureof“justgettherigupandrunningandkeepitrunning”ischanging.Figure13outlinesalistofcashimprovementlevers,whichmanyoilandgascompaniesarenowconsidering.
DSO: days sales outstanding DIO: days inventory outstanding DPO: days payable outstanding C2C: cash-to-cash, with metrics calculated on a sales-weighted basis.*FIFO
Industry Integrated IndependentE&P IndependentR&M Oilfieldservices
DSO 37 36 62 21 67
DIO* 32 30 13 42 61
DPO 37 36 68 31 31
C2C 32 30 7 32 97
Source:Ernst&Younganalysis,basedonQ42009publiclyavailablefinancialstatements.
22 SustainingtherecoveryErnst & Young’s global forestry, pulp and paper report 2011
FIGURE12:Theworkingcapitalcomponentsofthepulpandpaperindustry
High
Average
Low
0 25 50 75 100 125 150 175
Days of sales outstanding
Days of inventory outstanding
Days of payablesoutstanding
Source:Ernst&Younganalysis
23SustainingtherecoveryErnst & Young’s global forestry, pulp and paper report 2011
Workingcapitalrepresentsasignificantimprovementpotentialalsoforpulpandpaper,andmanycompanieshaveduringrecentyearssteppeduptheirefforts.AscanbeseenfromFigure12,therearemajordifferencesbetweendifferentcompanies—35daysvs.74daysinC2C.Someofthekeyissuesinperformanceimprovementinpulpandpaperaremakingsurethatcorrectmetricsandincentivesareinplace,improvementofsupplychaintransparencyandtheuseofintegratedandmodernforecastingtechniques.Significantefficiencyimprovementsarepossible,buttheyrequirecontinuouseffortsandtopmanagementownership.
Thesearenowmorewidelybeingadoptedinoilandgas.
Sometimesthisalsorequirestrade-offs—tighterinventorymanagementmaymeanlossofsomebusinessanddelayingpaymentsmayresultinadditionalcostsintheformofpenaltiesetc.However,thiscanalsobeconsideredasanoptimizationproblemandacost-benefitanalysisofsignificantlytighterworkingcapitalpolicycouldbeveryuseful.Atleastthenmanagementcanmakeaconscientiousbusinessdecisionregardingpossiblyhigherlevelsofworkingcapitalthancompetitors.
Althoughtherearesimilaritiesbetweenthetwoindustries,thereareobviouslyalsofundamentaldifferences.Onecannotdirectlybenchmarktheperformancebetweenanoilcompanyandapulpandpapercompany.However,managementpracticesandsystemscanbecomparedandperhapstherearesomeareaswherethepulpandpaperindustrycouldlearnfromoilandgas—especiallythosecompaniesthatarecollaboratingwiththeoilindustryandinvestinginbiofuels.Inouropinion,workingcapitalstillofferssignificantimprovementpotentialinpulpandpaper.
FIGURE13:Cashimprovementleversconsideredintheoilandgasindustry
Oilfield servicesR&ME&P
Strategicplanning Demandforecasting
Productionschedulingandsupplychainplanning
Facilitiesmaintenancescheduling
Outsourcing
Collaborationacrosstheextendedenterprise
Managementofproduction/serviceagreementsandcontracts
Effectivemanagementofpaymenttermsforcustomersandsuppliers
Managementofexciseduties
Managementofroyalties
Speedandaccuracyofbillingandcashcollections
Appropriatemeasuresandincentivesforcashimprovement
Paymentdeferrals
Collectionspushviadiscounts
TimelybillingTactical
Opeartional
Structural
Sourcingandfulfillmentstrategies
Source:Ernst&Younganalysis
24 SustainingtherecoveryErnst & Young’s global forestry, pulp and paper report 2011
Nearlyallofthebiggestpulpandpapercompanieshavelaunchedmajorcostreductionandperformanceimprovementprogramsduringrecentyears.Allthemaincostitems—personnel,supplychain,purchasing,chemicals,energy,finance,IT,salesandadministrativecosts—havebeenreviewed,benchmarkedandreducedwherepossible.Companieshaveestablishedsharedservicecentersformanyfunctionsandoutsourcedsomenon-corefunctions.Manyexecutivesmayfeelthatthewellisdryingupandadditionalcostreductionsareincreasinglydifficulttoachieve.
