Paper companies have been proponents of supplier consolidation but views on whether costs, service, and innovation will be better or worse vary

Rapid Supplier Consolidation Narrowing Mill Purchasing Alternatives

Paper producers have been a key driving force behind this consolidation - at least at the corporate purchasing level. They've asked for more service and broader product lines, at a lower cost, and they want to deal with fewer vendors. The industry has responded, but a number of questions remain about the true impact, and some mill personnel fear the changes that they have urged. Will mills actually see lower costs over the long term? Will research and development efforts be sufficient, as mills become more reliant on supplier R&D?

A summary of major mergers occurring in the last two to three years is given in Table 1. It's not an all-inclusive list. In some cases, mergers going back further in time are listed if they were of unusual significance to pulp and paper mills. A number of acquisitions have also occurred where, for example, only a portion of a company product line was acquired. In addition, mergers in a number of other areas, such as software, used equipment supply, etc. has occurred. These were excluded from the list simply for brevity.

Consolidation has swept through many, if not all sectors of the various industry groups that serve pulp and paper mills in North America and worldwide. At this point, it's even hard to even keep all of the names straight. In some areas, consolidation has reached the point where two major players, followed by a number of smaller suppliers, compete for business. This is particularly true in North America and Europe. In other areas of the world, the market remains somewhat more fragmented in areas such as chemicals, where additional regional players continue to operate.

The largest number of mergers has occurred in the chemical industry. However, if an area such as process automation is broadened to include instrumentation and software, many ownership changes have occurred there as well. Mergers in areas such as petrochemicals, which are mainly driven by non-paper mill issues, also have a major impact on the paper industry. For example, oil, gas, and other chemical concerns drove the Mobil and Exxon merger, but they are also two major suppliers of paper mill lubricants.

WHY MERGE? Paper companies have merged, at the urging of Wall Street, as a means of improving the industry's recent dismal financial performance. As they become larger, they're trying to drive down all costs at the mill level, and thus they're asking for suppliers to carry more of this burden. In order to supply a wide range of products to multi-mill companies, suppliers have been forced to extend their reach as well. Initially, many tried to ally with competitors, to forge alliances or marketing agreements The more prevalent trend recently, however, has been for companies to actually merge. As producers focus more and more on driving costs out of their mill manufacturing systems, corporate purchasing sees the Òcost per lb. of xyz productÓ as the method of doing so. As this mentality has become more prevalent, suppliers have been forced to try and find a way to provide the same value and services for a lower cost.

As a result of all of these market forces, mills now have the option in many cases of Òone stop shopping.Ó Or at the very least, have the option at the corporate level to simply put up their business for bid and state up front that they will select only one or two major suppliers that they expect to deliver the whole package.

Among the largest mergers of companies largely dedicated to the paper industry has been the merger of Valmet Corp. and Rauma Corp., announced in 1998 and completed July 1, 1999. The new company, named Metso Corp., brings together the most complete line of pulp and papermaking equipment by combining Valmet, Sunds Defibrator, Valmet Automation and Neles Controls. The new group had combined 1998 sales of $4 billion, with nearly two-thirds delivered to the forest products industry. Combined sales in 1998 were 49% in Western Europe, 30% in North America and 17% in Asia.

The merger proposed by Ahlstrom and Kvaerner would also be a big change if it occurs, combining two large producers of pulp mill and chemical recovery equipment. The merger is still pending.

As noted, several large mergers occurred in paper chemicals. However, even larger ones have occurred in areas where companies serve multiple industries. Notable examples include the Allied Signal acquisition of Honeywell who had earlier acquired Measurex.

MERGER BENEFITS. What are the goals of these mergers? In addition to responding to customer needs, companies are trying to shore up their market positions as well. Acquisitions can add added heft in existing product lines via extending geographic reach and thus enlarging market share, or it can allow them to supplying more products to the same groups of customers, or it can do both.

So is bigger better? Normally of course the bottom line -- improved earnings and /or shareholder value -- is given as the ultimate reason behind a combination of assets or business lines. Certainly, if a merger doesn't offer cost or efficiency savings, simply becoming larger and gaining market share may not be sufficient justification. Historically, for example, over expansion by paper producers was in part driven by this kind of Òretain market shareÓ mentality.

However, there are certainly opportunities for larger companies, with broader product lines and increased technical knowledge, to improve a mills operation. As pointed out by Thomas W. Fredericks, President, Pulp and Paper Div. of Hercules, one result of a larger company with a broader product line is that that company can also better manage the interaction among different aspects of a mill. For example, ensuring that chemicals or additives used at one point in the mill or on the machine interact effectively with another product added somewhere else. While this, of course, was done in the past via the inter-relationship of multiple suppliers in the same mill, it can certainly offer the papermaker the potential to better operate the machine via increased efficiencies, he notes. This provides the opportunity to look at the whole machine and in the case of chemicals for example, to lower costs by improving overall efficiency.

