According to some views, buying and selling paper via the Internet will force radical change on the pulp and paper industry as it expands

E-Commerce Dot-Com Companies Target Pulp and Paper Industry Transactions

But what does this mean if you buy or sell industrial products such as pulp or paper, or buy chemicals or equipment to run a mill? Just as consumer e-commerce has grown rapidly, the potential for business-to-business (B2B) transactions has grown as well. A wave of Internet-based e-commerce web sites that provide the opportunity to buy and sell pulp and paper products have proliferated over the last year. This article will delve into what all the hype is about, provide some background into the current and projected market for e-commerce, and describe some of the dot-com businesses that have targeted the pulp and paper industry.

E-COMMERCE DEFINED. What is e-commerce? It’s simply the use of the Internet to effect business transactions. More specific definitions exist as well. E-commerce is the purchase of goods and services that must be at least initiated from the web, according to International Data Corp (IDC). Forrester Research defines e-commerce as the trade of goods and services in which the final order is placed over the internet.

FIGURE 1: The new economy could transform how the paper industry operates.

However, while consumers shopping for shoes or clothes, or looking for financial data, get most of the general public’s attention right now, B2B e-commerce potential dwarfs the retail or consumer markets in terms of scale. If only some of what dot-com proponents think will occur in the paper industry, it could impact the way almost every employee in the industry—at the mill and corporate level—does his or her job. In fact, in many cases, it will change the job itself.

The paper industry has jumped on the bandwagon—at least in terms of using the Internet—and most paper producers and supplier companies now have some form of web site. To date most are merely extensions of traditional corporate communications functions, and many are still just trying it out for size. You can find news releases, descriptions of the business, some product information, etc. But these efforts haven’t changed the way companies work and interact with their customers, except in a couple of cases, although this is beginning to change. Currently, the most widely quoted example that is changing how customers interact is Weyerhaeuser’s Door Builder site, which allows distributors to order and specify doors via the internet.

ALL PLUGGED IN? Will people in the industry use such sites to buy and sell products to a large extent? One key requirement for the widespread use of a new technology—the key to success—is ready, easy, cheap, and broad access. Being able to access the Internet isn’t an issue for pulp and paper company personnel according to a recent study. It’s whether there is anything on it that they are interested in. Data developed by Freebairn and Co. in 1999 found that by this year about 96% of paper company employees will have access to the internet either at home or work or both. This data is based on a sample of the industry surveyed last year (Figure 5).

How the industry uses the Internet, and how it impacts business could all change in the next few years if e-commerce use expands. In fact, proponents of this technological revolution, notably companies involved in it either as providers of e-commerce services or management consultants, believe the internet will radically transform how paper is bought and sold. It will change what is bought and sold to whom and by whom. It will certainly make the job of a company’s chief information officer important. In addition, major suppliers of products to paper mills, in particular chemical producers, are looking at using this technology as well.

Over the past year or so, the potential of the internet to change the paper business has moved from a whisper in Silicon Valley to a louder call that many are listening to. The first evidence of this of course is the emergence of numerous web sites devoted to the buying and selling of pulp, paper, and paperboard, and to a lesser extent equipment, services or chemicals (Table 1). Some of these Internet sites and companies have ties to the industry via some of their personnel, who are former industry employees. The most notable are “new economy” startup firms that have been funded either by venture capital and/or by initial public stock offerings (IPO), as in the case of VerticalNet. In addition, as discussed further below, the chemicals industry is moving considerably faster than the paper industry to embrace Internet e-commerce.

FIGURE 2: Share of the Internet B2B Economy by Industry Segment in 2004

TIP OF THE ICEBERG. So far, most observers would agree only a miniscule amount of pulp and paper is being sold via these sites. Many are simply on-line catalogs for existing merchants. Other true exchanges, such as PaperExchange, charge a 3% commission on sales. Some other sites merely offer the opportunity for buyers and sellers to meet, and charge no fees at all.

