State of the North American
Pulp & Paper Industry
– An Update
p
& Outlook –
Industry Competitiveness &
The Innovation Imperative
Value Resolution Group – Dan Cenatempo
Center for Paper Business and Industry Studies (CPBIS) – Jim McNutt
1
The North American Pulp & Paper
Industry -- Preview
 How Competitive?
 The Innovation Imperative
 The
Th Innovation
I
ti Shutdown
Sh td
 Restarting
g The Innovation Machine
2
How Competitive?
3
How Competitive?

North American Paper Industry:
 Remains one of the largest world regions for
paper consumption and enjoys significant
fiber resources
 Competitiveness
C
titi
has
h been
b
boosted
b
t d by
b a weak
k
U.S. dollar
 Is on the brink of a p
probable,, cyclical
y
upturn
p
 If realized… prices, volume and financial
performance will likely improve over the next
12 to 24 months
months…
 …Companies will have the most resources
and opportunities
pp
to invest in their
businesses since 1995.
4
How Competitive?

Competitiveness Is Multidimensional:
 Mill Performance vs
vs. International Competition
(i.e. North American vs. SA vs. European vs.
Asian mills’ productivity and quality)
 Product Performance vs. Substitutes (i.e.
paperboard folding cartons vs. plastic packaging
– newspaper vs. TV)
 End
End--User Performance vs. International
Competitors (i.e. domestic vs. international
manufacturers))
 Financial Performance vs. Other Investments (i.e.
returns on paper investment vs. alternatives of
similar risk)
5
How Competitive?

Based on these dimensions, industry participants
mustt recognize:
i
 Off
Off--shoring and substitution by alternative mediums
will drive longlong-term demand below current levels
 North America is increasingly uncompetitive in pulp
and p
paper
p production
p
 The industry’s cost based competition and capital
rationing strategies have eroded its asset base.
 The composite financial performance of the industry
has been pitiful and will dissuade future investment
– even in an improved shortshort-term environment
environment.
6
How Competitive?
The U.S. Does Not Enjoy Low Cost Producer
Status On Most Grades
Grade Category
Low Cost Production Centers
Pulp
Brazil, Chile, Argentina, Indonesia
and Canada (selected)
Printing & Writing
Papers
Brazil, Russia, Indonesia, Thailand,
Scandinavia, Western Europe
7
Newsprint
Eastern Europe,
Europe Brazil,
Brazil Chile and
Canada
Premium Folding
g
Carton Grades
Brazil, Russia, Sweden, Chile and
Finland
How Competitive?
Net Imports Are Gaining Significant Share of The
U.S. P&W Market
Net Expo
orts (Imports) % of U.S. Consu
umption
10%
0%
-10%
-20%
-30%
-40%
-50%
-60%
-70%
-80%
-90%
-100%
1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003
UCFS (WFU)
8
WCU (UCGW)
WFC (CFS)
WCC (CGW)
How Competitive?
High Volume North American Grades Have
Significant Substitution Threats
Grade Category
Containerboard
Re--usable shipping containers,
Re
offshoring of manufacturing
Packaging Grades
Flexible packaging, offshoring of
manufacturing
Printing & Writing
Papers
Electronic communications,
alternative advertising mediums
Newsprint
Electronic communications,
alternative advertising mediums
Tissue
9
Substitutes
No major substitutes
How Competitive?
Substitutes Have Hurt – U.S. Shipments Were
Off 14% In 2003 From Their 1999 Peak
U.S. Totall Paper & Paaperboard (S
ST 000s)
110,000
100,000
90,000
80,000
70,000
60,000
,
50,000
40,000
30 000
30,000
20,000
10,000
1975
10
1978
1981
1984
Capacity
1987
1990
1993
1996
Shipments
1999
2002
H
How
C
Competitive?
titi ?
Worldwide Print Advertising
g Has Lost 8 Points
of Market Share Since 1991
E-Advertising, 1%
Cinema, 0%
Cinema, 0%
Outdoor, 5%
E-Advertising, 0%
Outdoor, 4%
Television, 33%
Television, 40%
Print, 46%
Print, 54%
Radio, 8%
Radio, 9%
1991
11
2002
How Competitive?
Large Share of North American Assets Are Approaching
The End of Their Economic Lives
-- Containerboard Example --
Num
mber of Con
ntainerboared PMs
30
Economic
Obsolescence
(37% of PMs)
25
20
15
10
5
0
1916-'20
12
'26-'30
'36-'40
'46-'50
'56-'60
66-'70
76-'80
Year of Original PM Installation
85-'90
96Present
How Competitive?
p
Europe Is Facing Similar Demand Issues
– But Has A Newer Asset Base --
450
Number of P
Paper Machin
nes
400Source: CPBIS
350
300
250
200
150
100
50
0
1890- 19001890
1900 '10-'19
'10 '19 '20
'20-'29
'29 '30-'39
'30 '39 '40-'49
'40 '49 '50-'59
'50 '59 '60-'69
'60 '69 '70-'79
'70 '79 '80
'80-'89
'89 '90'90
1899 1909
''99
North America (1,102) Europe (1,861)
13
20002000
'03
How Competitive?
Average U.S. Industry Returns Are High Enough To
Service Debt – But Not To Create Value
20%
ROTC averages 7% vs.
11% cost of capital
15%
10%
5%
0%
1975
14
1978
1981
1984
1987
Return On Total Capital
1990
1993
1996
1999
Cost of Capital
2002
How Competitive?
 The industry has been a poor performer since
the 1970’s – it faces an increasingly tough
environment
 Participants must learn to thrive under these
negative conditions
 The overall industry will probably not fare well…
…but the individual companies can thrive
if they
th use the
th nextt shortshort
h t-term
t
upturn
t
tto
embrace and leverage innovation!
15
The Innovation
Imperative
16
The Innovation Imperative

