A recent business study projects major changes in use for key print products, but growth will exceed projected substitution losses

Where Are Printing And Writing Papers Going In An Internet World?

A recent study by the Boston Consulting Group (BCG), “Paper and the Electronic Media: Creating Value from Uncertainty” is one recent attempt to answer this question. This article is a summary of the major findings of this report, which projects demand growth and possible substitution by EM over the next five years.

The study concludes that overall paper use in the key regions studied, which account for a majority of global printing and writing paper demand, will continue to increase in the next five years despite some losses to electronic media that are projected to occur. The losses will be greatest for newsprint, and a considerable amount of the displacement will occur in the United States, the world’s most advanced economy and thus the area most susceptible to the impact of EM substitution.

As the study points out, predictions about the electronic substitution of paper-based media are often excessive: online newspapers will eliminate print editions, email will wipe out conventional mail; commuters carrying paperless briefcases will board trains bound for paperless offices. But of course none of this has come to pass, and while obviously the use of electronic-based information is growing at unbelievably rapid rates, the impact on the use of paper is at best unclear.

However, even these modest losses predicted in the study will have far reaching impacts on the pulp and paper industry, and even more directly on their customers in the publishing, printing and communications industries. Even the ubiquitous U.S. Post Service will feel the effect of substitution via displacement of envelope use.

METHODOLOGY AND SCOPE. The study describes and quantifies the likely effects of electronic substitution on graphic (or printing and writing) papers—i.e.,. newsprint, uncoated mechanical, coated mechanical, coated woodfree and uncoated woodfree grades—identifying key factors that will drive the switch and discussing strategic implications for paper producers. The substitution effects were quantified through the year 2003 for five major countries and the rest of the world (RoW). The countries are: U.S., Germany, U.K., France, and Japan.

At the core of the analysis are evaluations of the impact on seven major print products: newspapers, magazines, catalogs, books, inserts and direct mail, directories, and office papers. The countries studied represented 53% of global printing and writing paper markets.

In addition to quantifying the impact on paper use in terms of tonnage, a goal is to also provide industry managers with a framework to consider their own business assumptions and strategies for survival in the information age.

For each of the print markets, growth rates were projected through 2003 using various traditional forecasting techniques including trend line and other market projections from various sources, without assuming that any substitution effects would occur. Then, a model was used to assess various substitution effects over the next five years. The study focused on printing and writing papers since they are directly impacted, but it was noted that packaging grades could be impacted by trends such as e-commerce.

The effect of substitution was evaluated by application rather than by grade because a shift in behavior or use by consumers or users is focused at the application level (e.g., a book, magazine, or catalog). Once the impacts by application were projected, projected paper use by application in 2003 was converted back to consumption by grade.

DIRECT SUBSTITUTION FOR PAPER. Overall, two key criteria were used to determine direct substitution: (1) availability of the new medium (Can I get it); and (2) switching probability (Will I replace the old application, i.e. print product). These factors in turn can be broken down into six major drivers of direct substitution (Figure 1).

FIGURE 1: Six Drivers are used to evaluate the likelihood of substitution.

A key aspect pertaining to availability is Internet penetration and match of demographics. Internet access enables access to electronic newspapers, magazines, catalogs, etc. The following Internet penetration rates compare December 1998 levels to 2003 projections by region: 44% in 2003 vs. 24% in 1998 in the U.S.; 20% vs. 15% in the U.K.; 20% vs. 13% in Germany; 25% vs. 7% in Japan; and 20% vs. 7% in France. The match of demographics was used, for example, to match Internet users to application users. In some cases the match was as high as 100% but as low as 50% for some applications.

Once consumers have access, then the probability that they will switch from a traditional print medium to an electronic one is strongly influenced by the following factors:

Superior economics. While difficult to pinpoint, it’s obvious in many applications that electronic information products can be up to 50% cheaper to produce, thus leading to cheaper consumer prices. So far, most electronic media are published in addition to print, postponing any cost advantages to the publisher and actually increasing overall costs.

