United States: Avoiding The Petrified Forest

Even the most perfunctory look at the international forest and paper industry tells us that it needs to improve its performance to create shareholder value. In Canada, in particular, over the past decade overall results have been moribund.

In theory, therefore, change should not be feared. We all know technology is dramatically changing the ways we work and communicate. Social, political and economic systems tend to change incrementally, like a growing chip pile. Every so often, however, the addition of one more chip changes the entire shape of things. That is what E- Business is doing today: creating dramatic change at an exponential rate.

E- business is integral to the changes coming to the forest industry. Fortunately, players in the industry can, and indeed must, direct the changes wrought by this new communication technology.

Let's learn from history. Where has shareholder value been created since the Second World War? It has moved from production- related industries, including forest products, to the mega- retailers (Wal- Mart et al), and again, most recently, to those companies that best own and manage the customer relationship. This new model is, perhaps, best exemplified by Amazon. com.

Amazing Financial Facts

The world's top 100 forest and paper companies have total shareholder value of $200 billion produced by assets of $380 billion— a one to two ratio— versus $27 billion created by $648 million for Amazon. com— a 42 to one ratio. Amazon's value is only partially a result of hype; the rest lies in the expectation of profit that will be created by the company's outstanding customer ownership and branding.

Three related factors are hurting the forest products industry. First, the industry is overly fragmented. Even International Paper, the revenue king among producers, accounts for only three percent of total revenues. Fragmentation contributes to global overcapacity, poor price discipline, and, compared with others in the value chain, little power to determine trends in its own industry. For example, relative newcomer The Home Depot, at $30 billion in revenue and growing at 31% compounded over the last 10 years, is able to demand certified forest products and chain of custody documentation, with the costs being borne by producers. Consolidation is taking place, but the industry has a long way to go, especially when compared to, for example, the automobile or aluminum processing industries.

Second, forest and paper is one of the most capital- intensive industries on earth; return on capital employed is a key business measurement. The industry has targetted ROCE of between 8% and 12%. In 1998, ROCE for the global Top 100 was 4.2%; Canadian producers averaged 3. 8%. Falling 4% short of the ROCE target means the shareholder value of the Top 100 suffered a $30 billion hit in a single year.

Last, this capital- intensive industry has traditionally focused on production— targets for volume produced and machine utilization abound. What is out of focus are the needs and buying criteria of the end user, the ultimate customer, the reason behind the business. This is not surprising; it's a long way from the woodlot to homeowners buying two- by- fours for their deck. In fact, the most successful sector in the industry is tissue paper. I do not believe it is a coincidence that this sector is the one closest to the end user, nor that Kimberly- Clark and Fort James are two of the most profitable companies in the entire forest and paper industry. Tissue paper companies differ from the rest of the industry in one other important way: they invest heavily in branding and marketing.

If the industry agrees change is necessary, inevitable, and even preferable to the current situation, just what are the forces that will drive this change? Influential business theorist Peter Drucker wrote, "The customer is the business." The overriding preoccupation in forest products, then, should be the strength of the customer relationship— not the saw, pulp, or paper mill. Making the customer, instead of the means of production, the focus requires a radical change in direction. To avoid going the way of the dinosaurs, or in this analogy, becoming overseers of a valueless petrified forest, industry leaders need to embrace a new way of thinking: a customer- centric business model.

Placing the wishes of customers at the heart of the business model introduces several requirements:

• creating innovative new products

• making a large investment— at least in terms of mental energy— in branding

• creating integrated planning systems

• developing customer relationship management processes.

The customer- centric model, in short, makes customer service performance measures more important than production measures. For example, if the customer is king, new questions rise to the fore: How good are we? How do we measure customer satisfaction? How much do we invest in our customer relationships versus our production assets?

Even before measurements are taken, the customer- centric model presupposes another question, namely: Are we good at this? Are we world class? If the answer is no, whether in logistics or even production, the follow- up questions have to be: Why do we do it? Is the investment required to become world class worth our while?