But what if a true paper auction or exchange develops that moves billions of dollars worth of pulp, paper, equipment, and chemicals? The following outlines what e-commerce is all about and why it could change many aspects of the paper industry.

Much of the information for this article is based on presentations made at The Global Outlook Conference, sponsored by Miller Freeman, and held in New York in November, 1999. In particular, the content is based on Session VIII, “Using Information Technology to Enhance Competitive Advantage.” A summary of key information presented at the conference is included here. In addition, other sources of information have been culled to provide additional insight (See end of article for sources of information). In upcoming issues, Pulp & Paper will delve into more detail into this subject by examining the lead players involved, as well as the challenges and problems with delivering all of the functions and benefits that Internet-based businesses promise.

FIGURE 3: Paper industry Internet-based sales are forecast to top $90 billion by 2004.

I.T. AND THE NEW ECONOMY. E-commerce is just the latest, but possibly the most influential, component of developments that are driving unprecedented changes that affect all business. This includes the staid old pulp and paper industry. According to Bradley Rosencrans, partner, Andersen Consulting LP. in his talk entitled “Using I.T. in the New Economy,” the major points are:

• We are already in the midst of a new economy

• Old business models won’t work

• Two sets of imperatives have emerged for I.T.:

1.) Addressing the impact of the new economy

2.) Determine the right strategy for Enterprise Systems

In the New Economy, globalization, over-capacity, customer-centricity, e-everything, re-regulation, and shareholder value are the key issues. And to some extent, the New Economy is being driven by what’s happening with e-commerce and information technology, although it is much broader than that.

Even more importantly as related to a process industry such as pulp and paper, Rosencrans noted that the old, “production push” business model won’t work. In the old model, a mill ensures fiber supply by overproducing trees, mills are run at 100% all the time, and product is pumped into the market based on running these mills at maximum output. The whole system was set up to run, run, run the mills in order to spread fixed costs across maximum volumes. In turn, in this environment, the role of marketing and sales are relatively straightforward—I will sell 100% of production. Mills do what’s needed to make the sale, by providing a little better service or by cutting the price.

In the new model, the market and the customer will drive the business, i.e., “manage the relationship.” Businesses will be designed from the customer backward, not from the mill forward. This new model can be called “demand-pull.” It starts out with the idea that the marginal costs of the last few percent of capacity actually go up in a big way.

Given this new understanding of marginal economics and the cost of the last ton of production, the approach of marketing would change because an understanding of true costs influences the customer mix. This means that for the first time, the business could be designed more from the customer side backwards.

But what are the new rules then? One of the key rules is that the consumers will manage the relationship. One outgrowth of this, Rosencrans notes, is that new network intermediaries are going to emerge that increasingly will broker the customer-supplier relationship. These are the dot-com intermediaries, of which many have emerged in just the last year or less. Another key point is that Wall Street is going to, in the future, value companies very differently. It’s not just about market share; it’s about mind share and intellectual property.

TABLE 1: The number of web sites covering the pulp,paper and forest industries continues to expand.

TABLE 2: Another view of how e-commerce models function.

Brand new business models have developed too, such as new order-to-delivery models emerging in the high-tech world, exemplified by Cisco and Dell. In these models they do not own everything, i.e., every piece of the manufacturing process. The sense from this work is that the paper industry will undergo change as have other industries.

For example, what if a radical consolidation occurs in the paper industry? This is starting to occur. Furthermore, what if the industry radically consolidates around portions of the value chain? For example, companies don’t have to own all of their timber. What would happen if efficient markets emerge between these components of the value chain, enabled by these new information brokers (dot-coms).

Of course, to “pull off” these big changes he notes, will require information technology. This will be particularly key as producers move away from the “production-push” model. By contrast, in a demand-pull environment, a fast changing integrated system is needed. Furthermore he notes, in terms of playing in a new economy, a company has to quickly establish and align with the partners and customers that are strategic. These are customers that value a high degree of interaction and value the relationship, and the process of dealing with them has to be streamlined and easy. But at the same time, there will always be customers that are going to buy on the basis of price. This is where many of the auction houses on the Internet will be supporting business. All of this will lead to a different operating model that’s emerging (Figure 1).