Reading habits. These strongly influence consumers’ openness to change. Real obstacles to substitution can be created as well, such as reading at the beach or on a train.

Emotional attachment. Liking a collection of books, and their appearance on shelves, make a consumer less likely to switch.

INDIRECT SUBSTITUTION. Indirect substitution that affects the use of print products is another factor addressed by the study. Advertising is a key example of indirect substitution. As more advertisers go online, a reduction in print advertising revenues will undermine many companies’ financial base. For example, if online substitution for newspaper advertising occurs, it will hurt newspapers significantly.

KEY CONCLUSIONS. Overall consumption of these grades will continue to rise, but substitution by EM will reduce demand by 5.2 million short tons in 2003 vs. growth without the effect of substitution (Table 1):

• Newsprint will be the biggest loser. About 15% of North America’s 1997 capacity will be superfluous by 2003, or the equivalent loss of 1.4 million tons of demand.

• Cut-size papers will win. The shift from printing and distribution to individual printing will continue.

• Producers of paper face changes, too; but only in the long term. In general, information–based applications are likely to see substitution first, while leisure-related applications will follow more slowly.

The impact on projected average annual growth rates for the most part will be modest in coated woodfree and uncoated woodfree. For coated mechanical grades, the impact will result in a 2.3% decrease from potential demand in 2003. In newsprint and uncoated mechanical grades, however, the impact of substitution in percent (i.e., substitution losses in 2003 divided by projected volume in 2003) will be more substantial, projected at 19.9% and 6.0%, respectively (Table 2).

The impact of EM substitution on each of the key products is summarized (Table 3),

illustrating the impact from a tonnage standpoint by region and print product for newspapers, magazines, directories catalogs and books. The impact on cut-size is presented separately (Figure 2).

FIGURE 2: Growth in cut-size use will be strong, and electronic media will help, not hurt.

NEWSPAPERS. The study concluded newspapers would be the biggest losers, accounting for half of all losses due to substitution. Newspapers have a high information content susceptible to substitution, have high fixed costs (paper, printing, and distribution), and are subsidized by advertising. If advertising revenue drops due to shifts to electronic information (e.g., online classified), the whole underpinning of the industry is jeopardized. In addition, there are traditional editorial rivals such as television and on-line information services.

Among the new media identified as threats to newspapers are portable electronic newspapers, fax-on-demand, and on-line news services. The first two to date haven’t had much impact. However, online services have the potential to be more competitive. To date, the economics are complicated, as few online services are making money.

Indirect substitution through a reduction in advertising will compound the effects of direct substitution of electronic-based information for traditional paper-based newspapers. Newspapers have already weathered the first wave of indirect substitution, i.e., TV, direct mail, and radio. However, the advantages of electronic media, in terms of cost and targeting capabilities, means online advertising strongly threatens newspaper advertising. The study projects that classified ads, the biggest single revenue source for newspapers, are already beginning to shift to online format. It’s projected that that by 2003, 15% of the U.S. classified market will be online; 10% each in Germany, France, the U.K. and Japan. Eventually classifieds, yellow pages, and related vertical information sources should merge into one seamless service.

Overall, the study’s results for newspapers show the trend in stagnating or downward worldwide circulation will continue. Assumptions for development without substitution effects include an annual decline in newsprint demand of 1.9% in the U.S., a 0.2% drop in Japan, and 1.3% growth in Western Europe. Internet access will remain the main obstacle to, and key driver of, direct substitution. Critical scale for electronic classifieds also will depend mainly on Internet penetration. Thus, the U.S. is believed to feel the effects of substitution most strongly. In terms of total impact on newsprint producers, the results show that of a projected total in 2003 of 27.8 million tons without substitution, electronic substitution will cause a loss of two million tons.

