FEATURE:

Discussions with catalog publishers and printers show a rebound from the impacts of recession and war, although with some shift in paper grades spurred by European exports

by Will Mies, Editorial Consultant

Catalog Publishers Rebound from Low Consumer Confidence to Fuel Future Paper Demand Growth

The past year has been a challenging one for catalog publishers, with consumer confidence and business spending suffering under the negative impacts of the economic slowdown, the September 11th terrorist attacks, and the anthrax scare. This has reduced response rates on catalog mailings and forced some publishers to reduce circulation, trim size, or page counts, and look for cost-saving measures such as less expensive grades of paper. In addition, catalog publishers are now facing a new challenge in the form of another 8.7% increase in postal rates scheduled for June 30, with talk of yet another double-digit increase for early 2003. Not surprisingly, many catalog publishers are hoping to drive more of their marketing activity online, although most forecasters expect printed catalogs to show some growth in the future.

After growing 5.6%/year during the period of 1997 to 2000, the number of catalogs mailed in the U.S. in 2001 declined 2.7% to 19.0 billion units with a further 2.1% decline to 18.6 billion units expected in 2002, according to Resource Information Systems Inc. (RISI) estimates (based on mail volume statistics). "Catalogs are bracing for a bad year," commented John Maine, vice president, RISI. "Circulation dropped 9% in the quarter following the terrorist attacks, and we do not expect much improvement from that level."

However, the Direct Marketing Association (DMA) estimates catalog sales (including online transactions) still grew by 6.3% to $118.1 billion last year from $111.0 billion in 2000, which was the year the economy peaked. Overall, that is not a bad performance for the estimated 10,000 catalogs published each year in the U.S. Approximately 60% of all U.S.-published catalogs are consumer-oriented marketers (examples of the largest include J.C. Penney Co., Spiegel, Brylane, Lands' End, L.L. Bean, Intimate Brands, and Williams-Sonoma); and 40% serve the business-to-business market (Dell Computer, International Business Machines, W.W. Granger, Corporate Express of North America, CDW Computer Centers, Office Depot, and Staples). Table 1 ranks the top catalog publishers.

PROFIT MARGIN SQUEEZE. "Catalog publishers have seen better times, but it's not the worst of times," said Sherry Chiger, editorial director of Catalog Age, the industry's leading trade publication. Nevertheless, it is clear that the profit margins of catalog publishers have been under pressure from lower response rates, higher postal costs, and the decline in consumer confidence following September 11th. Of 17 publicly-traded consumer catalog publishers, nearly 59% reported declines in revenue and 10 reported net losses for the third quarter, according to Ulin & Holland, a Boston-based investment firm, as reported in Catalog Age.

J.C. Penney Co. Inc.'s catalog sales, for example, were down 19.7% to $3.3 billion in 2002 and off about 26% for the first two months of 2002 from a year ago, even though the Plano, Tex.-based retailer's department store sales are beginning to turn around. The company, which describes itself as "the largest catalog merchant of general merchandise," plans to reduce the page count of its spring catalog by 10%—although it will increase the trim and use heavier paper—and cut back on circulation.

"Direct marketers such as Lillian Vernon Corp. have found the last six months to be challenging because of the recession, war, and anthrax scare," said David Hochberg, vice president of public affairs, Lillian Vernon. The Rye, N.Y., marketer of gifts, household, and gardening merchandise reduced its overall circulation, mailing out 169 million catalogs in its fiscal year ending this February, down 5% from the previous year. In addition to trimming the size of mailings, the company has also been cutting page counts for its more marginal catalogs and trying new marketing strategies.

"Business for Brylane and other catalog companies has certainly been down from the robust level in 2000, but we are beginning to see signs of recovery," said Jack Graber, director of operations, Brylane. He said the New York-based company had made some adjustments in circulation and page counts. Brylane mails more than half a billion catalogs annually in the U.S. under such names as Chadwick's of Boston and the Lerner catalog.