However,facilitiesmanagementisanareathatmostpulpandpapercompanieshavenotyetfullyconsidered.Costssuchassecurity,catering,officesupplies,switchboard,clothinghandling,buildingmaintenanceandcleaningareoftenoverlooked,becauseassingleitemsthecostsaresmall.Ifacompanyhas,forinstance,15–20productionsites,20–30salesofficesandregionalheadofficesinseveralcountries,thesesmallstreamsbecomeaformidableriverwhentheyarebundledtogether.Althoughmostpulpandpapercompanieshaveoutsourcedthesefunctions,thathasmostlybeendoneonalocalanddecentralizedbasis.Figure14showstheimprovementpotential.
AscanbeseeninFigure14,accordingtoourexperience,thetotalfacilitiesmanagementcostsareashighas€4,000perfull-timeemployeeandeven15%-40%ofcostscanbetakenout.Thisobviouslydependsonacomprehensivereviewofcurrentcosts,servicelevelsandserviceproviders.Basedonthereviewthescopeandmethodologyforcostreductionscanthenbedefined.Thisisbecomingmoreandmorecommoninmanyotherindustries,butsofarnotinpulpandpaper.Consideringthesignificantcostsinvolved,improvedfacilitiesmanagementoffersoneadditionalareaforfurtherimprovementpotentialinbothindustries.
INSERT: Reducing costs and improving performance through facilities management
FIGURE14:Costreductionpotentialoffacilitiesmanagement
Numberof:Suppliers•Middlemanagement•Operativeemployees•Differentservicelevels•ITsystems•KPIs•Projects•
Improvementpotential:1%–10%
During2006–09anaverageof22.5%wasachievedincostreductioninFMprojectsdeliveredbyErnst&YoungintheNordics.Onaverage,FMcostsareEUR/FTE4,000.
Improvementpotential:10%–20% Improvementpotential:15%–40%
Volumediscounts•Synergiesbetweenservices•
=Site/building =Service
Source:Ernst&Younganalysis
25SustainingtherecoveryErnst & Young’s global forestry, pulp and paper report 2011
What does the future look like?In2007Ernst&Youngconductedamajorsurveyonthemostcriticalissuesandfuturedevelopmentofthepaperindustry.Alothaschangedsincethen,andwedecidedtoupdatethesurveytoseewhatthosechangesareandwhattheoutlookoftheindustrynowis.
Methodology
Altogether,36interviewsinninecountrieswerecarriedoutin2007—UnitedStates,SouthAfrica,Finland,Sweden,Germany,France,GreatBritain,IndiaandChina.Thistime,wedecidedtoupdatethisonasmallerscale—themainemphasisbeingonverifyingthemostimportantchangesandwhattheoutlooknowseemstobe.
DuringJanuary—March2011,altogether25interviewswereconductedusingastandardweb-basedquestionnairetemplateinUnitedStates,Canada,Brazil,Sweden,Finland,Russia,France,GreatBritain,SouthAfrica,IndiaandChina.Anumberofinterviewswerealsocarriedoutfacetoface.Thequestionswerethesameasin2007,withonemajorexception:weaddedasectiononcost-efficiencymeasuresthatcompanieshadimplemented,wereintheprocessofimplementingorwereplanning.
Intervieweesrepresentedthetopmanagement(forinstance:CEO,CFO,headofstrategyandheadofbusinessdevelopment)ofpulpandpapercompanies,itssuppliers,customersandanalysts.Theintervieweeswereaskedtorankinorderofimportance(1:littleornoimportance,5:veryimportant)altogether70questionsrangingfromconsolidation,R&Dspendingandcorecompetencestoenvironmentalissuesandrisks.
Mainresults
Theresultsandhowtheviewpointshavechangedbetween2007and2011areshowninFigures15–25.