Direct substitution is also a key threat to newspapers, as more and more readers use electronic news services. While most of these currently lose money, the study points out that users will begin to pay for content and this will make online newspapers a major force. When this occurs, the fact that there is a considerable oversupply of traditional newspapers will force consolidation and change the geographical scope and business mix by product grade.

Strategic implications. Newsprint producers face fierce competition owing to oversupply issues, and strategic options for producers in the face of the expected declines will continue to put pressure on costs and force some players to exit. Otherwise, strategic options include focusing on low-cost production, adapting geographic scope (Europe will be affected later, Asia very little over the next five years), and reviewing grade portfolios.

OFFICE PAPER: A WINNER. A rise in individual printing will increase consumption of cut-size papers, the largest segment within office papers. It will mean a near doubling of cut-size consumption by 2003 compared to 1996 levels (Figure 2). The factors driving this are: continued shifts in the office from copying to printing and the much smaller effect of growth through transition from mass printing to print on demand in the home.

These changes will also change distribution channels, which will continue to shift from traditional paper wholesale toward office superstores and other retailers. Thus, cut-size will increasingly resemble a packaged consumer good.

However, substitution will also hurt paper use. For example, of the three office paper segments considered in the study—cut-size, special repro, and envelopes/forms/labels; only cut-size will grow significantly. Other applications will likely deteriorate.

For example, the study predicts that a rise in e-mail will lead to a one million-ton drop in envelope use. Paper demand for forms will also drop—a continuation of a long-term trend, and there will be a shift in from pre-printed to printed formats.

Also, regional growth differences will be significant. In the U.S., for example, the growth of cut-size already has slowed, whereas expectations for Western Europe, where saturation has not yet been achieved, are stronger. Also, for paper producers, cut-size gains will not compensate for overall substitution losses in publication papers (Figure 3).

FIGURE 3: Printing out “publications” received electronically will lead to cut-size use in place of publication papers.

Strategic implications. From a paper producer standpoint, these changes will lead to fundamental shifts in the market. The shifts underway will lead to increased use of color printers, and, thus ,demand for smaller product units. This will also change distribution and retail skills needed to be successful, i.e., paper companies will be marketing more to the end use customer, making branding important.

MAGAZINES AND CATALOGS AFFECTED. Losses due to substitution will also occur in magazines, books, catalogs, and directories; but they will be slower than for newspapers. While magazines may mimic the economic model of newspapers, high fixed costs and subsidization of content by advertising—the threat of electronic replacement is reduced in the near term because timeliness is not as critical with magazines as with newspapers. In addition, emotional attachment, reading habits, and handling are critical. Magazine advertising also will not erode as rapidly because it is mostly brand-oriented, rather than classified, the study concludes.

Also, magazines promise growth with increasing readership and advertising revenue. Online substitutes will significantly affect only 12% to 33% of magazines, particularly financial magazines, where the need for updated, in-depth information may foster greater substitution. The study projects that over the time frame analyzed, direct substitution will reduce the projected 15.6 million tons of paper consumed by magazines by only one million tons.

Catalogs are more likely to be affected by electronic substitution, with information-based applications substituted first, and leisure-related applications following more slowly. Elimination of paper costs as well as reduced production and distribution costs make electronic catalogs a viable alternative for mail order companies. Paper accounts for 10% to 15% of total catalog expenses. For consumers, the advantages of electronic catalogs (searchability, interactivity, animation, and timeliness) will outweigh the portability and familiarity of paper catalogs. The study concludes the shift will occur relatively quickly and predicts that by 2003, substitution will reduce projected catalog paper demand by 12%.

BOOKS: SOME SEGMENTS THREATENED. Overall, the study predicts that the book industry can expect a slight overall growth, but substitution poses a danger for information-based books. Traditional reference books are already the biggest losers (e.g., encyclopedias) and the study predicts technical, scientific, travel, and education books will follow as electronic databases continue to expand. Entertainment oriented books will be less affected, with fiction least likely to go online. By 2003, 9.5% of total 1996 paper consumption by books will be lost to electronic substitution.