Not all catalog publishers, however, are cutting back on their mailings. Lands' End says that it really "does not plan to make any major changes" in circulation this year, after mailing 272 million copies in 2001, up from 269 million the previous year, according to Charlotte LaComb, director of investor relations. The Dodgeville, Wis.-headquartered "direct merchant of classically styled apparel and home furnishings," reported a 93.0% jump in profits to $66.9 million last year on a 7.3% increase in sales to $1.6 billion following a weak performance in 2000.

"We felt a temporary jolt after September 11th, but sales quickly came back because our catalog focuses on the home and family," said Jody Palzer, director of catalog services, for Hanna Anderson, a Portland, Ore.-based catalog retailer specializing in "soft clothes of the nicest European quality for kids and their families." When facing the paper price spike of the mid-1990s, the company tried to cut expenses by reducing mailings and shifting to lower quality paper, but found that the cost-saving measures hurt response. Consequently, Hanna Anderson made the decision to upgrade to lightweight coated free-sheet paper in its catalogs and has continued to use the higher quality paper in the No. 3 to No. 4 range.

In the business-to-business segment, Staples Inc. reported that sales from its catalog and e-commerce operations for its fiscal year, ending February 2, increased 8.2% to $3 billion, and profits jumped 83.0% to $205 million. In contrast, revenues from its retail stores remained relatively flat, and net income declined 24.8%.

GRADE SHIFTING. "Catalogs seem to be holding their own, and the number of catalogs being mailed are close to the same year over year, although page counts are slightly down," reported Rob Carter, paper purchasing manager for Quad/Graphics, a top catalog printer (Table 2). "The main way publishers are trying to reduce costs is through grade changes and making the move to lighter basis weights. There have been more requests for paper samples and trial runs of rolls in the last six months than in the previous three years."

The interest in shifting paper grades appears to be related to increased availability of paper, particularly from Europe, in addition to the need to reduce expenses. "A lot of customers have been showing interest in blue-white, high-brightness European style sheets," said Carter.

European mills have become more active in the U.S. market due to the strong dollar and are offering paper with better opacity and stiffness than in the past, making their products more attractive to U.S. buyers. In addition, a number of them have been expanding their distribution networks in North America. U.S. mills have also been retooling to offer the blue-white, high-brightness paper, and, of course, some of them are now under European management that is bringing in new technology. Buyers are sometimes finding that they can buy paper with the brightness of a No. 2 or No. 3, but with pricing like a No. 4. As a result, some catalog publishers have been shifting from coated free-sheet to coated groundwood paper.

SIZE OF CATALOG MARKET. Apparent consumption of paper by U.S. catalog publishers in 2001 was about 3.6 million tons, down 2.1% from the previous year, according to RISI (Table 3). Of this amount, 2.7 million tons consisted of coated paper grades; 799,000 tons was uncoated groundwood (mostly supercalendered); and the remaining 31,000 tons were uncoated free-sheet. Among coated paper grades, coated No. 5 was the most popular with catalog publishers at 1.26 million tons; followed by No. 3 at 865,000 tons; and coated No. 4 at 595,000 tons. RISI projects total paper demand for catalogs will decline 1.8% to 3.5 million tons in 2002 and then jump 5.8% to 3.7 million tons in 2003.

Graphic Arts Products Tracking Research and Consulting (GAPTRAC) predicts that in 2002 paper demand for catalogs will decline 2.2% to 3.3 million tons from 2001 numbers, which were down 4.4% from 2000. Of the 3.3 million tons, 60.1% is coated groundwood, 12.3% is SC-A (supercalendered), 2.5% SC-B/SNC (soft nip calendered), 4.7% other uncoated groundwood, 1.3% uncoated free-sheet, and 0.9% newsprint, according to the Jaakko Poyry Consulting (JPC) unit. "We see a slight shifting, 1% to 2%, from coated free to coated groundwood because of lower price and basis weights," said Mark McCready, senior consultant with JPC. According to McCready, SC-A has not taken any share away from coated groundwood because price differentials between the two grades have remained relatively stable for the past couple of years.