As noted, a merger can simply increase the scope of the products available, increase market ÒheftÓ geographically, or do both. Michael T. Mack, President, Worldwide Paper Division, of Imerys, the company that brings together ECC and Imetal's DBK, RCC and Georgia Marble into a large multi-pigment company, notes that they can now mine and source kaolin and carbonate from Europe, North America, South America, Australia and Asia. This allows them to provide a wider range of products, and options in transportation costs, etc., being the only supplier to offer a complete kaolin and carbonate product range. Investment in GCC and PCC (ground and precipitated calcium carbonate) sites and process technology is a priority, he notes.

The $4.1 billion acquisition of Nalco Chemical Co. by Suez Lyonnaise des Eaux provides similar opportunities, notes Terry Burns, President of Nalco's Pulp and Paper Div. Suez is a world leader in private infrastructure services. Nalco's broad product line of process and water treatment chemicals is now combined with the parent company's capabilities in water treatment equipment and plant management expertise. A mill can now opt to have the company manage or even construct a treatment plant and provide all necessary chemicals, essentially outsourcing incoming raw water treatment or effluent treatment. Again, mills have the opportunity to focus on making paper, rather than being in the business of running a treatment plant, a recurring theme noted by many suppliers. Suez-Lyonnaise also purchased Aquazur in Europe and Calgon Corp in the U.S., making the company the largest in the global water treatment business, moving it ahead of rival Vivendi. Suez Lyonnaise recently took over complete ownership of its partly owned subsidiary United Water Resources, which manages municipal water treatment facilities, including those of the city of Atlanta.

IMPACT ON INNOVATION AND RESEARCH AND DEVELOPMENT. As fewer, larger supplier companies dominate sectors of the industry, one question of key importance to mills is the impact on research and development. The pulp and paper industry has relied on supplier expertise for many years. Mills in Europe have tended to be further along in this. But undoubtedly, mills are cutting technical staffs and either cutting or eliminating research and development staff as a cost cutting approach, making them even more reliant on suppliers for technical knowledge, and in turn R&D.

Is this a good thing, or will this decrease the options available to mills to differentiate their products from their competitors? The view on this is mixed but is more negative than positive according to a sample based on our mill managers survey (see story in this issue). Some mill staff feels that increased reliance will limit their options and product development efforts. ÒWe'll all be buying exactly the same thing, with no proprietary technical edgeÓ, noted one technical manager for a smaller mill. However, another at a small specialty paper mill noted that they've never had the same resources as the larger paper companies and have always depended on supplier innovations.

As noted by one major supplier, in theory, this (less innovation and new product development) shouldn't be the case. Fewer suppliers should afford pulp and paper manufacturers the luxury of working with fully integrated supplies with tremendous resources and a vast experience base. This should help to drive some changes and innovations more rapidly without the conflict that sometimes arises with competitive scenarios (multiple vendors).

In addition, as noted by Fredericks of Hercules in the case of papermaking chemicals, the papermaker can focus on the business of making paper productively and the supplier can focus on chemical management -- both parties can make progress on long-term projects that improve machine operations the most.

One benefit noted if mills do give their business to one supplier, and commit to that relationship over the long term, is that mill staff will spend less time managing the supplier and reviewing contracts and bids. Similarly, if longer term arrangements can be worked out, mill staff is spending less time putting out bids, and more time focusing on their own operations.

The slow down in capital spending, notably in North America, but also due to the collapse of Asian financial markets two years ago, has also been a major factor driving consolidation. As noted by Robert D. Puhr, Group Vice President, Communications, Ahlstrom Machinery Group, the fall off in major pulp mill expansion projects means that there is simply not enough business to support multiple suppliers. Citing the U.S. as an example, the leading region in the world for paper/board production, the last five years have seen the purchase of three cooking systems, four recovery boilers, and one large white liquor plant. Any single supplier has the capacity to handle this market volume over the five-year period, Puhr noted. With business this weak, no manufacturer of capital equipment such as fiberline systems or recovery boilers can generate acceptable margins to fund intensive R&D programs. Given this market situation, Puhr noted that Ahlstrom has tried to offer creative solutions such as Òopen bookÓ contract partnerships with owners and other Òno business as usualÓ approaches. However, the Boards of Directors of customer companies seem unwilling to try such approaches, preferring the traditionally costly, and mostly adversarial, competitive-bidding war. The proposed merger of Ahlstrom Machinery and Kvaerner Pulp & Paper, originally conceived to consolidate some of the excess capacity in the supplier industry, has been delayed. It has been reported that certain parties have raised objections to the merger.

