Is Smurfit-Stone All Boxed In?
Patrick J. Moore spends his days thinking inside the box. Lately, it has become a little too snug. Moore is chairman and chief executive of Smurfit-Stone Container Corp., the world's largest maker of corrugated-paper containers. Its customers include top industrial and tech companies such as Emerson Electric and Sony, as well as a who's who of the household-products sector: Anheuser-Busch, Kellogg, Kimberly-Clark, and Procter & Gamble. "I guarantee that if you go through your cupboards at home, there are a lot of Smurfit-Stone products there," says Moore.
True enough, but almost every day, it seems, Smurfit-Stone sees its market shrink. Manufacturers are moving operations to China or other low-wage nations, where they buy boxes from local suppliers. Many of the remaining customers are ordering less. They are demanding thinner, lighter packaging so they can reduce costs and meet ever-lower price targets set by the likes of Wal-Mart Stores Inc. Industrywide shipments of containerboard have been down for four straight years, an unprecedented decline.
Smurfit-Stone is getting smaller, too. The Chicago company has shuttered 25 packaging plants in North America since it was formed in a merger in 1998. And on Jan. 9, it announced that it would close four more, bringing recent layoffs to roughly 1,700 workers. Yet even those moves may not be enough. Industry analysts reckon the $7.75 billion company lost $110 million in 2003 and will see $10 million or more slip away in the first quarter of '04.
Moore is hopeful, however. Although overall orders have yet to rebound, the surge in online shopping is boosting demand for corrugated containers. Plus, Smurfit-Stone is growing in China, with five plants there. Moore, 49, who took over as chief executive in January, 2002, recently met with Senior Correspondent Michael Arndt in the company's adjunct offices in Clayton, Mo., in suburban St. Louis, to talk about his struggle to get ahead in a declining business.
The economic numbers are pretty strong these days. But I sense that those of the paper industry and a lot of others may not be anywhere near that strong. What's going on?
You have to recreate in your mind the environment we've been working in the last four years, which has been a recession. It really kicked off with the Y2K inventory buildup, when people stocked up on everything and then cut back on buying. Since then we've just gone from one thing to the next that has worked against manufacturing in the U.S. So manufacturers are fairly skittish. They're probably not willing to go out on a limb and say things are really much better, because every time they've done that over the last four years, the economy seems to have reversed itself.
With that said, we sense that things are beginning to look a little better. I think it's going to be a gradual process. We're still fighting a continued loss of manufacturing to offshore sites. The change in the retail environment is affecting us as well. The uncertainty today is how much further the U.S. economic restructuring has to go as we move from a manufacturing to a service economy. This is a huge structural change, and structural changes don't happen in a year or two.
Quantify how significant the downturn has been for your industry, please.
Demand for corrugated products has declined 7% since 1999. The industry has closed about 50 plants with somewhere in the neighborhood of 5.5 million tons of capacity, or more than 10%. Pricing has fallen 12% from its peak in 2000. But recently, it has been fairly stable. Into 2004, one could paint a picture of improved pricing, probably in single digits. For our planning purposes, we're saying shipments will be 1% positive in 2004.
Is there still overcapacity even after all these shutdowns?
I think there is. We'll probably have some additional closures. It's tough to cut enough to match the loss of manufacturing. The fact of the matter is, it's a smaller industry than it was 10 years ago, and potentially it may be even smaller looking forward a couple of years. With the dollar's correction, the worst of the manufacturing exodus may be behind us. That's not to say, though, that we won't see any more loss, because we will. By the way, I'm not sure if you ever make up that 7% decline in volume. I think a lot of that demand is permanently gone.
On the other side, you're also seeing new products in corrugated. Each year, we see more and more online shopping, and anything you buy online comes shipped in corrugated. So there are growth markets.
How does the change in retailing affect you? I thought packages were getting bigger in these big-box stores like Wal-Mart and Costco.
They actually like smaller boxes. The volume is the same, but packaging is more condensed today. The American consumer has a mindset that, every year, things should cost less. That means taking costs out wherever you can. So what historically would have been a box made out of 42-pound linerboard is now a box made with 33-pound linerboard. There is 20% less fiber in the box. It drives down the cost of the packaging. And it lets our customers stick more on every truck, because it's lighter. It's a ripple effect that has had a big impact on us.
That pressure from these big-box retailers is not going to go away next year or the year after, or maybe ever. How do you offset it?
You have to take costs out of your system. That's how you're going to survive. One of the major technological developments that is very exciting is RFID, or radio-frequency identification. These are microchips that get embedded into products, allowing you to track them through the supply chain. Wal-Mart has asked its 100 major suppliers to have the capability by 2005. It's not only going to allow us to give our customers a better means of tracking things; it's going to allow us to do the same thing. Using the technology, we could take costs out of our system as well. It could potentially be a generational breakthrough.
It's still pretty costly to manufacture a chip and put it on every product in a factory. The chips are probably 30 cents apiece. At that price, it's too expensive to embed one on every single package, but you could embed chips by a pallet-load or by truckload. But when it's a penny apiece or a fraction of a penny apiece, it won't be a cost issue. Once you get to the point where it's embedded in every single product, it'll take the place of a bar code. Theoretically, you could then track your inventory to minuscule levels. And therefore you could meet the targets of cost-driven customers without necessarily losing margins.
Is cost-cutting a sustainable way to do business?
It is sustainable until you get to the point where you have the right supply base for demand. It won't work forever, of course. But we're in a gray period. We don't know how big the industry needs to be. It's a question of how much growth you can get from what remains here.
How long will it be before you are building new capacity?
I don't think we will ever see another greenfield mill in North America. Within the existing infrastructure, we could find ways to increase output, and we have done that. But there is not in my wildest dreams any scenario where we would have to build new capacity.
While the U.S. is cutting capacity, China has been adding it. If there is demand, can't you sell more there?
The economics of trying to ship a ready-made box from the U.S. to China doesn't work.
Why, then, is China importing so much recycled paper from the U.S.?
You can fill out a container ship pretty easily with lots of tonnage of recycled material. You can just throw it into a ship. You can beat it up. You can put together a bale of waste paper as big as a conference table and it weighs 2.5 tons. You go with corrugated products instead, and it weighs 200 pounds but takes up exactly the same amount of space.
Do you see this industrial movement to China continuing?
There is still a lot of risk with having all your facilities there. You could have an implosion in China. I think there will come a point where people have outsourced as much as they can. I don't think we'll get to the point where we'll turn into a complete service economy. But we're not sure where we are in that process. We just need to remain diligent.
If nobody is building new facilities in the U.S., aren't you just ending up with the best of a lot of old technology and equipment? Meantime, the stuff in China is brand-new. How can you compete?
It's no secret that what they're building in China today is technologically on a par with or superior to what we have in North America. But our customer needs are very wide-ranging. So all our plants don't have to be the biggest, newest, or flashiest. You can be the biggest player in a smaller market and produce attractive returns for shareholders over time. There are U.S. companies that are world-class manufacturers. We're moving in that direction, but we're not there.