A suppliers
As
li
to,
t and
d participants
ti i
t in,
i the
th
American Paper Industry, we all want to enjoy
the benefits of strong
g financial performance

We want to grow, be profitable, generate good
returns, etc. – we want to create value!

The value created in a business is generated
by acquiring, building, maintaining and
exploiting assets.
assets
Not All Assets Are Created Equal!
17
The Innovation Imperative
Intellectual Property Is Risky, But Required
To Sustain Superior
p
Returns
Intellectual
Property
Intangible
Assets
Commodities
Expected
Return
Tangible
g
Assets
Working
Capital
C h
Cash
18
Risk
Legal
Monopoly
The Innovation Imperative
 Companies that are limited to ownership of
commodity assets will NOT be able to create
value for any sustained period of time due
to the competitive nature of commodities…
 They must have something special –
intellectual property in the form of patented
technology, trademarks, copyrights or trade
secrets.
19
The Innovation Imperative
 No intellectual property – no sustained
value creation.
 No innovation – no intellectual property.
Innovation Is Imperative To
Create Value!
20
The Innovation Imperative
The North American Industry Has Focused Almost
Exclusively On Commodity Assets!
Commodities
Tangible
Assets
Expected
p
Return
Working
Capital
Cash
Risk
21
Intellectual
Property
I t
Intangible
ibl
Assets
The Innovation Imperative
The NA Paper Industry’s
Industry s
Continued Commodity
A
Asset
t St
Strategy
t
C N
Can
Nott
Result In Acceptable
Performance
22
The Innovation
Shutdown
23
The Innovation Shutdown
How did we get here?