TheresultsdepictedinFigures15–25aresummarizedinthefollowing:
Demandandsupplyimbalance1.continuestobetheindustry’snumber1worry.Bothin2007and2011,thescorewas4.4,indicatingthatdespitesignificantcapacityclosures,overcapacitycontinuestobeamajorconcern.Thesituationobviouslyvariesbetweendifferentproductgroupsandgeographies,butthemostsevereovercapacitypersistsinfinepapers,magazinepapersandnewsprintinNorthAmericaandWesternEurope.
Electronicmediaanditsimpacton2.certainpapergradesisalsoamajorconcern.In2007,thisreceivedsurprisinglylowscores(2.9)whereasnowitscored4.0.In2007,forinstance,digitaladvertising’sshareoftotaladvertisingspendingwasclearlybelow10%,whereastodayitis13%.(ZenithOptimedia,2010).Since2007,tabletcomputingandonlinenewspapershavesignificantlyimpactedthewaypeopleconsumemedia,anditislikelythatthistrendcontinues.
Energycostshavealsoincreasedtheir3.rankingasachallengetotheindustry.Priceofoilhasrecentlyincreasedsubstantially,theturmoilinArabcountriesandJapan’snuclearpowerplantcrisishasundoubtedlyhadanimpactonthis.
Industryconsolidationisexpected4.tocontinue.Nearly90%oftherespondentsstatedthattheyexpect
thecurrentleveloftop10capacitysharetoincreasefrom25%to30%orabove.Themostimportantdriversforincreasedconsolidationareexpectedcostsavingsfromeconomiesofscale,improvedproductfocusandmarketshareaswellasgeographicdiversifi-cation.Itshouldbenotedthatregion-ally,andwithinspecificgrades,theindustryisalreadyhighlyconsolidated—forinstance,inLWCinEurope.
Similarly,useofwoodforbioenergy5.wasnotperceivedtobeamajorchallengetotheindustryin2007(scoringonly2.8),whereasnowthisisconsideredfarmoreserious(scoring3.7).
Therehavebeennomajorchanges6.intheestimatedgeographicgrowthpatterns.ChinaandIndiaareconsideredtogrowrapidly,whereasNorthAmericaandWesternEuropearematuremarkets.
Carbontradingandclimatechange7.continuetoremainontopoftheagendaforenvironmentalissues.Therehasbeenlittlechangeintherelativeimportancebetween,forinstance,illegalloggingorbiodiversityconservation.
Woodandfiberavailabilityhavebe-8.comemoreseriousissuessince2007.Nowthesescored4.0,where-asin2007,thecorrespondingfigurewasonly3.6.IncreasinguseofwoodforenergyandtheexporttariffsforroundwoodimposedbyRussiaaremostlikelysomeofthemainreasons.
Costreductionsremainveryhighon9.theagendaoftheindustryexecutives,ratingagain3.8.Figure24showsthedifferentcostreductioninitiativescompanieshaveimplementedorareeitherinprocessofimplementing
26 SustainingtherecoveryErnst & Young’s global forestry, pulp and paper report 2011
orareplanningtoimplement.Forty-twopercentoftherespondentsstatedtheyhavealreadyclosedtheiruncompetitiveunits,while58%werestillinprocessorplanningthis.Mostcompanies(73%)havealreadymadepainfulheadcountreductions,whiletheremaining27%areintheprocessofdoingthis.Ninetypercentareintheprocessofcarryingoutregularinternalandexternalbenchmarkingand47%areincreasinglycentralizingsourcing.Only44%statedthattheyhaveachievedsignificantreductionsinworkingcapitalwhereas56%areintheprocessofimplementingthis.Sharedservicecentersforfinanceandpayrollarealreadyfairlywidelyinuse,with69%statingthesehave
beenimplementedandtherestareinprocess.InsharedservicesforIT,thefiguresareslightlydifferent—with53%fullyimplementedand47%inprocess.Thesefiguresshowhowextensivelyandseriouslytheindustryistakingcost-efficiency.However,theyalsoindicatethatthereisstillpotential,asmanyoftheseinitiativesarestillinprocess.Thesesameissueswerenotaskedin2007,sowecannotdeterminewhathasactuallychanged.