Integrated ERP systems are a key to support this new demand-pull environment. Rosencrans noted that a recent industry survey showed that about one-third of Forest Products companies surveyed globally either have no plans whatsoever to touch ERP or are just thinking of it. Fully another third are just getting started and the last third are in the middle of roll-outs with a very small percentage saying they were completed. There are many reasons for this slow pace of adoption, he noted, including the fact that it’s not a slam-dunk for the industry.

FIGURE 4: The Internet could transform the forest products supply chain.

B2B E-COMMERCE POTENTIAL. The size and potential of e-commerce in the pulp and paper industry is tremendous, noted Bill Lenihan of Andersen Consulting. The New Economy is going to change the industry in many ways. It will force industry to de-integrate, to specialize, and to increase new network-based value propositions. Among the changes, Lenihan noted, are that it will force the paper industry to focus on customers and intellectual capital instead of assets. Valuations will be based on soft assets, not hard assets, which will be a major shift for this industry.

E-business is real and growing rapidly, and much more rapidly than anyone had anticipated. The actions that paper companies take over the next 18 months (from Nov. 1999) will determine who’s going to win and who’s going to lose. It also may be that larger companies who are well established, asset intensive companies, lose out to smaller startups.

The pulp and paper industry, however, is conservative by nature, Lenihan noted, and this will stand in their way by and large. In addition, business units also tend to be fairly autonomous and many companies make the mistake of developing e-commerce strategies as a series of business unit strategies. Paper companies don’t have a good track record of developing and implementing systems, and many companies view e-commerce as just another IT project. Speed of action is an important aspect of this New Economy, and current e-commerce companies such as Chem-Connect and PaperExchange have come to market and established a presence quickly.

B2B POTENTIAL HUGE. E-commerce can be segregated into retail and business-to-business segments. The retail segment, which is where someone orders clothes online, is big, at an estimated $3 billion in 1997, but rising to $108 billion by 2003, according to a report in the Wall Street Journal, using data from Forrester Research in late 1998. By contrast, B2B, at $19 billion in 1997 is projected to grow to $1.3 trillion by 2003. Exact projections vary by source, he noted, but the magnitude of the data are similar (Figure 2).

And as Lenihan points out, projections for the paper industry itself are for growth to be strong. He cited a Goldman Sachs report projecting B2B revenue by 2004 at $1.5 trillion. The paper industry’s share of this is forecast at 6%, or $90 billion in Internet-based sales. (Figure 3).

Regarding B2B in the paper industry, the bad news is that it’s still in the very early stages he noted. In fact, many are asking whether it is really real? The good news is that every other industry has asked the same question, and most of these have moved to expand B2B e-commerce.

One of the first questions asked about e-commerce is how fast should a company move into the whole e-business area. Over the last 12 months, major companies such as Shell, Dow, DuPont, Mobile, etc., have asked the question and moved forward. They are radically changing the nature of their culture to create innovation-based cultures. Some are establishing whole new e-commerce ventures, which are separate businesses. Again, speed is important in the New Economy; today there are at least 15 Internet-based companies that are selling pulp and wood products on the Internet today.

Lenihan noted that someone told him not so long ago that “‘You’re never going to see e-commerce work in the steel industry, because UPS won’t deliver big cold rolls of steel.’ In late 1989, Metal Site opened for business and seven months later, they were responsible for facilitating 1.5% of the entire industry sales in the U.S. over that time.” He noted that Weyerhaeuser used its Door Builder system to sell twice as much product to half as many customers, and improve ROA from 2% to 27%.

So how does the industry move to embrace e-commerce? There are two dimensions to the e-business:

1. E-basics. Focusing on current products and services and how to cut costs to become more efficient.]

2. Moving to new e-ventures such as partnering with competitors or companies who make products that are different by could be complementary.