The dynamic mix of:
1. Industry market realities
2. Financial market realities
3. Industry culture
4 Good intentions…
4.
intentions
Th t R
That
Resulted
lt d In
I The
Th Shutdown
Sh td
of Our Innovation Capacity
24
The Innovation Shutdown




Industry Market Realities
 Maturing demand
 Substitute products
 Offshore growth
Financial Market Realities
Capital portability
Short--term earnings focus
Short
R&D “expensed”
Shift from Industrial to
Service to Knowledge
economy
Poor Decisions In The Pursuit of
C
Cost
B
Based
dC
Competition
ii
Good Intentions
 Perform well
 Be “World Class”
 Increase Productivity
25





Industry Culture
Low Conflict Tolerance
Risk Averse
Management From Operating
Background – Enamored With
Equipment
Implementation Oriented
Parochial vs. System Thinking
The Innovation Shutdown
 Cost Based Competition:
R&D is an expense…cut it! … push it off on
suppliers and research consortiums!
Risk is bad … reduce it!
Profits are down,, cut capital
p
spending!
p
g
Build market power by acquisition!
Lower cost through increased scale!
Lost proprietar
proprietary assets!
26
The Innovation Shutdown
One outcome has been the stagnation
of capital investment:
No
consequences
q
Sl k capacity
Slack
it
built into each
project
Throughput
targets always
exceeded
Under--perform
Under
Engineers &
operators
rewarded for
“world class”
performance
Fall behind
Credibility
falls &
become
risk--averse
risk
CAPITAL
INVESTMENT
Do only lowlowrisk projects
Facilities
chronically
out of
balance
Perpetual
p
de
de-bottlenecking
27
Demand for
project capital
rises
Note: Adapted from Kayoma and Van Tassel,
Must invest
for future
Use
capital
to fix
f
Capital
rationing
Projects padded in
anticipation of cuts
The Innovation Shutdown
 The RESULT: no innovation = low risk
projects, old and commodity assets = poor
performance = no investment = industry
p
y
decline.
 IS IT THAT BAD? Initial evidence says YES
YES::
 Industry statistics say YES.
 Industry management says YES.
YES
28
The Innovation Shutdown
 To illustrate, we selected a basket of
companies
i and
d looked
l k d att key
k statistics
t ti ti
 Did an informal survey of 20 highhigh-level
i d t executives
industry
ti
and
d managers.
“There
There are two kinds of statistics, the
kind you look up, and the kind you
make up.
up.” - Rex Stout “There are lies, damned lies, and
statistics.”
t ti ti ” - Mark Twain 29
The Innovation Shutdown
Capital Expenditures Have Fallen Well
p
Levels
Below Depreciation
PP
P&E Capital Expend. As % of Deprecciation
300%
275%
250%
225%
200%
175%
150%
125%
100%
75%
50%
25%
0%
30
1975
1978
1981
1984
1987
1990
1993
1996
1999
2002
The Innovation Shutdown
Paper Industry Returns Are Minimal To Negative
Company
Coca-Cola Corp.
Microsoft
P&G
Kimberly-Clark
Intel
Nucor
Weyerhaeuser
GP
Mead-Westvaco
Smurfit-Stone
IP
Bo ter
Bowater
U.S. Steel
31
12 Month ROTC
22.8%
13.5%
18.0%
13.5%
14.6%
1.7%
1.1%
1.1%
-2.0%
-2.1%
1.5%
-4.0%
4 0%
-6.0%
Source: Multex Investor
5-Year ROTC
24.0%
21.6%
16.0%
15.7%
15.5%
5.5%
2.9%
1.4%
1.2%
0.6%
0.6%
0 3%
0.3%
-1.6%
The Innovation Shutdown