Asin2007,overwhelmingmajority10.oftherespondents(86%)statedthattheindustryneedstospendsubstantiallymoreinR&D.WorriesaboutnewproductdevelopmentandR&Dfundinglevelshavenotabatedduringthepastfouryears.Thisis
asignificantmessagetoindustryleaders,anditneedstobetakenseriously.
Themostcriticalcompetencesfor11.futuresuccessare(inthisorderofimportance)understandingofemergingmarketcultures,assetmanagement,newproductdevelopment,improvedbusinessfore-castingandM&Acapabilities.In2007,themostcriticalareawasclearlyassetmanagement,sothishastoacertainextentchanged.Outsourcingandenterpriseresourceplanningsystemsreceivedthelowestscores.Perhapsthisslightchangeinprioritiesisduetoincreasedglobalizationduringthepastfouryearsandtheneedformanycompaniestogrowintheemergingmarkets.
FIGURE15:Whichofthefollowingtrendsdoyouseeshapingtheindustryoverthenextfiveyears?
5=verysignificant,1=noimpact2007 2011
3.43.5
2.93.0
3.63.9
3.74.3
2.83.7
3.63.9
2.94.0
High energy costs continue to persist
Consolidation of paper producers continues
Production capacity in North America and Western Europe falls significantly and is increasingly displaced by capacity in emerging markets
Real-term prices continue to fall
Consolidation of customers continues
Electronic media increasingly displaces printed media
Use of wood for bioenergy
”Electronicmediaanduseofwoodforbioenergyhavenowbecometopconcernsoftheindustry.”
27SustainingtherecoveryErnst & Young’s global forestry, pulp and paper report 2011
”Chinaremainsthemostattractivemarketintermsofbuildingnewcapacity,withIndiaalsogainingground.”
FIGURE16:Howwouldyouestimatethenewpulpandpaperproductioncapacitygrowthoverthenextfiveyearsinthebelowregions?
5=stronggrowth,1=nogrowth
4.6
3.7
3.6
3.2
3.1
2.3
2.2
1.6
1.3
4.7
4.0
3.8
3.4
3.0
2.3
2.4
1.2
1.2
2007 2011
China
India
Latin America
Russia
Eastern Europe
Rest of the world
South Africa
Western Europe
North America
FIGURE17:Whichofthefollowingenvironmentalissuesdoyouconsiderasthemostrelevanttotheindustry?
5=highrelevance,1=norelevance2007 2011
3.43.6
3.23.7
3.7
3.8
4.63.8
3.73.2
3.0
3.2
Kyoto and carbon trading
Illegal logging
Transportation
Forest certification
Increased recycling
Biodiversity conservation
28 SustainingtherecoveryErnst & Young’s global forestry, pulp and paper report 2011
”Despitesignificantcapacityclosuresduringthepastfouryears,demandandsupplyimbalanceremainsthemainproblem.”
FIGURE18:Whichofthefollowingissuesyouconsiderarethemostimportantfacingtheindustrytoday?
5=veryimportant,1=notimportant2007 2011
3.83.7
3.64.0
3.93.8
4.44.4
4.24.3
3.4
3.4
3.3
3.3
3.0
2.9
2.9
2.7
2.7
3.8
3.7
3.9
3.4
3.1
2.9
2.9
3.3
2.8
Demand/supply imbalance
Rise of the emerging market capacity
Cost reductions
Improved customer focus
Wood and fiber availability
Electronic media
Insufficient consolidation
Developing higher added-value products and services
Lack of attractiveness to the capital markets
Poor image of the industry
Funding for R&D
Improved product focus
Currency fluctuations
Availability of skilled personnel
FIGURE19:Whichofthefollowingrisksdoyouconsiderthemostimportantfortheindustry?
5=verysignificant,1=norisk2007 2011
2.52.8
2.02.3
2.93.2
3.53.5
3.33.2
Investment and project risks
Country and political risks
Foreign exchange
Technology and know -how security
Fraud
29SustainingtherecoveryErnst & Young’s global forestry, pulp and paper report 2011
”91%ofrespondentsexpectconsolidationdegreetosomewhatincreaseduringthenextfiveyears.”
