COMMERCIAL PRINTING Outlook -- Shadows Cast on 2006

BY MARK SMITH

Technology Editor

Printing industry sales may no longer track exactly with GDP, but the two remain inextricably linked. Unfortunately, recent events have greatly increased the difficulty in trying to forecast the economy's track in 2006 with any degree of confidence.

In the fall, the National Association for Printing Leadership's (NAPL) economic team revised downward both its printing industry forecast for 2005 and projection for 2006, reports Andrew D. Paparozzi, chief economist. Growing concern about the economy and ongoing resistance to price increases in the marketplace were the main reasons.

"In an industry as competitive as ours, it doesn't take a recession to cause a problem," Paparozzi says. "Just a slowing from the kind of economic pace we've seen over the last two years becomes an issue for print sales."

The U.S. economy grew by 4.1 percent in 2004 and now is on track to grow somewhere around 3.4 or 3.5 percent in 2005, the economist believes. If GDP growth even just slows to between 2 and 2.5 percent in 2006, printers will feel an impact, he contends.

Lack of pricing power is a key part of the equation. Printers are finding it difficult to pass along rising costs—including direct costs such as ink, transportation and paper—much less boost their margins.

"Particularly starting in the second half of 2005, our tracking shows printers have been able to push some of the cost increases through," Paparozzi says. "They've been able to raise prices more than they have in a long time, but not enough to protect profit margins given their broadly rising costs.

"In fact, the results from our '2006 State of the Industry' survey show the top concerns heading into 2006 are (in ranked order) rising energy prices, rising wages and benefits—particularly benefits—and the economy," he adds.

As for print sales, NAPL now expects industry revenues to grow between 2.5 and 3.5 percent in 2005. That figure will probably gravitate toward 3 or 3.2 percent by the end of the year because of what gains there have been in pricing power, he adds. "Next year we're looking more at growth in the 1.5 to 2.5 percent range, maybe 2 to 3 percent if market trends are on the more positive side."

Yield Signs Ahead

With the qualifier that NAPL is not in the business of forecasting the overall economy, its chief economist says the variables that could impact economic performance are weighted toward slower growth.

"We use the 'Blue Chip Economic Indicators' consensus forecast, which is still 3.3 percent for 2006. It's easier to make a case that growth will be lower than that figure, rather than higher," Paparozzi says.

Ronnie H. Davis, Ph.D., chief economist at PIA/GATF, also sees reason to be cautious in making projections. The hit from two hurricanes (Katrina and Rita) battering the country's "energy belt" and the resulting up-tick in inflation and unemployment have made the future path of the country's economy much more uncertain, he explains.

Through the first half of 2005, Davis says the likely scenario seemed to be that the economy would stay on course for continued growth at a rate ranging from 3 to 4 percent through the remainder of 2005 and into 2006. However, developments in the latter part of the year have set up the potential for three different scenarios to unfold, the economist suggests. Clearly inspired by 1960s westerns, he labels these projections "the good, the bad and the ugly."

* The "good" scenario calls for continued growth in the economy as the built-up momentum withstands the drag of higher energy costs and disruptions resulting from the hurricanes. After slowing only slightly in the last third of 2005, the economy regains its footing by early 2006 as spending for hurricane relief and recovery sets in and the hit from the energy shock subsides. The net result is continued growth of 3 to 3.5 percent with a slight rise in inflation and unemployment.

Bottom line for the printing industry: revenues grow 2.5 percent to total $169.2 billion in 2006, up from $165.1 billion in 2005.

* The "bad" sees the economy slow down—but still grow, albeit at a lower rate—as the energy shock and hurricane-related disruptions take a toll. The economic growth rate is cut in half to around 2 percent in 2006, with inflation rising more than 3 percent and unemployment edging up toward 5.5 percent.

Bottom line for the printing industry: revenue growth slows to around 1 to 2 percent.

* The "ugly" is a recession, as the energy shock and hurricane-related disruptions cause a collapse in consumer and business spending. Economic growth falls to under 1 percent for the year, and is even negative for a quarter or two. Inflation is kept in check by the decline in spending, but unemployment rises to about 6 percent.

Bottom line for the printing industry: revenues decline 1 to 2.5 percent.

Anticipating the obvious question, Davis asks, "Which scenario will prevail? For now, the most likely outcome is still for continued growth, but printers need to plan now for the other two scenarios."

Regardless of which track the economy most closely follows, the performance of individual printing sectors will vary, the industry economist notes. Direct mail, packaging and labels/wrappers will probably do better than other sectors, he believes. In all cases, digital printing and ancillary services should continue to be greater business opportunities than ink-on-paper printing.

Tight profit margins and lack of pricing power are amplifying the business risks for printing firms, adds NAPL's Paparozzi. In the case of energy costs, for example, rising prices can have a significant impact even though they are a small line item compared to paper or employee wages and benefits, he points out.

"Anything that increases costs, even at the edges, is very significant. Printers don't have a lot of margin to give up," the NAPL economist says.