Moving to e-ventures involves looking at aggregating complementary and competitive products across the value chain. It’s about moving away from verticalization and is going to force specialization, requiring companies to partner more closely, and create alliances. Regarding what e-ventures are, there are several models that represent the various types of business models

A key point discussed in a panel question and answer session was the impact of e-commerce on profitability. The information revolution is a re-invention of how we sell and buy products. One aspect of this is that the pressure on prices will be even more severe, noted one panelist. Thus it’s even more important for paper companies not to wait for the next pricing recovery, but to work hard to reduce costs at the mill level.

In addition, a key trend is that buying and selling via the Internet doesn’t have constraints, such as channel conflicts placed on them. And they’re not constrained by short-term earnings goals either. Several conference participants did comment that not all transactions, and likely not even most, will utilize an auction or exchange mechanism, but rather will continue existing relationships.

Supply Chain Management. To illustrate just how big the Internet has become, Tom Beatty, director, Industry Architects for Oracle Corporation shared a quote from the well-respected CEO of GE Corp., Jack Welch. Mr. Welch stated in 1999 that “I don’t think there’s been anything more important or more widespread in all my years at GE. Where does the Internet rank in priority? It’s number one, two, three, and four.”

Beatty also noted that the Internet changes basic economic assumptions. One of the major ones is that the traditional supply chain will disappear (Figure 4). Internet companies have already significantly impacted some traditional “brick and mortar” companies, he noted. Examples include the impact of Amazon.com on Barnes and Noble or E-Toys on ToysRUs. This of course changes the basic economic assumptions for the forest and paper industries by radically altering how products move. Among the key issues that these changes will bring include a consolidation across the extended supply chain that leads to increased price pressures.

A key impact of all of these trends on the paper industry is that margins will tend to erode as increased information availability forces greater price competition. In turn, this will change a traditional company’s business model and increase the collaboration among competitors in order to increase efficiency.

He also reviewed, in retrospect, some of the changes that have occurred due to the implementation of ERP systems. He pointed out that while ERP has provided benefits such as reduced costs and wider use of better business practices, they have also had drawbacks. Among these are that ERP is no longer a sustainable competitive advantage and that the “half-life” of better business practices is now months instead of years.

HOW/WHY IT WORKS. Colin Carroll with PaperExchange, one of the most prominent paper industry e-commerce sites on the web, noted that for any innovation such as e-commerce to work, it must create value for all participants; buyers and sellers. Sellers certainly won’t participate if it’s a money losing proposition. In fact, new ideas must help improve margins.

What’s different today that makes e-commerce viable? Technology has evolved to make new ideas viable.

The various transaction models, i.e., the Old World and how they relate to the industry, and how they will be manifested in the Internet world, were outlined by Carroll (see sidebar). The catalog model is first, and it’s the core of retail transactions, i.e., this is how groceries are purchased. Amazon.com is also an example. It best applies to standardized products, such as stock boxes or cut-size papers in the paper industry world. But this model is mainly used in retail distribution since it is very limited.

Another model is one-to-one negotiation which is currently the paper industry’s model, and most business-to-business works this way, Carroll noted. It works well to find the right fit for buyer and seller, but there is a significant cost associated with finding the right trading partner and negotiating with them on a regular basis. These are marketing and sales costs for paper mills. Some relationships between buyer and seller are good, and there’s a lot invested in the relationship. However, in some cases a company has to compete on price, and it may not be the best-fit, i.e., it’s a “sub-optimal trading partner”.

Another model is an auction. He noted that PaperExchange is not an auction site. An auction is a one-to-many model and the winner is the one who values the product the highest. However, it’s not a good business-to-business model because auctions are seasonal, volatile, and very hard to forecast. It may be best suited for job-lot tons and one-time events, however, such as selling a corrugator or head box. A fatal flaw of auctions is an over dependence on one variable—price. Most B2B transactions also have to value quality, delivery, price, service, etc. Certainly some paper products are sold via auction in some areas such as disposing of seconds, off-spec paper, etc.