”86%ofrespondentswantsignificantlymoreR&Dspending.”
FIGURE20:Currentlythe10biggestproducershaveaglobalmarketshareofca25%.Atwhatleveldoyouanticipatethistobeinfiveyears?
3%
0%
4.5%
0%
6%
62%
9.1%
29%27.3%
59.1%
2007 2011
30%
40%
Current level
50%
Other
FIGURE21:Whatdoyouconsiderthemostimportantdriversforincreasedconsolidation?
5=noimportance,1=veryimportant2007 2011
3.12.8
3.1
2.8
2.7
3.2
2.6
3.2
3.53.1
4.04.1
3.64.0
Cost reductions from economies of scale
Product focus and market share
Geographic diversification
Customer consolidation
Reduced risks
Product diversification
Supplier consolidation
Figure22:Currentlytheindustryisspendingonaverage0.7%ofturnoveronR&D.Additionally,machineryandchemicalssuppliersspendca2.5%.WhatleveloffutureR&Dspendingdoyouthinkwouldbemostappropriatefortheindustry?
2007 2011
12.5%
3.1%
0.0%
4.8%
14.3%
23.8%
9.5%
4.8%
18.8%
34.4%42.9%
31.3%
< 0,7% of turnover
0,7% of turnover
0,7—1,0% of turnover
1,0—1,5% of turnover
1,5—2,5% of turnover
> 2,5% of turnover
30 SustainingtherecoveryErnst & Young’s global forestry, pulp and paper report 2011
FIGURE23:Whichofthefollowingcostreductionandperformanceimprovementmeasuresyourcompanyhasrecentlyfullycompleted,isintheprocessofimplementingorisplanningtoimplement(onlypulp&paperrespondents):
Issue (% of respondents) Ready In progress Planned
Closure of uncompetitive capacity 42.1 36.8 21.1
Significantly reduced headcount in sales and administration
72.7 27.3 0.0
Regular internal and external benchmarking 11.8 64.7 23.5
Centralizing and rationalizing sourcing 53.3 40.0 6.7
Substantial improvements in working capital efficiency
44.4 55.6 0.0
Sales/lease-back arrangements 54.5 27.3 18.2
Shared service centers in IT 53.3 46.7 0.0
Shared service centers in finance and/or payroll 69.2 30.8 0.0
Outsourcing non-core activities such as facilities management
46.2 30.8 23.1
Other — please specify
Asset management
New service solutions
Better demand planning and forecasting
Risk and project management
Understanding of emerging market cultures
Outsourcing agreements
New product development
M&A capabilities
Enterprise resource planning systems
eCommerce solutions
FIGURE24:Whichspecificcompetencesandcapabilitiesdoyouthinktheindustryneedstoimprovefurtherinordertosucceedinthefuture?
5=veryhighimportance,1=noimportance2007 2011
3.8
4.3
2.7
4.2
3.7
3.4
3.5
4.0
3.8
4.0
3.7
3.83.8
3.73.1
3.6
3.6
3.4
3.0
2.9
”Despitemajorimprovementsinrecentyears,significantcostreductionpotentialinmanyareasstillexists.”
”Emergingmarketcultures,assetmanagement,newproductdevelopmentandimproveddemandforecastingarenowthetopfourfuturecompetences.”
31SustainingtherecoveryErnst & Young’s global forestry, pulp and paper report 2011
Whathaschangedinfouryearsandwhatdoesthefuturelooklike?
Basedonoursurveysin2007and2011,anumberofchallengesandissuesfacingtheindustryhaveremainedthesame—whereassomeothershavemovedtotheforefrontoftheagenda.Themainpointsaresummarizedinthefollowing:
Despitefouryearsofpainfulcapacity•reductions,demandandsupplybalancestillremainsthenumberoneconcernoftheindustry.Unfortunately,moreneedstobedone.
Therestillexistssignificantcost•reductionpotentialinmanyareas.
