MarketIntellibitsTM                    
November 15,   2005
Volume I   Issue 19


The Tonnage Disease

Last time, I talked about Customer Service, and how it can get
commoditized, and how shortening lead times can sometimes become
comparable to cutting prices.

This time, I’ll address the big victim of commoditization: price.

We have no control over prices. The market determines price levels.  It’s a
capital intensive business, and the need to operate at full capacity puts
pressure on prices.  It’s a global market, driven by global supply and
demand.

Sorry, I’m not buying it.

Several years ago, I was at a Forest Products conference and an industry
analyst demonstrated that of the major capital intensive industries, the
paper industry had the highest operating rates and the lowest returns. I
suspect that is still true today.

So, what’s going on here?

The industry suffers from the tonnage disease. It measures itself on tons,
not dollars, and so it sets records on tonnage production. But not on profits.

This is a terrible disease, and it has many symptoms.

I remember when I was in sales in 1995. We had enjoyed a tremendous run
up in prices – and yes, some thought the industry had “manufactured” that
shortage, but believe me, if the industry was capable of doing that, it
wouldn't be in the shape it’s in today.

But I digress. The bubble had burst, but prices were still high: down 15%
from the peak, but still 25% above today’s prices. Profits were good, but the
driving force in our sales effort was not profitability. It was “No downtime.”
The tonnage disease.

The papermakers spend millions of dollars de-bottlenecking and speeding
up paper machines. More tons per day means more margin per day and
lower cost per ton as fixed cost is spread over more tons. Fair enough, but
what happens to those extra tons in a market that is flat, or simply growing
slower than the papermakers add capacity? More capacity means excess
supply and that means lower prices. Again, the tonnage disease.

A few years back a major consulting firm raised a lot of eyebrows with a
study detailing how much money the paper industry loses because of a lack
of good marketing. It mentioned the need for segmentation, and customer
relationship management. And smarter pricing.

It’s odd. Paper companies always manage to find money to fund engineering
studies to speed up paper machines, while marketing dollars are often hard
to come buy. Another symptom of the tonnage disease.

Printers suffer from something similar to the tonnage disease. They’ve got
those expensive presses and they have to keep them running.  Lots of
overhead to cover. Sound familiar? They have to deal with print buyers who
want to buy the paper because they want to avoid the 15% mark up on the
paper. That’s a topic for another day, but how many of the companies that
are buying that print live on selling their products at 15% above direct
cost?    

For a startling contrast, let’s look at the small retailer. Small retailers have a
tough road. They face competition from the Wal-Marts of this world. They
face escalating rents and energy costs. They struggle to fund benefits for
employees.

They don’t have MBA’s and cost accountants who understand the intricacies
of ABC costing and semi-variable cost, but they do understanding pricing.

They have a lot of fixed cost: rent, light, salaries, and the cost of the money
tied up in inventory. If you look at fixed cost as a percentage of sales, this
kind of business can look like it’s even more capital intensive than a heavy
manufacturing business like paper.  Retail mark ups are often 200% or more,
and for some, this isn’t enough.  

Consider two major differences between paper manufacturing and small
retailing: metrics and price discipline.

I’ve already covered  metrics: measure dollars, not tons sold, not thousands
of sheets printed, not thousands of square feet converted. Can you imagine
a small jewelry store that measures pounds of jewelry sold?

Regarding price discipline, I often tell a story about ordering an item from a
hobby shop. Prices at the local hobby shop are quite a bit higher than
catalog prices, but the hobby shop provides advice and service. So, even
though the item I wanted was not in stock, and the price was higher than the
catalog price, I ordered it from the hobby shop. The price was about $100,
but, when the item came in, the manufacturer had raised the price, and the
shop wanted $115.

I asked him to honor the quoted price. He could not, his costs had gone up. I
said I respected that, and offered to meet him half-way. Sorry, he could not. I
explained that I could buy it for $89 from the catalog, and was willing to pay
well over that, but he said he’d be out of business if his margins didn’t cover
his costs.

I was irritated, and left, and bought the item from the catalog.  Now some
readers may think I was foolish to be willing to pay anything more than the
original price – after all, a deal is a deal (that, too is a topic for another day).
Others may think that I was being a ----- well, you fill in the blank. Still others
may feel he was a fool for letting me walk.

I suppose you’d all be right to some degree, but the overall feeling I had
about this incident was tremendous respect for his price discipline, and the
strong feeling that the industry I worked in was in trouble because it couldn’t
muster even a shred  of this kind of discipline.

We all know that Christmas in coming, and we also know that  after
Christmas, most retailers have sales with discounts of 20%, 30%, and even
more. Did you ever visit a store after the sale ends and become outraged
that prices had just gone up by 30%? Of course not.

Paper prices are cyclical.  When paper prices reach a reasonable level, i.e. a
price level such that profits and investment in R&D are possible, market
conditions inevitably weaken and paper prices slide, perhaps 10%, 20% or
even 30% over a period of time. Then, when market conditions inevitably
improve once again, a series of price increases are implemented that  
simply return prices to where they should be. But now, paper buyers are
surprised, perhaps even outraged, when prices increase by 10% or 20%
over time.  

When the market is weak, the industry should  have a sale. Paper,  20% off.
But when the sale is over, it’s over. Don’t take a year’s worth of small
increases to get back to where you were.

I’m not naïve. I’ve been in paper sales and marketing for quite a few years,
and well understand that in the real world, the market doesn’t work the way
we’d like it to. I realize that in a commodity or near-commodity business,
market forces determine prices, and if you are the only producer with
discipline, you’ll be the only producer with no orders.

But…

Remember what I said at the start of this article.   The paper industry has had
the highest operating rates among capital intensive industries, and yet the
lowest profits. The industry does need a new way of looking at things, a real
paradigm shift. Somehow, the industry needs to cure the tonnage disease.

For more information about paper pricing and price trends, or how to
recover some of those lost dollars due to a lack of good marketing, call Jack
Miller at 203 925 0326, or email Jack Miller at
 jack.miller@market-intell.com



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