The other model is the exchange. It allows the buyer to find the seller who is the most efficient producer of the product you want to buy. Similarly, it allows the seller to find the buyer for what you want to make. For example, machine trim can eat into margins, but at the same time you can’t spend too much time and money finding the customer for just the trim you want to produce. But there is probably someone out there if you can find them, that wants your most efficient trim. Thus by allowing buyers and sellers to identify the optimal trading partners and negotiate with each other directly, exchanges create value and lower transaction costs. He noted that the larger the scale, i.e., the more bought and sold via an exchange, the lower the costs as well per incremental ton.

INDUSTRY IMPLICATIONS. Among the industry implications are that it will allow suppliers to cut costs and improve returns. It will also allow suppliers to gauge demand, pricing, and inventory levels.

Exchanges offer several benefits Carroll noted. Markets are more stable due to more efficient market information, have less price volatility, and are less cyclical. This will increase paper industry P/E ratios over time. In addition, margins will be higher as the industry cost curve will shift to favor those who use an exchange to lower costs, optimize yield management, and increase price realizations. Those unwilling or unable to use an exchange will have a higher cost position. Companies on the forward edge of technology adoption will reap significant economic profits.

WOOD IS MOVING ON THE NET. James F. Olmedo, president of TAXPX, an e-commerce company that deals in wood products described his firm and commented on some key trends. The key factors making an Internet exchange work for this industry segment (wood products) include: it’s large and fragmented; has price volatility; reliable market and price data are tedious to extract. He commented on the inefficiencies brought about by inventories in the lumber industry, which on average are in excess of four weeks, but it ranges from four to nine weeks. Obviously, better market data would make the process from the manufacturer more efficient. He also commented on how a broader range of sellers can increasingly target other areas. For example, currently TALPX has customers in Finland looking at the U.S. market because they wouldn’t have to build the “bricks and mortar” in sales and marketing staff and organization that would previously be required for such an effort. Similarly, producers in other regions are looking to use the Internet to enter the North American market. The company’s exchange as of November 1999 represented 12% of N.A. lumber production he stated. By early 2000 this is expected to rise to 20% of capacity being represented.

HOW TO BUILD A SITE. Maggie Springer with FH&K, a management-consulting firm that helps companies develop e-commerce strategy and implementations, commented on various sites in order to show some of the key features that make sites useful. She noted that ChemExchange and PlasticsNet.com provide a range of technical data that are easily accessible. In contrast, most paper industry sites don’t offer this kind of information, only corporate profiles, environmental policies, etc. Another site of interest is FreeMarkets.com because it’s an exchange of equipment.

Another interesting site, noted Springer, is REI.com. It includes functions that consider the local distributor for its products both in terms of commission based activity that occurs on the web as well as allowing the local merchant to build a personal relationship with the customer. Another interesting function is that REI puts kiosks in their stores. Thus, if a customer buys a tent, the sales clerk gets a cue that they have a tent liner, for example, that is not available in the store but that could be shipped direct to them at home. This up-sell opportunity is huge. Sellers to the small office-home office (SOHO) segment should take particular note of this feature.

A key to building a successful site is the capacity to build in database-marketing capabilities and to be able to analyze results daily. This provides data on behavior, usage, and purchase patterns. A case in point noted was the GoodNites site for Kimberly-Clark. The site helps consumers find out how GoodNites can help their child and a kit that contains two GoodNites underpants, two information guides, and a coupon to save on your first purchase can be ordered easily.

Why is E-commerce Being Adopted? Another interesting source of information about e-commerce is work done by Goldman Sachs Investment Research. Some of this information was sourced in the conference as noted above. However, in addition selected excerpts are included to provide background information.