Electronicmediaandfibreavailability•aswellasrisingenergycostshavenowrisentotheforefrontofindustry’schallenges.
Keycompetencesforfuturesuccessare•assetmanagement,understandingofemergingmarketcultures,newproductdevelopmentandimproveddemandplanningandforecasting.
Respondingtothesechallengesrequiresthatcompanieshavetherightgovernancestructures,processesandmanagementandreportingtoolsinplacetosupportdecision-makingandimplementation.
32 SustainingtherecoveryErnst & Young’s global forestry, pulp and paper report 2011
33SustainingtherecoveryErnst & Young’s global forestry, pulp and paper report 2011
Manyissuesfacingtheindustryhaveremainedthesameduringthepastyears,whereassomehavemovedtotheforefront.Thepulpandpaperindustryhasdefinitelyturnedthecornerduring2010andinverychallengingcircumstances.Profitabilityhasclearlyimprovedand2011islikelytobeanothergoodyear,providedthatthestillfragileworldeconomydoesnotderailthefavorableoutlook.
Althoughmanyotherindustriesstudiedinthisreportarestillmuchmoreprofitablethanpulpandpaper,in2010,theindustrysignificantlyreducedthegap.However,whilethefinancialresultsof2010areencouraging,onlyoneyearofreasonableprofitabilityaftermanyyearsofpoorprofitsdoesnotyetconstituteasustainedrecovery.Inouropinion,theindustrymustcontinuethemanymeasuresalreadyundertakenduringthelastyearsandensurethatthereisnorelapse.
IntheErnst&YoungprogramCompeting for growthweoutlinedwhattheleadingcompaniesaredoinginordertoreturntoprofitablegrowthafterthefinancialcrisis.Theseareenhancedcustomerreach,improvedoperationalagility,cost-effectivenessandensuredstakeholderconfidence.Inmanyways,thesealsoapplytothepulpandpaperindustry.Theemergingmarketsgrowrapidlyandthemature—butlargeanddiverse—Westernmarketsstilloffersignificantpocketsofgrowth.Maintainingcost-efficiencymustcontinuetobeontopoftheindustryleaders’agenda.
Sustaining the recovery in pulp and paper
Operationalagility—intheformofrapidlyadjustingsupplytodemandandtakingadvantageofnewopportunities—isalsoveryimportant.Duetocapitalintensityandthetraditionoflongplanninghorizons,decisionsinthisindustryhaveoftenbeenmadeonlyafteraverythoroughandlengthyanalysis.Inthe“NewNormal,”thisveryprudentandcautiousapproachisnolongerpossible—theworldhasbecomemuchmoreturbulentandthereforedecisionswillneedtobemadefaster.Thisplacesadditionaldemandsonseniormanagementandtherighttools,processesandgovernancestructureshavetobeinplacetofacilitatespeedydecision-making.
Reassuringstakeholderconfidenceisequallyimportant.Thefinancialcrisisrockedtheconfidenceofinvestors,regulatorsandotherstakeholdersthroughoutdifferentindustriesandregions.Restoringconfidenceisextremelyimportant,andthiscertainlyalsoappliestoanindustrysuchaspulpandpaper,whichhassufferedfrommanyyearsofconsistentlowprofitability.Thebestwaytorestoreconfidenceistosustainthepresentrecoverytocontinuedandhealthyprofitability.
Manyofourcustomershavebeeninterestedtoknowhowotherindustriesaretacklingthefinancialcrisis.Inthisreport,weprovidedsomeinsightsonissuesthatwefeltweremostcriticalfortherecovery:businessinnovationandR&D,successfultransactionsandcost-efficiencythroughworkingcapitalimprovementandfacilitiesmanagement.Inouropinion,thepulpandpaperindustrycouldlearnfromthepharmaceutical,privateequityandoilandgassectors—however,itmustbestressedthateach
industryhasitsowncharacteristicsanditisimpossibletosimplytransferthesepracticesfromoneindustrytoanother.
