Avoid panic – take control!

By Joachim Klein and Ralf Möbus

BRUSSELS, July 31, 2009 (RISI) - It was bad to begin with - now it's even worse. Recession has arrived. All major indicators have plummeted dramatically since the middle of 2008. Most companies in the paper value chain are hard hit as commodity markets are particularly coupled to the development of the overall economy.

The industry has long been in bad shape, taking overall profitability and return on capital into consideration. Some market players have just barely survived despite the positive overall economic development in the last years. In a time when governments are stepping in at a large scale to support multi-national corporations, the term "bail-out" has replaced the term subsidies giving it the positive connotation of a one-off rescue.

Bail-out funding pretends to support "otherwise healthy" companies. In case of the global paper industry a bail-out would probably lead to further years of low profitability and stalemating. Therefore, it cannot be recommended to have government money support a structurally dysfunctional industry. As hard as it may sound, this may be the right time for the industry to finally consolidate. The current global downturn was in part caused by short-term profit orientation and greed. A lesson learnt should be that long term thinking needs to be incorporated into the business culture again. The right actions and bold steps are required to take control.

Now the question is how to align a company to deal with the downturn and to emerge from the downturn in better shape. For some companies in the industry it will be a challenge to survive as they were not structurally well positioned going into the recession. For other companies the downturn will test their strength and overall health but will also provide opportunity to increase competitiveness and potentially help to restructure the overall industry.

Some companies may be inclined to concurrently try to do too much too quickly, stressing the overall internal capacities. Other companies may be frozen like Bambi in the headlights taking too much time to define the right "strategy" to deal with the situation. Either management approach may lead to panic and will not deliver the expected results. In one case the numerous projects started may not pay off as quickly as expected. This will lead to continuous readjustment of management decisions and exasperation of the staff involved, overburdened by the multitude of projects started. In the other case a lengthy strategy definition process may lead to impatience, nervousness and ultimately to frustration about not getting anything done. This will result in fear of not being prepared for future developments.

Probably the best approach is to take a middle route between the two paths in order to take control of the situation taking the following recommendations into consideration:
• Take time to design the program
• Have top management lead the initiatives
• Focus cost reduction and margin improvement
• Don't neglect long term strategies and planned investment programs
• Avoid compromising on sustainability or "green" issues
• Take advantage of the downturn: expand geographically
• Grasp opportunities for acquisition and consolidation
• Maintain a long-term approach with respect to talent management
• Don't compromise on priorities set; enforce and monitor execution of the initiative.

An assessment of the situation should be conducted quickly identifying the major focus areas in dealing with the downturn but considering and reprioritizing existing initiatives. The threat in a downturn is that running programs may be halted prematurely leading to excessive startup costs at later stages. However, companies should be courageous enough to incur sunk costs by stopping initiatives that will not deliver the initially expected returns. Running programs need to be (re-)assessed for their strategic importance and continued - potentially in a modified form - if deemed of future importance.

Focus areas require priorities, targets, milestones and dedicated resources to have clarity. It is important to cast all initiatives into an overall program sponsored and led by top management. It is equally essential to communicate the program to all employees and explain the priorities of the program, the full (and worst case) consequences and the expected outcome to achieve buy-in on all levels.

Figure 1 - Focus on costs continues to be a primary response But requires alignment with longterm strategy

Accelerate what should have been done earlier

The natural tendency for many companies in a downturn is to focus internally and reduce costs wherever possible. However, sometimes such programs are designed too simplistically, general and without focus on big ticket items. In a recession, cost reduction programs should be bold in approach and focus on those areas that are not of long-term strategic value, using the situation to accelerate necessary adjustments. The programs should focus on:
• Closure or divestment of low- or unprofitable assets
• Disposal of long-term unprofitable product portfolios
• Adjustment of headcount and streamlining of functions (accelerate outsourcing, shared service center concepts) and creation of more effective management structures
• Renegotiation of supplier contracts - reducing number of suppliers and focusing on long term partnerships
• Creation of customer incentive programs to achieve customer retention
• Reassessment of logistic chains and forcing of cost reduction or service level charges
• Separation of desirable customers from "opportunistic" customers to strengthen relationships on the one side and to selectively adjust pricing on the other
• Enforce credit control mechanisms and receivables management to improve liquidity and avoid bad debt
• Integration of supply chains on both sides.

Often these programs focus purely on internal cost opportunities neglecting opportunities to reduce costs and manage margins externally. Sometimes companies get so tied up with their internal programs that they neglect the core of business existence - the markets. Collaborative cost improvements should to be developed both with suppliers and customers.

Figure 2 - Collaboration is a key for unlocking further value

Don't compromise on long-term strategy

The biggest danger of a recession is trying to turn the ship and negligence of long-term targets. Compromising on long-term strategy in favor of short-term goals will probably pay off to be expensive at a later stage. As energy costs have decreased and wood prices have dropped companies may be inclined to postpone long-term programs. Examples of programs threatened are sustainability strategies along with bio-energy investments. Most strategies that are deemed to be right will probably remain right such as:
• Investment in low cost fiber sources and regions
• Investment in low cost capacity
• Investment and research in bio-energy
• Long-term positioning with focus on sustainability
• Supply chain leadership through transformation and integration
• Investment in state of the art decision support systems
• Research and development in new applications and development of new services to enhance the product portfolio.