Depressed paper prices have been helping catalog publishers offset the adverse trends pulling down their profit margins. In 2001, the average U.S. price of $803/ton for coated No. 5 (40-lb) paper was down 7.1% from the previous year, and, due to first-quarter price reductions, that number is expected to decline another 9.6% to $726/ton in 2002. "We do not expect any further reduction in North American coated paper prices in 2002," said Maine. He said there is the possibility of a price increase in the second half of this year, and RISI expects a 7.2% increase in the average price of coated No. 5 to $778/ton in 2003.

POSTAL CRISIS. In addition to rising paper prices, catalog publishers are also bracing for another hike in postage rates. The United States Postal Service (USPS) is expected to approve a new round of postage increases of around 8.7% on bulk mail effective June 30. This follows two 2001 rate hikes averaging around 10%, and there is already speculation that the USPS will ask for another double-digit increase this fall to take effect in early 2003 so that it can cover a surging deficit.

The 226-year-old USPS is in "crisis," said H. Robert Wientzen, president and CEO of the DMA at the annual Paper Week meeting in New York this March. "As postal rates go up, we mail less—whether in the number of mail pieces or in the size or weight of the pieces." He also said that standard mail volume has plunged a startling 8.3% so far this fiscal year. "Less volume obviously means less revenue for the Postal Service. Unfortunately, under current law the only way for the Postal Service to get more money is to raise postal rates."

Wientzen further said the "only real fix" is the enactment of meaningful postal reform legislation that will help the USPS compete "in the increasingly competitive, global, Web-driven communications and delivery marketplace." He called on the paper industry to join the direct mail and printing industry in lobbying the Bush Administration and Congress for postal reform legislation.

APPEAL OF THE INTERNET. Not surprisingly, catalog publishers are turning increasingly from paper-based mail to the Internet. As Wientzen pointed out, "From a direct marketer's perspective, there is a lot to love [about the Web]." Online marketing campaigns are fast to produce and send, interactive, and capable of tracking customer feedback. It can be customized and is cheaper than ink-on-paper marketing. "Five years ago, the Web generated 2% of catalogers' total sales. Last year that was 19%, and in three years, nearly a third of catalogers' sales will come in via the Web," Wientzen emphasized.

Even in the past year's difficult economic environment, many catalog publishers were chalking up double-digit growth in their e-commerce/online divisions, while showing relatively flat or declining growth from their print catalog operations. Take troubled Spiegel Inc., which last year posted a loss of $17.8 million from continuing operations on an 8% decline in revenues to $3.1 billion. While revenues from the Downers Grove, Ill.-based marketer's catalog business declined 18% to $1.2 billion and sales from its retail stores (Eddie Bauer) dropped 8%, e-commerce sales jumped 46% to $332 million.

"Our industry has transformed its business model from being exclusively catalog retailers to multi-channel retailers with retail stores and expanding e-commerce operations," said Hochberg of Lillian Vernon. "The catalog industry is trying to become less reliant on the Postal Service and on printing and paper, with its wildly fluctuating price."

According to DMA, direct marketers' Web-driven sales last year reached $30.3 billion, up from $172,000 in 1995, and are projected to reach $134 billion by 2006. "E-sales are likely to surpass catalog sales within a decade," commented Wientzen. DMA projects that 19% of catalogers' sales came from the Web in 2001, up from 2% in 1997, and will reach 32% in 2005.

Except for price fluctuations, most catalog publishers seem content with their paper industry suppliers in terms of quality, innovation, and service. And even though the Internet may sap some future growth from paper catalogs, demand for paper from the catalog industry is expected to continue to show modest growth. RISI, for example, projects the number of catalogs will grow 1.0%/year for the next five years through 2006. In addition, the DMA projects dollar volume of catalog sales will grow 6.5%/year and reach $163 billion by 2006.

"Print catalog publishing is a somewhat mature business," said Chiger of Catalog Age, "but there will always be entrepreneurs trying to start new ones on their kitchen table." Only this time, tomorrow's entrepreneurs will also be designing an online catalog on their home computers as well.