Sustaining the recovery - EY · PDF file34 Sustaining the recovery in pulp and paper List of...

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


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


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


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


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.


FIGURE5:Regionaldevelopmentphasesofthepulpandpaperindustry

Western/NordicEuropeMaturemarket•Restructuringunderway•Technologyleadership•

RussiaHugeconiferousfibersources•Sizablemarketpotential•Poorinfrastructure•Investmentsneeded•

ChinaHugegrowth•Limitedfibersources•Aggressiveinvestments•

IndiaBigpotential•Limitedowncapacity•Limitedfibersources•

Source:Ernst&Younganalysis


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



13

“ToomuchfocusofR&Donproductionefficiencyandcostshaveledtothecommoditizationofproductsandservices.Newandinnovativeproductsareurgentlyneeded.”


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



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.


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



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



Learningsfrompharma

Challengethecurrentbusiness•modelsandtheirrelevanceinthenewenvironment

ReviewcurrentR&Dandtechnology•strategiesandinvestmentlevels

Considershiftingthefocusincreasingly•totheenduser,ratherthanthecurrentintermediaries—merchants,printers,publishersandpackagingfirms

Useofnewtechnologytoaccess•theconsumer—thewebcanalsobeanopportunity

Collaborationandpartnershipswith•printersandpublisherstodefendagainstelectronicmedia


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


FIGURE11:DifferentapproachesinM&Atransactions

Resources

Illustrative

- 6 months Acquisition + 6 monthsPre-studyandtargetselection

Exitplanning

PE

Public

DuediligenceValuation&offer

IntegrationActiveownership



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.


FIGURE12:Theworkingcapitalcomponentsofthepulpandpaperindustry

High

Average

Low

0 25 50 75 100 125 150 175

Days of sales outstanding

Days of inventory outstanding

Days of payablesoutstanding



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



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



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


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.”


”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


”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


”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



> 2,5% of turnover


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.”


Whathaschangedinfouryearsandwhatdoesthefuturelooklike?

Basedonoursurveysin2007and2011,anumberofchallengesandissuesfacingtheindustryhaveremainedthesame—whereassomeothershavemovedtotheforefrontoftheagenda.Themainpointsaresummarizedinthefollowing:

Despitefouryearsofpainfulcapacity•reductions,demandandsupplybalancestillremainsthenumberoneconcernoftheindustry.Unfortunately,moreneedstobedone.

Therestillexistssignificantcost•reductionpotentialinmanyareas.

Electronicmediaandfibreavailability•aswellasrisingenergycostshavenowrisentotheforefrontofindustry’schallenges.

Keycompetencesforfuturesuccessare•assetmanagement,understandingofemergingmarketcultures,newproductdevelopmentandimproveddemandplanningandforecasting.

Respondingtothesechallengesrequiresthatcompanieshavetherightgovernancestructures,processesandmanagementandreportingtoolsinplacetosupportdecision-makingandimplementation.


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.


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.


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Brazil•AntonioFioravante,SaoPaolo,[email protected]

Canada•BruceSprague,Vancouver,[email protected]•HeinWinckler,Vancouver,[email protected]•RafikGreiss,Montreal,[email protected]

China•RobertPartridge,HongKong,[email protected]

Finland•TimoUronen,Helsinki,[email protected]

France•Henri-PierreNavas,Paris,[email protected]

Germany•KlausDyck,Stuttgart,[email protected]

India•NitinGupta,NewDelhi,[email protected]

Indonesia•DavidRimbo,Jakarta,[email protected]

Ireland•KevinMcLoughlin,Dublin,[email protected]

Norway•FinnKinserdal,Oslo,[email protected]

Russia•DmitriBabiner,StPetersburg,[email protected]

SouthAfrica•EbrahimDhorat,Johannesburg,[email protected]

Sweden•UlfBorgcrantz,Stockholm,[email protected]

UnitedStates•JohnUtsch,Atlanta,[email protected]•GeraldB.Wilson,Atlanta,[email protected]•ClintonBowes,Richmond,[email protected]•GregHeston,Atlanta,[email protected]•RichardWright,Memphis,[email protected]

UnitedKingdom•BobForsyth,London,[email protected]

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