Paper Industry R&D Spending Levels Are Minimal
– Most Companies Don’t
Don t Even Report
Company
Intel
Microsoft
P&G
Kimberly-Clark
Mead-Westvaco
International Paper
Weyerhaeuser
Smurfit-Stone
32
2003 R&D %
of Sales
14.3%
13.7%
3.8%
1.9%
0.9%
0.3%
0.3%
0.1%
2003 Total
2001 R&D %
R&D ($
of Sales
Millions)
14.3%
$4,300
15.2%
$4,400
4.0%
$1,665
2.0%
$281
1.2%
$71
0.3%
$73
0.4%
$51
0.1%
$5
Source: Company Annual Reports
The Innovation Shutdown
The Level of Paper Company Patent Activity Is
Generally
y Low ((Less Than 3.5% = Erosion))
Company
Intel
P&G
Kimberly-Clark
Microsoft
Mead-Westvaco
Coca-Cola Corp.
IP
GP
U.S. Steel
Weyerhaeuser
Smurfit-Stone
B
Bowater
t r
Nucor
33
Issued Patents
(1976-2004)
7,075
6,304
2,849
2,801
2,096
799
750
582
505
497
160
16
11
Patent Applications
Pending (2004)
606
889
392
798
37
13
14
39
2
79
2
-
Source: U.S. PTO
Applications
% of Issued
8.6%
14.1%
13.8%
28.5%
1.8%
1.6%
1.9%
6 7%
6.7%
0.4%
15.9%
1.3%
0 0%
0.0%
0.0%
The Innovation Shutdown
The Quality of The Paper Industry’s
Intangibles
g
Is Very
y Low
Company
C
Coca-Cola
C l C
Corp.
rp
Microsoft
P&G
Intel
Kimberly-Clark
Mead-Westvaco
Nucor
Weyerhaeuser
International Paper
Bowater
Smurfit-Stone
GP
U.S. Steel
34
IP & Intangible
Value % of Total
84%
80%
78%
66%
60%
25%
9%
5%
-2%
-7%
-9%
-20%
-122%
Source: VRG, equals (Total Market Value Less Total Invested Capital) / Total Market Value
The Innovation Shutdown
Management Doesn’t Think The
Industry Is Innovative
1= Leaast Innovattive, 5=Mo
ost
5
4
Survey Question:
Question: How innovative is the U.S.
paper
p
p industry
y vs. other industries?
3
2.0
2
1.5
1.5
1.0
1
0
Average
Median
High
35
Source: VRG phone survey
Low
The Innovation Shutdown
Management Perceives Their Own
Companies’ To Be Better Than Average
g
1= Lesss Innovatiive, 5=Morre
5
Survey Question:
Question: How innovative is your
company relative to the overall paper industry?
4
3.0
3
2.3
2.5
2
1.0
1
0
Average
Median
High
36
Source: VRG phone survey
Low
The Innovation Shutdown
And They Believe Themselves To Be
Somewhat Successful When They
y Innovate
1= Leasst Successffull, 5=Most
5
4
3
Survey Question:
Question: How
successful have your
innovations been?
2.7
4.5
25
2.5
2.0
2
1
0
Average
Median
High
37
Source: VRG phone survey
Low
Restarting The Machine
38
Restarting The Machine
Creativity involves breaking out of
established p
patterns in order to look
at things differently. - Edward De Bono Creativity is the sudden cessation of
stupidity. - Edwin H. Land -
39
Restarting The Machine
 The chance of the entire industry rediscovering
innovation is unlikely
 Changes have and will happen at individual
companies
 There are many things we can do, both
grandiose and pedestrian, to capture value
through Innovation.
Innovation
40
Restarting The Machine
Keys To Innovation:
1. Open Our
Culture
3. Get
Intellectual
41
2. Become
Investors
Restarting The Machine
1. Open Our Culture:
Typical Culture Stifles Innovation:
 The norms and attitudes that are required
to excel in execution are damaging to
innovation.
 Desiring and rewarding innovation does not
necessarily increase its appearance
 Motivation may drive variations on a theme
but is unlikely to generate major changes in
perspective or reformulation.
42
Restarting The Machine
1. Open Our Culture (Continued):
There are three major sources of innovation
that work alone or in combination.
Innovation From
The Top
i e Visionary
i.e.
leaders like Steve
Wynn – Mirage
Resorts
43
Innovation From
Within
i e creative
i.e.
organizations or
cultures like 3M
Innovation From
Without
Example: Teaming
with IDEO, venture
development spinspinouts
This is the area that
we typically have the
greatest
t t iimpactt
Restarting The Machine
1. Open Our Culture (Continued):
T become
To
b
“C
“Creative
ti F
From Withi
Within”,
” open your
culture to Innovation oriented practices.
Practices That Drive Innovation
Decide to do something that will probably fail
