Q1 Paper Outlook — Market Taking Stock
BY MARK SMITH
Predictions of the paperless office may have lost their edge, but not the threat of a paperless printing plant. One only has to go as far back as 1995 to find the last time some printers were faced with shutting down their presses for a lack of paper to run through them.
The buyer's market of recent times saw printers, and their clients, being doubly blessed with a ready supply of paper at historically low prices. Everyone knew it was just a matter of time before the market swing came, though. In the case of paper, the more apropos saying would be: what goes down, must come up.
Lester Samuels, co-managing partner of Pictorial Offset in Carlstadt, NJ, says he can pinpoint exactly when the market for web papers turned. "It happened on Friday, November 15th," he recalls. "We started getting calls from the mills to notify us that they were going on allocation. Paper that was immediately available for shipment from a mill went to having a four-, six- or eight-week delivery date. The change seemed to happen at all the mills at the same time."
Samuels qualifies this observation by pointing out that, in the web grades, Pictorial almost exclusively buys number one and number two coated stocks. The organization also has an extensive sheetfed printing operation. "Sheetfed paper is not tight at all right now," the company exec notes. "There is a lot of foreign competition and imports in that market segment—with more than 50 percent of the sheetfed paper imported today—which helps balance supply and demand."
Inventory Reductions
There is some element of a self-fulfilling prophecy at work here. "Everybody in the system, including mills and printers, had brought their inventories down over the last two-and-half to three years," Samuels notes. "Suddenly, printers saw they could be stuck with no paper and started placing orders. Supply concerns have triggered a certain amount of hoarding of paper."
As one mill goes on allocation, people who buy on the spot market then turn to the other mills to try and get paper, which can force them to go on allocation, he points out. This leads to a domino effect in the market, at least in part driven by "what ifs" and emotion.
In this case, there are hard numbers to back up the concern. For example, the most recent report from the Montreal-based Pulp and Paper Products Council (PPPC) showed that demand for all printing and writing papers in North America rose 1.9 percent in October 2002, compared to the same period last year. The post-9/11 business fallout undoubtedly accounts for some of the difference, but the year-to-date data all show an increase in paper demand, albeit a more modest +0.5 percent. The more telling finding is that paper production for the first 10 months of 2002 was running 1.1 percent lower than the previous year.
Looking at conditions another way, the PPPC reports the industry's operating rate (measured by the shipment-to-capacity ratio) stood at 93 percent in October 2002, compared to 89 percent the previous year. Mill inventories were down more than 8.5 percent compared to October 2001 and had dropped 3 percent just from the prior month (September 2002), according to the association's monthly market data.
Pricing is also subject to a domino effect, of sorts. A mill typically will float a price increase in advance of a proposed effective date in order to gauge market reaction. If other mills see that the increase is likely to stick, they tend to follow suit with a comparable hike. An example of this market dynamic recently played out when International Paper, Domtar Inc. and Stora Enso North America each proposed increasing the price of coated freesheet stocks to $40/ton.
Pictorial's Samuels says before the end of 2002 he already was getting reports of another price increase for web papers proposed for February or March of 2003. He is expecting it to be in the 4.75 percent range.
So far, paper price increases generally have met with understanding on the part of buyers. Rather than grumbling, they recognize that the historically low prices had put mills into an unsustainable financial situation.
Cuts to Capacity
Every mill basically had been losing money, Samuels notes, which led them to cut capacity. "A paper machine has to be kept running 24 hours a day, seven days a week. It can't just be turned on and off," he points out. "This has led to a 20 percent decrease in capacity over the last two years as papermaking operations were shut down."
Viewing the market from the supply side of the equation, Jack Miller, director of market intelligence at Domtar Inc. in Montreal, paints a similar picture. Miller says conditions are right for a strengthening paper market because inventories are currently low and mills are running at close to full capacity. He believes the market dynamics were markedly different during the industry's last availability crunch in 1995.
"The markets were extremely volatile and prices were depressed, so there were overreactions to a modest increase in price and demand," Miller asserts. "The buying frenzy created false demand and led to inventory shortages. Prices rose rapidly from depressed levels."
Miller contends that industry consolidation has introduced greater stability into today's paper market. "In addition, printers and merchants are better equipped to respond to (supply and price) fluctuations. We don't foresee the same pressures leading to the creation of false demand, and we don't anticipate seeing the same overreactions to modest demand increases," he says.
"As the economy recovers, we do expect gradual and modest increases in prices," Miller continues, "but they won't be nearly as extreme as they were in the past. The industry is not recovering from as extreme of a downward trend as we were in 1995."
Changes in buying patterns have put the market on a thinner edge with regard to the domino effect, however. Over the last few years, many merchants and printers have switched to just-in-time inventory management and have learned to operate on much leaner inventory pipelines, Miller points out. As long as buyers don't stray too far in their paper inventory management practices, the combination of sensible demand levels and greater stability on the supply side should minimize the market swings, he says.