Overall investment budgets typically shrink below depreciation during a downturn as companies restrict spending - enforcing recessionary trends in other industries such as industrial goods and machinery (e.g. paper machines or corrugators). However, anti-cyclical investment behavior in line with long-term strategy can be highly rewarding at later stages. In a downturn, the cost of investments will be much lower as machine and technology suppliers struggle to get contracts. At the same time dedication and quality of resources will be higher. Of course investments require funds. A company struggling for survival will not be able to afford anticyclical investments. However, healthy companies that have improved their debt/equity ratio during the upswing are fully able to afford such strategies.

Figure 3 - The customer is at the core of business activities: Opportunities exist to increase customer loyalty

Don't be afraid to invest

Independent of the industry, stock-listed companies typically engage in mergers and acquisitions during bullish market times. The acquisition multiples paid are typically justified by the overall good economic climate and aggressive synergy and growth expectations. However, financing is readily available to support acquisition during times of overall growth. As most acquisitions fail to deliver on the synergy targets promised, they are especially bound to fail as markets retract.

The recent downturn has led to a rapid decline in market capitalization of stock listed companies in the sector.

While share price increases would be expected upon an acquisition announcement, the funding required to help consolidate the industry is only a fraction of what it was before the decline. Some companies have even listed below book value. There is probably no better time to achieve long-term benefit through cheap acquisition at present prices. Yet it is to be expected that stock listed companies in the sector will shy away from the financial engagement of an acquisition although some companies should have the financial strength to carry such a burden. If carried out properly and uncompromisingly through fast capacity consolidation and cost synergy achievement, the relatively low funding required at present will pay off fast. If companies in the sector do not proceed, it may be expected that outside investors may grab the opportunity.

The other opportunity that arises from the overall global economic climate is geographic expansion into emerging markets. Anti-cyclical investment can be the right approach for the long term. Just as most companies acquire other companies when prices are high most also do the same with respect to geographic expansion; entering markets late in the game typically does not pay off.

Opportunities for long-term strategies open up again in emerging markets. As global capital is withdrawn from these markets, currencies and prices for assets and properties will drop. This may just be the time to look for geographic expansion or local enlargement of one's footprint.

Figure 4 - Many companies are reactive; few (can) take advantage

Don't forget your people - they will remember

Typically during a downturn the inclination is to announce large-scale headcount reduction programs. While this will be necessary it is also important not to compromise long-term for short-term success. Despite years of personnel reduction the industry often still has relatively high overhead and staffing levels that need to be tackled. Therefore, the downturn can serve as a catalyst to accelerate the inevitable. However, on the other side it is necessary to continue fostering and building people. The industry has a bad record in attracting talent. With the current situation a lot of talent is available - at lower cost. This may just be the time to look at the existing talent pool to enhance and potentially replace internal capabilities.

Experience from the last downturn after the burst of the dot.com bubble shows that it may be too short sighted to just manage against headcount numbers. People are not machines and people have memories. One-sided management of human capital during a recession may lead to increased attrition during an upswing. Letting go of key people prematurely may prove to backfire in the future. Therefore, early identification of key people and talent is required before making hasty decisions. Who will turn around a company in a recession if it is not the people who are working in it?

Dealing with the downturn requires continuous dedication and sponsorship from the top level. Companies sometimes establish programs and announce them pompously but then forget to follow up and be consequential in implementation and communication. This results in a loss of credibility.

The strategies defined and programs started will have to be led vigorously by top management. Making it the "president's agenda" to relentlessly drive and monitor the programs installed will become essential to uniformly guide a company through the troubled waters. Often large transformation programs fail because they lack the required structure. Therefore, significant resources should be assigned to track and monitor

the goals and milestones defined with the design of the initial plans. This structure should however not be

considered an addition to the regular organizational structure with the burden to manage it on top of to daily business. Instead the actions defined and the structure necessary should replace the existing agenda and management structures. Even temporarily suspending existing hierarchical reporting lines and replacing them with the primacy of the program structures may be advisable. In accordance with military structures a "situation room" may be installed to provide oversight on current developments and enable fast decision making.

Figure 5 - Anticyclical investment can provide the basis for future Growth, but is limited by appetite and availability of funds

Grasp the opportunities

One can conclude that while the global economy is in a bad state and the pulp and paper industry is hard hit, it is necessary to separate the industry's overall economic issues from the structural ones. There is no reason to freeze in anxiety or to churn projects just for the sake of trying to appear industrious. For healthy companies in the sector with visionary and yet pragmatic management this is the time to grasp the opportunities that arise from a downswing to invest in the future and to emerge as a victor coming out of it.

Joachim Klein (joachim.klein@stepchange.com) is founder and managing director of StepChange Consulting. Ralf Möbus (ralf.moebus@stepchange.com) is a senior manager at StepChange Consulting

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