fail,, then convince
everyone else that success is certain.
Reward success and failure;
failure; punish inaction
Take your past successes and forget them
Seek out ways to avoid, distract and bore customers, critics
and anyone who just wants to talk about money
Find some happy people and get them to fight.
Note: Adapted from “The Weird Rules of Creativity” by Robert I. Sutton, Harvard Business Review,
Review, 2001
44
Restarting The Machine
1. Open Our Culture (Continued):
Practices That Drive Innovation
Hire slow learners of the organizational code
Hire people who make you uncomfortable
uncomfortable,, even those you dislike
Encourage people to ignore and defy their bosses and peers
Ignore
g
people
p p who have solved the exact p
problem you
y
face.
Hire people you probably don’t need
Note: Adapted from “The Weird Rules of Creativity” by Robert I. Sutton, Harvard Business Review,
Review, 2001
45
Restarting The Machine
1 Open Our Culture (Continued):
1.
(C ti
d)
Innovative companies and teams
are inefficient and often annoying
places
l
to
t work.
k
Note: Adapted from “The
The Weird Rules of Creativity
Creativity” by Robert I.
I Sutton,
Sutton Harvard Business Review
Review,, 2001
46
Restarting The Machine
1. Open Our Culture (Continued):
The actions required to build and protect
intellectual p
property
p y are complex
p
– training
g
is essential for personnel in:
 Sales
 Marketing
M k i
 Product Development
 Technology
 General Management
 Legal
ega ((if you don’t
do t have
a e Patent
ate t Cou
Counsel)
se )
47
Restarting The Machine
1. Open Our Culture (Continued):
Consider innovation in different areas:
 Product – main focus today
 Service
 Market
 Process
 Strategy
 Organization
 Supply Chain
 Commercial and Financial
48
Restarting The Machine
2. Become Investors:
An Investment Mentality Is Required:
 Capital
p
spending
p
g = Investment
 Investment = spending with a potential
to generate returns beyond the current
period (i.e. training, R&D, trade secret,
patent,, trademark,, etc.))
p
 Just because accountants expense it
doesn’t mean its not an investment.
49
Restarting The Machine
2. Become Investors (Continued):
 Investors are portfolio managers
 They
y mix a number of investments
(projects) with a range of
correlations, risks and expected
returns
 They focus on the return and risk of
their overall portfolio – not the
individual investments.
50
Restarting The Machine
2. Become Investors (Continued):
Intellectual
Property
Expected
Portfolio
Return
Industry Focused On
Low Risk, Low
Return, Highly
g
Correlated Projects Intangible
Assets
Tangible
A
Assets
t
Working
Capital
Cash
51
Risk
Restarting The Machine
2. Become Investors (Continued):
Intellectual
Property Industry
y
Intangible
Assets
Expected
Portfolio
Return
Tangible
Assets
Working
Capital
Cash
52
Risk
Should
Focus On
A Mix of
Projects
With
Higher
Expected
Return &
Lower
Correlation
R t ti The
Restarting
Th Machine
M hi
3 Get Intellectual:
3.
Intellectual Property Is Required:
“Intellectual property is the central resource
for creating wealth (value) in almost all
industries. The foundation of commercial
power has shifted from capital resources to
intellectual property. In fact … capital
resources are now dominated by intellectual
property such as knowknow-how, patents,
trademarks, copyrights and trade secrets.”
-- Gordon Smith & Russell Par -53
R t ti The
Restarting
Th Machine
M hi
3 Get Intellectual (Continued):
3.
 Low cost overseas competition probably
precludes a “low cost” U.S. paper strategy
long--term.
long
 Creating and exploiting legal monopolies in
technologies products and processes in
technologies,
conjunction with nonnon-proprietary assets
creates value.
 Focus more heavily on highhigh-impact Patents,
Trade Secrets, Rights & Relationships.
 Paradigm shifting breakthroughs are not
necessary!
54
Restarting The Machine
3.
Get Intellectual (Continued):