The best examples of customer- centric focus lie outside this industry. Consider a company like General Motors. For decades, it has been known as the largest automaker in the world. But take a close look at it today. Automaker is a misnomer, as more and more of the actual manufacturing, fabricating, and production is done by other less well- known companies, such as Magna International. For its part, GM sees its business as design and marketing, that is, being responsible for the care and feeding of its most valued assets— its brands and customers. The design and the brands, ultimately, are the only cues that allow customers to identify the company with the product.

Is this approach too radical for the forest industry? After all, harvesting trees and shipping wood products are what forest and paper companies do best. Right?

It's true that some companies won't be able to make this transition, but the successful ones will see they have no other choice. Look at the telecommunications industry. After 100 years of defining itself as a manufacturer, Nortel is letting someone else take over that role.

Another concern forestry companies, and all companies, face is the reliance on the new communication technologies. What do foresters know about E- business? Not enough— yet. Those who do know E- business, however, are reaping the rewards. Kruger Inc. is the first newsprint company to offer on- line customer service. The customer service extranet provides its customers with direct access to order status information. Clients and business representatives are praising the new technology, and are especially pleased with the savings in time and money.

When General Motors concluded that Magna International could assemble part of its cars better and more cost- effectively than it could, GM was placing Magna at a spoke end of its operations, a spoke dedicated to production. GM remains at the hub. From here, it designs the products, and owns the brands and its customers (the average car or truck buyer will be loyal to Cadillac or Chevrolet, not Magna).

Forest and paper companies now have a choice to make: to be at the hub and build not only the product, but also the brand, or to be a spoke and commit to specializing in one link of the value chain, e. g., sawmilling— and doing it profitably. The forest industry has long operated with a "push strategy" that could be reduced to "produce it and they will come." Today, and especially tomorrow, the emphasis is shifting from the product to the customer. Loyalty from the right customer is more profitable than 100% machine utilization.

Brand is not merely the company logo; it refers to the entire relationship to the customer. The Coca- Cola brand (its look, feel, and its taste) is estimated to be worth more than all the other assets of the company. In contrast, a 1998 survey of North American forest and paper companies with sales of more than $2 billion found widespread lack of attention to key marketing activities like profit- driven market segmentation and strategic price management. These forestry companies saw profits fall by as much as 40% over what was estimated to be full potential.

The question facing forest and paper companies is this: If brand can be such a valuable asset, how much should be spent to develop and protect this asset compared with production assets? If the decision is to move to the end of the spoke, branding will be a much lower priority.

Brands depending solely on creating awareness of product associations will encounter greater limits in coming years. The main emphasis will be to brand deeper— below the waterline— by expanding the brand to include core capabilities, relationships with clients and suppliers, and the company's way of doing things. This provides a broader platform for growth. Recognition for world- class ability in customer service offers companies greater marketing opportunities than being perceived as an expert in a particular product category.

Brands are built upon three pillars: products, people, and communications. The emphasis given to each depends on what you sell. Cosmetics and beauty products are driven by communications, specifically packaging and print advertising.

Brands of service businesses are driven by people and their knowledge. Industrial manufacturers such as forestry and paper companies have been driven by products, but the other two pillars can not be neglected. All business is becoming more service oriented, and E- Business is becoming a key enabler of service excellence.

The first challenge those in the industry must overcome before launching a successful brand strategy is to find out who they are— not what they sell, but who they are. This means defining their:

• business

• products or services sold

• employees

• customers

• internal and external communications approach

• company values.

The next step is to communicate these definitions, the brand, to the world. But that is an area where outside experts can be brought in to help. The tough part is to define, or redefine, the company with the customer uppermost in mind.

The message here is not about technology. Forest products companies will need bulletproof technology, but that will not be enough to ensure success.

Dramatic change is necessary, and the direction of that change will be set by the customercentric imperative. Shareholder value will be created by companies that, over time— but not too much time— dramatically change their value proposition. The largest value will be captured by those who correctly execute customer segmentation, customer loyalty programs, and brand development.

The only certain statement that applies to all is: The status quo is not an option.