According to the 1999 Goldman Sachs report on e-commerce/Internet, there are five major catalysts stimulating adoption of B2B:

• Increasing experience with web technologies

• Consolidation of industry standards

• Simplification of application technologies

• Increasing stickiness in B2B solutions

• Cost savings and new revenue opportunities

The industries that are most likely to embrace B2B are those that can generate cost savings. For any given industry, cost savings from adoption of B2B e-commerce range from 2% to 39%, according to Goldman Sachs. The primary factors regarding potential cost savings are: (1) composition costs (i.e., product versus process costs, and (2) the number of intermediaries in the supply chain. Typically, industries that exhibit certain characteristics will lead the way. These include: a highly diffuse supply chain; technology innovators dominate the culture; process represents more than 20% of total costs; products exhibit complex configurations; and expense pressure is intense.

HOW DOES THE LAST MILE WORK? Among the questions posed from the audience at the conference many regarded transportation issues. Exchanges handle the financial flow of these transactions but working out the physical flow looks like a nightmare was one comment. As one panelist noted, many people never thought steel would utilize e-commerce because “UPS couldn’t deliver a roll of steel.”

However, one panelist noted that currently after an e-commerce transaction is completed, the buyer and seller handle the logistics off-line on their own. However, another sees this moving more towards the e-commerce sites offering logistics capabilities as well.

Mr. Olmedo with TALPX noted that in his exchange all of the freight rates are incorporated in the system. The members provide freight rates from the mill to various hubs. They are also working to set up a system where once a particular rail car of lumber is acquired, there will be linkages to the railroad for the buyer to identify where it is in terms of shipment location.

Carroll of PaperExchange noted that this is called the “last mile problem.” For transactions that have traditionally been brokered, it easy to solve as the mill continues to arrange the logistics, although the exchange can handle it as well. But they are working to improve logistics capabilities to help sellers defray those staffing costs. He also commented on the issue of local inventories that are needed for just-in-time delivery to customers that expect it such as printers. Solutions to this issue include options such as partnering with a traditional player such as an existing brick-and -mortar distributor. Other options include more non-traditional partners such as Office Depot, Staples, or Home Depot; and they are working hard to work all of this out very soon.

Another issue raised at the conference was security of proprietary information. Maggie Springer with FH&K noted that a password system can protect information from competitors by allowing only designated people access to proprietary information.

FIGURE 5: By this year, 96% of paper company employees will have internet access

E-CHEMICALS MAY BEAR WATCHING. As noted above, the chemical industry seems to be jumping into the e-commerce industry faster than the pulp and paper industry. There are a variety of web sites and e-commerce ventures already moving product. This area was discussed at the conference by Michael Eckstut,with ChemConnect Inc. The chemical industry and the paper industry are very similar, as both are global, and exhibit the same issues with inefficient pricing and asset intensity he noted. Chemical companies are now asking what can we do and how do we participate in e-commerce, while just a few months ago (six months before November) they were asking what is e-commerce. The chemical industry is the third largest in terms of e-commerce potential according to various projections. Also, the industry has already built the backbone needed to go forward via the wide spread implementation of EDI and ERP systems.

E-commerce will exist in various forms or channels. For example, for a large commodity like styrene, a few producers sell to a few buyers. In this case the ERP systems will be integrated, which is a form of e-commerce, but it doesn’t require an exchange. Another channel is web-based ordering system, which is an industrial version of Amazon.com. If you want to buy something you go the company’s website and order it, because it’s a brand name you want.

The third piece of the mix is the “e-market.” This is where a buyer isn’t looking for a brand name or where a seller is looking to move some product. The product is readily definable in terms of specification. His company’s version, the World Chemical Exchange, can eventually represent up to 30% of chemical industry sales, Eckstut believes.

Another source of information on e-commerce is an article in Chemical Engineering, in the July 1999 issue. It used a slightly different but informative approach to categorizing e-commerce models. They attribute this information to Andersen consulting as well, who identified four major avenues or channels, for e-commerce: low-cost interactive, high-value interactive, virtual marketplace, and spot auction (Table 2).