MILL LEVEL COSTS. Probably the biggest question about consolidation over the long term is its impact on mill costs. As noted, corporate purchasing's theory essentially is that fewer suppliers mean lower costs. As commodity producers, paper producers have always wielded pricing power over the customer and suppliers, which have tended to be smaller than commodity paper producers. Larger paper companies are extending this by bidding out larger contracts for multiple mills and asking for the lowest cost. For suppliers, of course, being bigger means companies can spread R&D, administrative and sales costs, over a larger sales volume. And as noted above, managing more products at a mill provides more opportunities to improve operations.

But some mill staff wonders if fewer suppliers will mean that there is reduced competition and thus higher costs. For example, one noted that when you have two major players and one or two smaller players, you get more competitive pricing. Even if the two top suppliers have a large portion of the business, the presence of the smaller players means mills have purchasing flexibility. Similarly, a senior engineering/capital project manager of a mid-size paper company stated that Òyou can bet if it gets down to two fabric suppliers that they'll raise prices as fast as they can.Ó

In contrast to this view, many supplier companies and mill personnel see that size and product diversity will lead to lower costs by allowing them (the supplier) to offer more efficient and compatible technologies and products. Furthermore, it was noted that it's hard to see how prices could rise unduly, since even in the most concentrated areas there are at least two major suppliers, and some smaller regional players as well that often compete on price. In fact, the smaller suppliers, in today's market, often compete mainly on price, and tend to pull down everyone else's margins as well.

CAN SUPPLIERS AFFORD THE PAPER INDUSTRY? However, a somewhat widespread concern of many supplier companies is the challenge to provide better service, better products and increased technical support while always, always having to compete for the business by bidding the lowest. It was noted that papermakers are so focused on driving down costs, that they are in turn driving down the value of what the supplier company provides. Thus one big challenge is that current pricing in some products doesn't leave much room for innovation. As another noted, this issue may have nothing to do with the number of suppliers and everything to do with profitability and profit margins. If there isn't some balance between the need for lower mill costs, and supplier profit margins, it will simply evolve to the point that even larger suppliers won't be able to offer the innovation customers request. Or put differently, their management or board or directors will simply reallocate their assets to businesses other than pulp and paper mills if they can't return an acceptable profit.

HOW CONCENTRATED? Mergers will likely continue to consolidate the industry, although in some areas it may have run the course for now. For example, in papermachine clothing in North America, there are now four major groups: Albany International, Voith Fabrics, Weavvex and Asten-Johnson. This is down significantly from the early 1990s. The most recent mergers in this important area for papermachine operations was the acquisition of the Scapa Group by JM Voith. Scapa Paper Machine Clothing was merged with Voith Appleton to form Voith Fabrics, with global headquarter in Raleigh, NC. Scapa Rolls was merged into the Service Div. Of Voith Sulzer Paper Technology and has taken on the name VSPT Service Div., and global headquarters were moved from Middletown, Ohio to Charlotte, N.C. The Albany International acquisition of Geschmay, and the Asten and JWI merger to form Asten Johnson, have quickly reduced the number of players in this area.

In papermachines, two major players now account for about 60% of new machine orders, based on complete new papermaking lines ordered for startup in 1999 and 2000. Based on capacity of the machines, according to data provided by CTS Consulting OY in Helsinki, Finland, Voith Sulzer Paper Technology has a global market share of 34.0 % and Valmet 26.3%, with Beloit at 9.0%, all excluding licensees. The remainder account for about one-third of orders. The future of the number three player, Beloit Corp., remains uncertain, as parent company Harnischfeger has filed for bankruptcy. Harnischfeger has said they've put Beloit up for sale. The only offer for the company that has been confirmed is one by KPS Special Situations Fund LP. This group helped finance the employee buyout of Champion's former Canton, N.C. mill.

IS PURCHASING GLOBAL? Certainly the trend towards larger paper companies using fewer suppliers on a corporate wide basis has occurred on a regional basis, e.g. within North America. Several large producers have taken the approach of putting the business out for bid and stating up front that they are going to choose a select group of companies from the bid list. This has been a driving force behind the mergers since it's necessary to have the market reach and knowledge to bid for a multi-mill contract. Most vendors report that at this point, however, purchasing on a global basis is relatively rare. A few companies are leading the charge, notably of course the larger global paper producers. Almost everyone expressed the view that purchasing on a global basis will become more common.

SUMMARY. Mills seem to now have what they've been asking for. Fewer suppliers that can deliver a whole package of products backed up by on-site technical staff and extensive research and development capabilities. However, there also seems to be concern that they've created potential problems for themselves, as they are now reliant on a smaller group of vendors. From the supplier viewpoint, mills are so focused on minimizing cost/lb. or cost/ton, that it's a challenge going forward to provide top-notch service at bargain basement prices. It will be interesting.