Special report: How paper packaging buyers are managing procurement risk
Private Papers: candid conversations with packaging procurement professionals
Sourcing paper packaging material is becoming more and more complicated for consumer goods companies, especially in this historic moment when unprecedented gas prices are posing serious problems for – and in some cases even existential threats to – paper mills and packaging production sites.
Packaging buyers have had to deal with high and volatile prices for the past couple of years, stemming from skyrocketing production costs, disruptions in the supply chain and high transport costs. As a consequence, they are struggling to prepare their budgets and forecasts and sometimes have to adapt their packaging needs by postponing production or by temporarily switching to other materials. Inflation in the packaging segment also contributes to higher prices for consumers, which, when tallied up with rising costs across the board, ultimately lowers demand and erodes margin.
In Europe in particular, skyrocketing gas and energy prices are forcing some paper mills to temporarily halt production, and this will further tighten the market, increase lead times and possibly bring further price increases.
In this special report, “How paper packaging buyers are managing procurement risk”, we will look at how consumer goods companies across Europe and North America are being affected by and responding to this complex set of procurement risks. To do so, we spoke to a number of senior procurement managers across the profession, representing different sectors, to understand how they are dealing with the many challenges the market has thrown at them in the past couple of years.
Paper packaging has become a risky business in recent years
Global shipping and road transport networks have suffered severe disruptions in the past few years due to the interaction of multiple, complex factors, including Brexit, a trade war between the United States and China, a container shortage and a lack of truck drivers.
In 2020, the arrival of the Covid-19 pandemic highlighted all the problems that global trade already had, and in some cases, intensified them. Meanwhile, lockdown measures imposed by governments around the world with the aim of reducing the spread of the coronavirus resulted in more and more people purchasing all types of goods online, thus giving a huge boost to e-commerce and driving corrugated packaging demand.
The Covid-19 vaccination campaigns that started towards the end of 2020 helped the world to return almost to normal, with the result that global trade quickly started to return to pre-pandemic levels. The sudden restart of global economic activity resulted in strong demand for all kinds of raw materials, which led to production problems, order delays and significant price inflation.
Pulp and paper for recycling (PfR) prices started to rise steadily in Q4 2020, as did containerboard prices. According to figures from Fastmarkets, bleached eucalyptus kraft pulp prices in Europe rose by Euro 128% or Euro 743/tonne between October 2020 and July 2022. Testliner 2 140-g prices in Germany increased by 82% or Euro 390/tonne between October 2020 and August 2022, while unbleached kraftliner prices grew by 70% or Euro 390/tonne over the same period.
At the beginning of 2021, chemical suppliers also began to increase delivery prices, blaming raw material shortages, dramatically increased international freight transport costs and rising energy, labor and regulatory costs. This led to strong inflation on all input costs that continues to this day.
Towards mid-2021, another cost component, namely natural gas, started to hit the headlines as prices began to rise steadily, reaching all-time highs. In July last year, gas prices in Europe started to soar due to a mix of reasons. Low gas supplies from Russia led to record-low gas storage levels in Europe, and Norwegian gas capacity dropped to its lowest level in two months due to maintenance at production facilities. In the Netherlands, the giant Groningen gas field was expected to be shut down three years ahead of schedule. Finally, below-average wind speeds hampered wind power generation, resulting in greater reliance on natural gas. In mid-September 2021, German baseload power for delivery next year, the benchmark European price, traded above Euro 100/MWh for the first time ever, corresponding to a year-on-year increase of around 150%. On December 22, the index reached a peak of Euro 267/MWh, but then eased at the beginning of the year. The Russian invasion of Ukraine in February of this year obviously aggravated the situation on the gas and energy side. In August this year, the German baseload power price for delivery next year traded at over Euro 500/MWh for the first time.
Being an energy-intensive industry, the paper sector began to struggle because of energy prices and paper mills around Europe had to implement further price increases and energy surcharges to offset these additional costs. In some cases, some paper mills even decided to temporarily stop production while waiting for gas prices to ease, while European governments implemented a series of measures to try and help both companies and households.