E
Example:
l A child’s
hild’ disposable
di
bl diaper
di
has
h
some 1,800 patents

The assets used to exploit these patents
(tissue machines, converting equipment) are
largely commodity in nature

Leading diaper producer’s returns are well
above paper industry average and their cost
of capital.
capital

Paragon Trade Brand’s infringement of one
of these 1,800
1 800 patents resulted in greater
than a $300MM damages award.
55
Restarting The Machine
3.
Get Intellectual (Continued):
Technology Pushed
Inventing
Technologists
Patent Attorney’s
Product Developers
& Financial Experts
Marketer
56
Traditional
Technology Pushed
Inventing Results In
A Low Hit Rate on
Value Creating
Intellectual Property
Restarting The Machine
3.
Get Intellectual (Continued):
Market Driven Inventing
Increases The Odds
That Your Innovation
Will Yield Value –
Whether it is a product,
service, process,
organization or strategy
innovation … but still
takes years to yield
results.
Market Driven
Inventing
Marketer
Technologists
Technologists,
Patent Attorneys &
Financial Experts
Product Developers
Marketer
57
Restarting The Machine
3.
Get Intellectual (Continued):

Valuation and Portfolio Management Tools
now exist to measure and manage the
value
l created
t d through
th
h innovation
i
ti
programs.

Th financial
The
fi
i l benefit,
b
fi risk
i k and
d target the
h
cost of R&D programs can be quantified
with such tools as:
 Option Approaches to Patent Valuation
 Market Simulation
 Competitive Simulation.
58
Recap
p & Final Thoughts
g
59
Recap & Final Thoughts





I
Innovation
ti is
i imperative
i
ti to
t create
t value.
l
Typical North American pulp and paper companies
have shutdown their innovative capacity
p
y ((if it ever
existed).
As a result, in part, industry performance has been
dismal.
dismal
Investment is spiraling downward and competitiveness
is eroding.
However, individual suppliers and paper companies
can leverage innovation to outperform the industry
and create value
value.
60
R
Recap
& Fi
Finall Thoughts
Th
ht

How?
 Open Up Our Culture – accept that innovative
companies are often inefficient and annoying places to
p
inactivity.
y Focus
work. Reward risk and failure,, punish
on more than just product development. Train key
participants on process to create and protect IP.
 Become Investors – manage a portfolio of projects with
a diverse range of expected returns, risks and
correlations. Do all that you can to make each project a
p in mind that it’s the overall portfolio
p
success but keep
performance that matters.
 Get Intellectual –IP is the key to creating value. A small
dose of IP mixed with commodity assets can go a long
way.
61
Recap & Final Thoughts
 How?
 Get Intellectual (Continued):
 Leverage Market Driven Inventing to
increase hit
hit--rate
 Use best available Valuation and Portfolio
management tools
l to ensure financial
fi
i l
success.
62
Recap & Final Thoughts
The essential part of creativity is not
being afraid to fail.
fail - Edwin H
H. Land If all
ll else
l fails,
f il immortality
i
t lit is
i
guaranteed by one humongous
error. - Anonymous -
63
Recap & Final Thoughts
Thank You! -- Copies Available At
www.valueresolution.com -- And -- www.cpbis@gatech.edu
Contact Information
Dan Cenatempo
President -- Value Resolution Group,
Group Inc.
Inc
770-522-8972 -- dan@valueresolution.com
Jim McNutt
Executive Director – Center for Paper Business & Industry Studies
404-894-5733 – jim.mcnutt@cpbis.gatech.edu
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