Getting caught without paper may be a disaster, but overstocking also presents a risk for printers, points out Donald Samuels who, as one of the other managers of Pictorial Offset, has primary responsibility for sales and marketing. "Just as fast as it tightens, the market can loosen," he cautions. "If you build your inventories to deep levels and then the price collapses, you are stuck with expensive paper that must be sold to clients at a discount."
Trying to gauge market swings traditionally has come down to little more than taking a best guess, given the number of variables and the difficulty in predicting human nature. While acknowledging that conditions were different, Samuels notes that the market took 14 to 16 months to fully work its way out of the restriction in paper supply that started in 1995.
Pictorial has tried to get feedback from its clients about their future paper demand, the sales and marketing exec reveals, but the current business climate makes it difficult for them to make marketing predictions, as well. "Nonetheless, we have been building up our paper inventory to protect our clients," he says.
Could the answer to paper supply and price concerns be found in an industry standards initiative called papiNet? Quad/Graphics is among the major North American printers investing time and money to find out.
The stated goal of the group is to facilitate the real-time exchange of information—system to system—between buyers, sellers and distributors of paper and broader forest products. The methodology being pursued is implementation of XML-based, global electronic business transaction standards.
From Quad/Graphics' Essex, WI, offices, Ron Nash, vice president of customer service, and Mike Ziegler, integration services manager, are helping direct the printer's efforts in this area. Both are active in the papiNet NA (North America) development organization, as well, serving as board member and work group representative, respectively.
Supply Chain Chatter
According to Nash, the goal of Quad/Graphics' involvement is to build a peer-to-peer communication process so it can speak more clearly and directly with its supply chain partners. "We want to see a common language put forth in the industry as a catalyst for investment in the infrastructure to take cost, time and complexity out of the supply chain," he explains.
A central benefit of papiNet is the ability to eliminate data entry, and errors that can go along with it, Ziegler adds. "For printers, direct cost savings are just the tip of the iceberg. papiNet is also going to help shops manage their administrative processes better," he says.
It's not a magic wand or silver bullet unto itself, but a first step toward a lot of opportunities to increase efficiency through automation, Nash believes. The potential is in eliminating what he calls human touch points in the process. The intent of the initiative is to create an opportunity to make the whole supply chain more efficient while not taking away any competitive opportunities, the company exec says.
Internally, this could include gathering data on consumption press side and reporting it throughout the company in an automated information flow, Nash explains. "We also can use papiNet as a communication bridge to the mills and to our clients."
Ideally, there should be a two-way flow of information in an open business relationship, but Nash concedes that requires a level of trust and cooperation among all of the parties involved. While they may say all the right things, he has been disappointed by the actions of some papiNet member mills.
"Everyone talks about the ability to improve the supply chain, to take costs out of the system and get better visibility into supply and demand," Nash says. "But some really see it as a new revenue opportunity and a way to invite other players to the party, thereby fragmenting and complicating relationships more than they already are. These parties are using technology as an excuse to introduce more noise into the system." He is troubled by the introduction of third-party, non-asset holders into the process in the form of independent paper dotcoms.
The ability to get an accurate snapshot of supply and demand is the only way to keep peaks and valleys out of the market, Nash asserts. This would require everyone to accept a level playing field, however.
"When the paper market last got tight in 1995, our perception (at Quad/Graphics) was that there never was a shortage of paper. We had paper stuffed in every nook and cranny of this plant," Nash admits. "We think papiNet will provide total visibility of the entire paper supply chain. That would mean everyone could wait later to make decisions, buy closer to their real needs, ship later, etc. Everybody could know what's needed, when it's needed and where it's needed."
Ziegler reports that Quad/Graphics has already progressed to live exchanges of purchase orders and delivery messages with its paper suppliers, with goods receipts in final testing. Some of the mills are sending electronic invoices and order confirmations in return, he adds.
From an IT standpoint, Ziegler says the preferred scenario would be for papiNet to be a new layer on top of existing business systems. "It opens up a whole new way of looking at the process," he claims. "For example, one of the members of the European papiNet organization is moving more toward a consignment model. The buyer's inventory level is tracked via a usage measure, and stock replenishment happens automatically when that level dips to a predetermined amount. Payment is determined off of actual consumption. They're changing the entire business model."
The activity of the papiNet development group with regard to publication papers is due to wind down with a release of the standard at the end of March, Ziegler says. (Work is expected to continue in other areas, however.) He believes the standard will be applicable across the printing industry, with the group offering implementation procedures and processes to make it easier for small- to mid-size corporations to participate.
The papiNet NA group was organized by IDEAlliance and the American Forest & Paper Association. For more information about the standard or to learn how to become a member, visit www.papinet.org.