The economic situation looks very challenging.
“Despite better paper availability in the European market, we cannot discard the possibility of supply shocks in the short- to medium-term. These disruptions go well beyond bottlenecks in transport through rail, trucks and barges. The ongoing gas and energy crisis in Europe is starting to worry buyers, who might again be exposed to lack of paper availability, especially if natural gas flows from Russia are further disrupted,” Alejandro Mata Lopez, Director, Europe Graphic and Packaging Paper at Fastmarkets commented.
He added: “According to our own estimates, up to 8.3 million tonnes, or about 17% of the European containerboard paper capacity, is at risk if Russian gas flows to Europe go down to zero. After Russia’s decision to keep the Nordstream 1 pipeline shut indefinitely, the risk of gas rationing in Europe is higher than ever, especially as the continent moves to the cold winter season. Fluctuations in gas prices will not only depend on how efficient other energy sources can be, and or unilateral decisions announced by Gazprom, but also on the mere swing in temperatures. An unusually cold winter this year or next would trigger more volatile energy prices than we have ever seen in Europe.”
In this special report, we look at the most significant risks facing those procurement professionals responsible for buying paper packaging – and how they are adapting their procurement strategies to mitigate those risks.
Five ways that procurement professionals are managing risk
In the current environment, packaging buyers continue to face enormous difficulties in obtaining packaging material and in ensuring that packaging purchase prices don’t erode their margins. Fastmarkets talked to a variety of buyers from different industries to understand how they are coping with this extremely uncertain situation and what tactics they are using to mitigate risks.
1. Investing in relationships with suppliers
The rebound of the global economy that followed the Covid-19 pandemic, together with the increased importance of the e-commerce segment, led to a surge in demand for packaging material, which made it difficult to obtain. A number of sources surveyed told Fastmarkets that having a good relationship with their suppliers was key in order to ensure that they were prioritized when it came to sales of packaging material. This process is known in the industry as “supplier relationship management”, quickly becoming a core skill for procurement professionals.
“The problem with paper is that demand is very strong, and even if paper mills work at full capacity, they still need to prioritize between customers. So, for us, it is really important to get in contact with paper mills and make full use of the relationships we have with them to ensure that we are among the customers prioritized,” one source said. “It is important to nurture relationships with the suppliers with whom we have a good relationship in the past, suppliers we might have helped when prices were going down; now they are able to reciprocate and to help us. It’s a bit of a quid pro quo. It’s not a secret that if you are a big buyer, maybe you have a better chance to get what you need, but that’s not enough,” she added. “Having good relationships with paper suppliers is key for us. Historically, I think we have been a good client and we’ve never been too aggressive. For this reason, relationships with suppliers are quite healthy, although in some cases we have still had to swallow price increases without discussion.”
“As for label paper, we were affected by the strikes at UPM’s mills in Finland, which lasted a very long time. Here, we engaged in ‘high maintenance,’ holding a lot of meetings with suppliers.” another one said.
Flexibility to switch from one material to the other, both within the paper segment and to other types of materials when necessary, was also important for buyers trying to meet production targets.
“If paper is not available, the question to us from management is, how fast are we able to identify another possible material and switch to it?” one source said. “Our Brazilian operations were affected in mid-2021, when our corrugated box suppliers could not find enough paper. We had to adapt fast and change the composition of the boxes we bought. Basically, if what we needed was brown recycled linerboard and only white linerboard, which is very often more expensive, was available, it did not matter at that time. We asked the supplier to produce the boxes with whatever paper they could find.”
“Even so, we did not manage to get all our material on time,” a second one commented.
A third market respondent said that, in order to manage the lack of label paper caused by the strikes at UPM’s Finnish mills at the beginning of 2022, he had to import some material from China, and, to do so, he had to change the paper specifications.
