Jan 14 2015
As originally published in Paper & Packaging International
Wood pulp and paper prices are on the rise – hitting historically high levels, in fact – and expected to continue growing over the next three years, which is bad news for manufacturers that use these goods as inputs. In particular, growing wood pulp and paper prices will threaten the profit margins of paper-based packaging suppliers in the three years to 2017. However, there is good news for these suppliers. Although their input prices are increasing, rising demand for paper and packaging products will allow suppliers to pass these input costs down to buyers, thereby keeping prices high. Additionally, paper-based packaging suppliers often can secure discounts by leveraging significant buying power and negotiating with wood pulp suppliers to reduce prices.
The year 2011 marked global wood pulp’s highest price point in more than 30 years. Despite declines in the past three years, prices remain at historically high levels. IBISWorld expects the global price of wood pulp to rise at an annualized rate of 1 percent in the three years to 2017, driven by a worldwide increase in construction and industrial activity.
Because wood pulp is the major input for paper, rising wood pulp prices are expected to flow through to the price of paper, which IBISWorld anticipates to increase at an annualized rate of 2.1 percent in the three years to 2017. Such costs threaten profit levels for suppliers of paper-based packaging.
The Consumer Side
Fortunately, several consumer trends are pushing up demand for paper-based packaging and allowing suppliers to raise prices without risking losing customers. One consumer trend driving demand is their heightened spending. Higher consumer spending drives demand for paper-based packaging that is used to ship and package discretionary and nondiscretionary items.
Because of more encouraging economic conditions, consumers have been spending more every year since 2009. In particular, lower unemployment rates and still-low interest rates are helping loosen consumers’ purse strings. If this trend continues in the coming years, a larger number of employed people will have greater income to spend, while low interest rates will let consumers make larger purchases. IBISWorld expects consumer spending to grow at an annualized rate of 2.7 percent over the next three years.
Furthermore, the surging popularity of ecommerce has boosted shipping activity. The rising adoption of broadband connections and Internet-enabled mobile devices has grown, increasing the ease and convenience of online shopping. As more consumers forego the malls in favor of shopping with just a click of a mouse, shipping activity has increased. Shipping goods to consumers often requires paper-based shipping products, such as corrugated boxes and packaging papers, thereby increasing demand for such packaging.
Population growth is also driving demand for paper-based packaging. The domestic population is expected to grow at an annualized rate of 0.8 percent in the three years to 2017. Larger populations require more essential goods, such as food products, which are often packaged and shipped with paper-based materials. Growth in demand from consumers for essential and discretionary goods will boost demand for paper-based packaging products, allowing suppliers to raise prices safely.
Strong Industrial Activity
Higher industrial production also requires a greater amount of paper-based packaging materials. The industrial production index (IPI) – which measures domestic output from the mining, manufacturing, electric and gas industries – is anticipated to rise at an annualized rate of 3.8 percent in the three years to 2017. IPI growth has been driven by increased domestic construction activity and improving economic conditions. A growing IPI leads to more shipping of industrial goods, which uses various paper packaging materials, such as corrugated boxes and packaging papers.
Also, IBISWorld forecasts that the number of businesses will rise at an annualized rate of 1.7 percent in the next three years, as a more positive economic environment encourages more entrepreneurs to start businesses. An increase in the number of businesses will drive further demand for packaging materials, because businesses use paper products to purchase and ship goods.
IBISWorld anticipates government spending, which measures federal, state and local government investment, to rebound at an annualized rate of 1.9 percent in the three years to 2017. Specifically, local and state government investment is expected to grow at an average annual rate of 1.2 percent in the three years to 2017. Government spending overall is anticipated to increase during the next three years because the improving economy will increase the tax base, thereby allowing for expanded budgets.
Growth in spending on all three levels of government will benefit suppliers of paper-based packaging in a number of ways because the different levels of government have different responsibilities and therefore purchase different products. Increases in different types of government spending will lead to surges in demand from different markets.
The federal government has responsibilities such as defense spending, and state and local governments handle items such as the development of public infrastructure and education spending within their regions. Higher government spending will increase demand for various goods, such as construction materials and office supplies, which in turn will boost demand for the paper-based packaging products needed to ship such goods.
In addition to passing on input costs to buyers, paper-based packaging suppliers can reduce input costs by negotiating with their wood pulp suppliers to limit wood pulp costs. Paper-based packaging suppliers should utilize the low switching costs of wood pulp products to gain leverage with their wood pulp suppliers. Switching costs are low because wood pulp is commoditized and several qualified vendors are in the market.
Having low switching costs gives packaging suppliers the ability to switch easily between wood pulp suppliers with minimal risks. Leveraging low switching costs, packaging suppliers can either seek additional discounts from an existing pulp supplier or simply switch to the supplier with the lower price without risking much in terms of quality or service.
At the same time, suppliers of paper-based packaging are faced with several negatives. A lack of direct substitutes for wood pulp limits packaging suppliers’ options beyond negotiating in the wood pulp market. Also, wood pulp prices are expected to be highly volatile in the three years to 2017, which could lead to dramatic price swings if packaging suppliers do not have existing contractual agreements with wood pulp distributors.
According to IBISWorld, wood pulp buyers have a buyer power score of 3.5 out of 5, indicating a moderate amount of negotiating power. Buyers should negotiate sooner rather than later while their buyer power score is higher. The 1.0 percent annualized growth forecast for the price of wood pulp will threaten buyer power in the three years to 2017.
Paper-based packaging suppliers can raise prices confidently thanks to several trends, particularly consumer spending patterns. Suppliers can rest assured that the demand for their products will continue growing and allow them to raise prices to offset their higher costs. Although there are some limitations to their negotiating power when purchasing wood pulp, paper-packaging suppliers can be smart and use leverage to keep their input costs low.