PIA's Davis agrees. Printers' direct energy costs are a relatively small part of their total outlays, he acknowledges, with delivery costs accounting for about 1 percent and utilities being about 2 percent of that total.

"However, energy costs will also push up paper, ink and other costs, plus the resulting higher rate of inflation will cause wages/salaries to go up. So, in total, it is a very big deal. Especially since printers have trouble passing cost increases on to customers and margins are already tight," he concludes.

The potential for acceleration of the growth rate of inflation and rising long-term interest rates are the biggest risk factors going forward, Paparozzi believes. "It could take up to a year for their effects to work through the economy," he says.

Printers Shifting Gears

Regardless of how the economy performs, NAPL's latest market data indicates there's been a big shift in thinking among printers as to what services hold the greatest sales potential. "Variable content-capable digital printing" was the top response to a question on the 2006 State of the Industry survey that asked, "What services do you expect to grow fastest over the next two years?"

This year's survey was the first to break out variable and static digital printing, Paparozzi notes. Variable content came out to be the overall Number One opportunity cited by a very large margin, he says. The other top opportunities cited were—in ranked order—mailing, fulfillment, four-plus color lithography, static digital printing and database management services.

Sales are great, but what about profits? Davis recently published an analysis of profit performance based on the 2005 PIA/GATF Ratios study. The chart below is part of his findings for all sheetfed printers, broken down by Profit Leaders (printers in the top 25 percent of profitability) and Profit Challengers (all the rest).

One finding that stands out in this analysis is that profit leaders tend to make a significantly greater investment in machinery/equipment per employee, thereby enabling them to employ fewer people to produce the same dollar volume of work as a profit challenger. This seems to bolster the case for automation.

Forecasts of any sort ultimately amount to educated best guesses, especially when the human factor and Mother Nature are among the variables. NAPL's Paparozzi agrees with the assertion that there is a greater than normal degree of unpredictability in the economic outlook heading into the new year.

"There is much more uncertainty about the economy going into 2006 than there has been in three or four years," he says. "At the same time, our industry is not simply changing, it is being redefined. That is creating historic opportunity for companies that are prepared and profound threats for those who try to do business the same old way.

"Enduring success will come from cultivating leadership skills and expertise in one's staff, not technology," Paparozzi continues. "It will require the ability to understand your client's needs and become a solutions provider, while looking beyond the traditional print buyer."

Judging by the level of interest, growing installed base and expanding monthly production volumes, it seems as though digital printing is finally becoming a force to be reckoned with for the broader market. PIA/GATF's Digital Printing Council is in the midst of a research project—Marketing 4 Digital—that promises to define the scope of this opportunity. Full results will come out in 2006.

TrendWatch Graphic Arts, meanwhile, has already declared digital color printing a mainstream service, with the publication of its "Digital Printing 2005: It's Mainstream, Baby!" special report. Among its notable findings are that:

* 42 percent of creatives say their use of digital color printing is increasing "a little" or "a lot;"

* 15 percent of graphic arts firms plan to purchase a digital color press in the next 12 months; and

* 39 percent of digital printers say their digital printing volumes are increasing "a little" or "a lot."

Direct mail continues to be the leading application for variable data digital printing, although more exploration is being done of its effectiveness and viability for catalogs and magazines. On-demand books still are what's hot in static digital production. Each of these industry segments is covered in the various market outlooks that immediately follow this story.

One sure thing in 2006 is that postage rates will go up. This may have the effect of giving an artificial boost to industry performance at the close of 2005 and depressing it in early 2006 to the extent its practical for print buyers to speed up projects to beat the increase.

Like printers, paper manufacturers are still struggling to regain pricing power and bring capacity more in line with demand. The demands of the manufacturing process and delivery make them especially sensitive to energy price increases, but they've also met resistance when attempting to pass through such costs via surcharges or other price increases. That doesn't mean they won't keep trying.

Getting Organized

Union activity had been fading from the industry's collective radar screen with the declines in membership, but attempts to organize plants and strike actions brought it to the forefront again in 2005. Discord within the AFL-CIO was a distraction for part of this year, but expect unions to again make a push for increased relevance in 2006.

Merger and acquisition activity also has been on the rise, especially in terms of headline-making big deals. There continue to be rumblings about more potential moves by major vendors to the industry, but deals between printers are the more likely scenario.

Forecasts are simply more fun when they include big ideas, even if that does greatly increase the odds of being way off. In that spirit, there's a strong likelihood that by the end of 2006 developments in e-paper technology will have reached the point where a meaningful assessment can be made of its implications for printing. E-Ink, Philips and Siemens are among the companies moving to commercialize small-format applications in the coming year.

It remains to be proven that the format size can be scaled up to become a broad competitor for physical paper. Other questions still to be answered include the cost competitiveness, resolution/visibility, durability and infrastructure requirements of any resulting products.

It could easily be another five to 10 years before any kind of real potential replacement for paper is commercialized, and then an adoption curve of some duration would follow. Given the potential implications of such a sea change, though, it is critical that printers stay up on developments in this arena in the new year—and beyond.