However,newideasandwaysofworkingcanalwaysbefound,andErnst&Youngwithitswiderangeofindustryservicesandglobalreachisinagoodpositiontoprovideadditionalinformationonabove.Weserveawiderangeofdifferentindustriesinadditiontotheabove-mentioned,andourglobalpulpandpapernetworkcontactpersons(listedintheend)arehappytoprovidemoreinformationonthese.
Theresultsofthepulpandpaperindustrysurveyalsoprovidedsomeveryinterestinginsights.Despitefouryearsofpainfuldecisionsregardingmillclosuresandcostreductions,thesesameissuesremainontopoftheagenda.Inmanypaperandboardgrades,oversupplypersistsandthisnecessitatesadjustingsupplywithdemandalsointhenearfuture.Fifty-eightpercentoftherespondentsofoursurveyindicatedthattheywerestillintheprocessofclosinguncompetitiveproductioncapacity.
Paperindustryhasbeenintensivelycuttingcostsduringthepastfouryears,andmuchprogresshasbeenmade.Butasindicatedbyoursurvey,therestillexistsasignificantpotential:inareassuchasworkingcapital,where56%oftherespondentsstatedthatachievingsignificantimprovementswasstillworkinprogress.Manyotherareas,suchasuseofsharedservicesinfinance,payrollandITaswellascentralizingsourcingfunctionsalsoindicatedsignificantpotentialforfurtherimprovement.Facilitiesmanagement—whenbundledandoutsourcedcarefully—offersadditionalreductionpotential.
34 SustainingtherecoveryErnst & Young’s global forestry, pulp and paper report 2011
Accordingtothesurvey,themostcriticalfuturecompetencesoftheindustryareassetmanagement,understandingofemergingmarketcultures,newproductdevelopment,improveddemandforecastingandM&Aknow-how.Thisreflectsverywellthedifferentphasesoftheindustry:marketsarematureintheWest,growthisintheemergingmarkets,newproductsandinnovationsarebadlyneededandthemainavenueforgrowthshouldbeM&Ainsteadofgreenfieldinvestmentsthataddtotheglobalovercapacity.Morethan80%oftherespondentswantedtosubstantiallyincreasetheR&Dspendingoftheindustry.Atthesametime,riseoftheelectronicmediaanduseofwoodforenergypresentmoreseriousthreatstotheindustry.Inordertobalancedemandwithsupply,newsolutionsareneededandperhapsPEfirmscouldactasthecatalyststhatcouldbreakthepresentgridlock.
“Thekeystosustainingthepresentrecoveryareincreasedoperationalagilityintheformofbalancingsupplywithdemandandincorporatingcostvigilanceaspartofthecorporateculture.Newideasandmoreresourcesinnewproductsandservicesareneeded,aswellaschallengingthepresentbusinessconcepts.EnhancedcustomerreachinexploringnewpocketsofrevenueinmaturemarketsandinvestmentsandM&Ainemergingmarketsarealsocritical.“
Theunderlyingthemeofthisreporthasbeentostudywaysinwhichtheindustrycouldsustainthepresentrecoveryandmaintainthepresentlygoodprofitability.Inouropinion,thepathtosustainedrecoveryrequiresalsoachangeinmindset:changemustbeembracedratherthanresisted.Agilityofdecision-making—whileunderstandingandmanagingtherisks-shouldreplacethetraditionofoverwhelmingcaution.Cost-efficiencyshouldbecomeapartofthecorporatecultureasanaturalwayofdoingthings(ratherthan“programculture”).And,ashasalreadybeendoneinthepharmaceuticalindustry,newwaystodefineandreconfigurethebusinessmustbefound.
Ashasbeenoutlinedbythefindingsofthisstudy,duetothefinancialcrisisthecompetitivearenahaschangedthroughoutallindustriesandmanyregions.However,therearealsomanyopportunitiesavailableforthosecompaniesthatprofoundlyunderstandthechangesintheirbusinessenvironmentandproactivelyrespondtothesechallenges.Thatisperhapsthebestwaytosustaintheongoingrecoveryoftheindustry.
35SustainingtherecoveryErnst & Young’s global forestry, pulp and paper report 2011
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