Consolidating paper gains

The Indian paper industry is in a sweet spot

The Indian paper industry has been in something of a sweet spot in recent years as strong growth drivers have supported increasing paper demand and a favourable supply scenario has helped improve profitability.

Between 2008 and 2018 India’s domestic paper demand grew at a CAGR of 6.3%, expanding from 9.3 million metric tonnes (MMT) in FY 2008 to 17.1 MMT in FY 2018. Kanvic forecasts paper demand to expand further to 20.7 MMT in 2021.

When compared to a global scenario where per capita paper demand is growing at only 1%, the outlook for the Indian paper industry remains highly favourable. Furthermore, the current growth rate seems sustainable due to India’s still low per capita paper consumption - which stands at only 13 kg per annum versus 150-250 kg in developed countries.

Multiple growth drivers are supporting increasing paper consumption in India: rising literacy rates are driving demand for books and textbooks; an e-commerce boom is expanding demand for paperboard and packaging; while premiumisation in consumer products is driving demand for higher quality paper packaging. In addition, increasing awareness and government regulation of single-use plastics in India is leading to a significant switch from polymers to papers across a range of products.

Along with this attractive demand scenario, a favourable supply outlook is also supporting the industry’s fortunes. Kanvic forecasts show that incremental demand will continue to outstrip incremental supply through to 2021. In this tight supply scenario, top Indian paper companies have managed to improve EBITDA margins from 14.20% in FY 2015 to 17.74% in 2018.

The stage is now set for industry consolidation

Although the outlook for Indian paper companies looks benign on the surface, the stage is now set for a major transformation in industry structure - with profound implications for incumbent players. Drawing on the trends observed in other developed and emerging markets alike, it is clear that the Indian paper industry is poised to enter a period of consolidation. This will lead to a small number of larger players emerging as winners while more marginal paper mills will be increasingly squeezed to the point where they may be forced to exit the market altogether.

At present, the Indian paper industry is highly fragmented with the top three players accounting for only 9% of market share. When compared with other key 5 developed and emerging markets it becomes evident that this is a transitional scenario in the Indian paper industry’s development.

In contrast in the United States, the top three players today account for 68% of market share, while in Indonesia this figure stands at 72%. Even in the much larger Chinese market, the top three paper companies control 21% of paper production, up from 12% in 2008.

Consolidation in these markets has been driven by the expansion of larger companies seeking to exploit greater economies of scale, along with M&A activity which has reduced the number of independent players and the exit of smaller paper mills who were unable to keep pace with changing technology and rising environmental compliances.

Looking at the current scenario in the Indian paper industry it is clear that the preconditions for a period of consolidation are already in place.

Firstly, India’s largest paper companies are expanding their margins and strengthening their balance sheets to pursue inorganic expansion and secure greater economies of scale. They are also leveraging their increasing financial strength to secure scarce raw material supplies like water and pulp. At the same time, they are investing in operational improvements to further reduce costs and extend the performance gap between themselves and the rest of the pack.

Along with the strengthening position of larger players, a growing number of smaller Indian paper mills are already suffering from financial difficulties as they struggle to compete with more competitive mills and rising imports from abroad. Lower cost paper imports from larger integrated paper mills - particularly in south-east Asia are growing at a compound annual growth rate of 10.3% - substantially above the industry growth rate. This combination has resulted in two out of three Indian paper mills closing in recent years. While Kanvic analysis has found that sixteen out of twenty-six of the listed Indian paper companies have stressed balance sheets.

The trend of smaller players exiting is likely to accelerate as stricter environmental regulations imposed by the Government of India force paper companies to invest or exit. The paper industry has been placed in the red category of high polluting industries which imposes stringent regulations on water and fuel consumption. The introduction of such tighter environmental regulations on Chinese paper companies a few years back resulted in many smaller players exiting the market and a rapid acceleration in industry consolidation.

While uncompetitive players will increasingly exit the market, the barriers to new entrants are rising. The paper industry is already one of the most capital intensive industries with high fixed asset and working capital requirements. The introduction of new environmental regulations and the increasing economies of scale of larger paper mills will continually raise the bar. In such a scenario the only new entrants are likely to be much larger international paper companies with access to the necessary financial firepower to rapidly build scale in the Indian market. Such moves are already evident in the proposed investments in India by Asia Pulp & Paper of Indonesia and China’s Nine Dragons. Both of these companies operate at a scale far larger than the leading Indian paper companies and will put increasing pressure on less competitive Indian players. 

The final factor driving the Indian paper industry toward consolidation is the more rational approach to capacity addition that has been followed in recent years. After getting their fingers burned in 2014-15 following a period of over-expansion, new capacity addition by the Indian paper industry has been limited to a few of the larger players. The restriction of capacity addition to a smaller group of increasingly larger companies will drive further concentration of the industry. 

In a consolidating market, incumbent players will have to perform or perish

As the Indian paper industry enters a period of consolidation, companies will need to act fast to improve performance and remain competitive. Those who fail to quickly close the performance gap with the industry leaders will be squeezed to the margins or be forced to exit.