A discussion of electronic books was part of the book analysis, and outlined some of the pros and cons of the new generation of these products.

DIRECTORIES DECLINE. Electronic directories offer significant advantages to consumers, cut costs for publishers, and offer value to advertisers. With such a convincing online value proposition, and because the electronic version presents few disadvantages, only Internet penetration will limit substitution significantly. The study results conclude that by 2003, if 80% of all Internet users use electronic directories, paper consumption by directories will drop 23% from 1996 levels. Modeling assumptions include a 2% worldwide growth rate and no indirect substitution.

EFFECT BY GRADE AND REGION. A much different picture emerges when application-based views of the impact of EM are re-interpreted as paper grades. For example, EM will not totally substitute for certain paper uses, nor will the overall effect be negligible. As an example, newspapers will suffer the most and will have their heaviest losses in the U.S. For all paper grades except coated mechanical, the U.S. will feel the negative impact of substitution most strongly. And in all but one region, substitution will have a negative effect on every grade. In Western Europe, the effect of substitution on uncoated woodfree will be positive; and positive and negative effects will roughly balance in the rest of the world.

STRATEGIC IMPLICATIONS. Overall, it seems, the message for paper producers is not as gloomy as the predictions would suggest. A number of product areas are likely to grow in spite of substitution. Large sectors of the world population don’t yet have access to a phone, let alone the Internet. Thus, significant growth in paper demand will occur in many emerging markets (Asia and Latin America, for example).

And yet, even under the fairly conservative assumption outlined in the report, some fundamental issues for pulp and paper company business portfolios and the strategic migration necessary to meet the challenges of a new competitive landscape. The risk of frequent, unexpected changes in technology, user behavior, and economics will increase. Such pressures, coupled with the change-averse culture of the pulp and paper industry (due to its asset intensity, and perhaps more fundamentally, to its traditional way of thinking), will create a volatile environment.

In general, the combination of an asset base that can be shifted only gradually with a rapidly changing environment will deny industry leaders a long wait-and-see approach.

MILL/GRADE PORTFOLIO CHALLENGE. An interesting aspect of the study is that it delves into the importance of the impact of the substitution effects outlined on the portfolio of assets that a paper company possesses. It notes that some players will be more vulnerable than others and offers some examples of generic companies and how they are impacted and how they could respond.

The portfolio threat, i.e., the exposure of a producer’s mills and/or product mixes to the substitution effects outlined in the study, is quantifiable along two dimensions—geographic regions and paper grades. The issue facing them are:

• What is the substitution threat for our current market and product mix? How is the supply/demand balance likely to evolve? Who are the key players (old and new) in both the threatened and the growth grades?

• Taking into account the varying grade and regional growth prospects, how will our portfolio’s performance be affected if nothing is done? What will be the resulting differences in segment attractiveness and profitability?

• How can we reconfigure locations and ourselves to participate in growth segments?

Strategic possibilities from a portfolio viewpoint include a focus on:

(1) Global, consolidated, lowest-cost operations (newsprint, for example),

(2) Regional dominance and high customer shares enabled by regionally cost-efficient delivery and service operations, key account management, and high flexibility (magazines),

(3) Regional and local consumer grade businesses, with strength derived from logistics skills, product development, branding, and eventually global production alliances (fine paper, for instance).

In addition, the study outlines the impact of these shifts, which will create new distribution channels and alter storage and inventory demands. All of these changes will alter the skills needed by paper companies, as well as introducing new R&D challenges due to changing customer requirements (for color printing, for example).

In general, the study concludes that grade and regional mixes will determine the strategic significance of substitution: companies with high newsprint share and a U.S. focus will lose most. Companies with fine paper concentrations in the U.S. and Western Europe potentially will benefit. Options vary widely for multi-grade and monograde companies. Whereas, the former need to rapidly shift their grade portfolio by altering the product range or adapting their geographic scope, the latter might choose to cocoon themselves in their specialty segment or region in a quest for leadership in a consolidating environment.