Drawing on the insights from our multi-year experience advising Indian paper companies on performance excellence, we have identified five key areas that every firm should focus on to remain competitive in a consolidating market.

1. Bring strategic alignment

To bring about the step-change in performance that Indian paper companies will need to remain competitive, it is vital to set clear strategic goals and build an appropriate review system to bring alignment of the organisation with these goals. The first step in this journey is to set clear and coherent goals based on sound market analysis and future aspirations. Next, these goals need to be broken down into key performance indicators across functions and management levels.

It is also important to bring visibility of these key performance indicators at a team and individual level so there is firm-wide consciousness of how they are progressing toward their performance goals. Once the goals are clarified across the organisation there is a need to have a robust management review system that aligns daily, weekly, and monthly actions to the overall business direction and goals. Finally, individual pay and incentives need to be linked to the achievement of performance goals to bring focus and accountability to the performance improvement process.

2. Achieve operational efficiencies

Paper is a commodity business and a large part of the business value is derived from achieving operational efficiencies. However, in our experience working with Indian paper companies, we have found that they trail behind many other industries in terms of key operational indicators such as process changeovers, waste generation, overall equipment efficiency (OEE), and shop floor management practices. As a result, we believe there is substantial scope to achieve efficiencies from raw material sourcing to finished product by targeting cost, quality, waste, equipment health, inventory, and delivery.

Paper manufacturers can take three types of actions to bring operational efficiencies. First, they should identify gaps in their manufacturing processes by the application of lean management principles. Second, they should measure everything in the factory. Finally, they should apply analytics to draw daily insights and act on them. By employing these measures we have found paper companies can reduce their costs by 10-15%. 

For example, in the case of one paper manufacturer, we uncovered opportunities for improvement by identifying the actual constraints on plant capacity through a single product run along with checking the availability of key process inputs. From this baseline we then adjusted the capacity to take account of the client’s actual product mix, making the client aware of substantial unrealised capacity.

Our work with paper companies has found that there is an over-reliance on past experience and less focus on gathering data to generate insights. Paper manufacturers have a large number of opportunities to measure key drivers of their business from raw material to finished product. For example, many waste paper and agro-based mills use rules of thumb to calculate raw material consumption. However, this leads to wrong conclusions and consequent wastage. By applying weighing systems at different stages in the process and using barcoding paper mills can get an accurate and real-time measurement of their highest cost input to not only know the real cost of manufacturing each product but also identify the variances across shifts.

Finally, paper companies should train their people in using analytics based on available data to make adjustment to their processes and business based on real insights. For example, we have found large gains can be made by recording details on equipment breakdown and analysing them regularly to reduce downtime and bring more predictability to operations.

3. Pursue strategic sourcing

With raw materials typically accounting from 55-65% of a paper company’s costs, strategic sourcing is crucial to reducing cost and achieving performance excellence. Many Indian paper companies are behind the curve on sourcing best practices, routinely leaving money on the table in procurement.

The first step toward strategic sourcing is to bring full visibility of the current spend by category, department, and suppliers. In a previous client engagement, we created an automated spend cube to provide a single-window view of sourcing - highlighting potential leakages and outliers to investigate further. 

After gaining visibility, companies need to apply tools like Total Cost of Ownership (TCO) to their sourcing practices to ensure the purchase of equipment and consumables is done on value rather than price.

Finally, the use of demand prediction models can help paper companies better anticipate periods of high demand and plan procurement more accurately, reducing their inventory costs. At the same time, price prediction modelling for key input materials helps organisations time their purchases to take advantage of favourable price fluctuations.

4. Improve sales and channel management

An important and often neglected area of performance in Indian paper companies is sales and channel. Through more effective segmentation and key account management combined with digitalisation of customer-facing processes, paper companies can increase sales and customer satisfaction at the same time as reducing their selling costs.

In a recent client assignment, we helped one paper manufacturer transition its customers to web-based ordering and provided real-time order-to-delivery status updates. This reduced friction for the customer during the buying process and improved visibility on their pending order - increasing their loyalty. At the same time, it improved efficiency for the client as their sales staff could be redeployed from non-value adding administrative activities to new business development.

5. Create a high-performance culture

The sustained performance improvement that Indian companies require demands a wholesale cultural shift across the organisation. Performance excellence programmes that rely only on top-down initiatives are destined to fail. Therefore Indian paper companies must focus on building their team’s capabilities in problem-solving, analytics, leadership and communication at every level of the organisation.

A programme of capability building must be supported by measures to energise the team for the challenging but exciting journey ahead. To achieve this mindset change paper companies can initiate workshops and individual mentoring to communicate the road ahead, engage people in overcoming the challenges at hand, and coach them to tap into their potential.

Creating a culture of high performance also means that HR must come out of the support role and play an active part in transforming the process of hiring, developing and retaining talent to ensure the workforce is aligned to the requirements of the new era of Indian paper.