3. Diversifying suppliers
Among the tactics for mitigating supply chain risk, diversification of suppliers is also important, according to most of the sources surveyed, in order to ensure business continuity.
“Typically, we have a split portfolio between one major manufacturer, a local partner and perhaps a low-cost national supplier. So, when it comes to issues with production capacity or with delays in shipments, we have other partners to rely upon. We usually have at least two suppliers with two sites each. If it’s a printer, then several printing presses,” one source said.
“Diversification of suppliers is also key, but it must be done before the crisis actually starts. When you are in a crisis, it is better to stick to your regular suppliers rather than start to build new relations with other partners,” another market source added.
4. Reviewing purchasing strategy
Other market players mentioned that a review of their purchasing strategy was also needed in order to overcome some of the issues linked to the lack of paper.
“In order to mitigate these issues, we reviewed our ordering behavior. Before, we ordered boxes when we needed them. Now, we have extended our reach and, for some portfolios, we are ordering three months in advance,” one buyer said.
“The absolute priority is supply security, and, in order to avoid any out-of-stock situation with the supermarkets, stock management also comes into play. We are moving away from ‘just in time’ purchasing and are instead building larger backup stocks. Having safety stock in place is important because we’ve gone through several cycles now – Brexit, then Covid-19 and now the war in Ukraine. All of these things can cause problems with the availability of materials, so we’re doing a lot of things in the supply chain to try and prevent that from happening,” another source added.
5. Going big
Finally, some market respondents said they believe that working with large integrated suppliers is also important in order to secure the stability of supply, although some noted that this does not fully guarantee the availability of material for smaller businesses in times of strong demand.
“In general, we try to work with integrated players that also have a lot of paper production capacity. When you work with an integrated producer, they communicate clearly whenever supply chain issues appear, and they can typically meet most of your needs with one grade or another. So, for us now, the key thing is to limit the number of independent converters that have no paper operations. We know that paper availability is improving, but every day we are very close to a new crisis, so we are preparing for the next one,” a market source said.
He added: “Nevertheless, working with large suppliers does not protect you from having an issue in the future, because when you have a huge contraction in the market, they have to allocate their material in a way that satisfies most of their customers. And in this business, even though we spend a lot of money with many of them, most of the time we are not among their largest customers.”
How packaging buyers approach price negotiations
Strong paper demand and increasing input costs, with gas and energy prices skyrocketing since the end of 2021 and even more now because of the war in Ukraine, have led to major price inflation in packaging material — a headache for paper buyers. According to most market respondents, having a clear cost structure based on indexes is key to trying to limit increases and avoid speculation.
“Having a pricing structure that shows how much paper costs, how much transport costs, how much all the different cost factors are, is very important. These days, it is very difficult to put a cost structure in place if you don’t already have one. It would be very hard to convince a supplier to accept a cost structure in a moment of the crisis,” one market respondent said.
“Over the past several years we’ve tried to implement contracts that have a clear pricing mechanism and a clear price revision mechanism, either based on a price index or based on cost models, where conversion costs are clearly defined and where we have energy, logistics and labor rates clearly set. Then, of course, it comes down to the price negotiations,” a second one added.
Those who did not have a clear cost structure in place are turning to their suppliers in order to obtain this kind of information. “We have tried to improve the transparency of our cost structure. When a producer tells us that there is a 20% increase on paper we say ‘okay, but now we will sit down together and you will explain the increase to me in detail’,” one buyer told Fastmarkets.
“When we didn’t have a cost structure in place, it was indeed more difficult and what we tried to do was to understand as much as possible the increases and to get a justification for them. In some cases, we even obtained invoices with the various costs from our suppliers,” another one added.
Some market players also decided to optimize their ordering process so as to mitigate price hikes. “We tried to optimize the value chain. We’ve realized that, for some materials, we were ordering every week or every other week. So, we proposed to the supplier that we would place a bigger order, which would optimize their production capacity, at a lower price for us. In the old world, this would be a cost-saving strategy, but today it’s just a way to reduce the price increase,” one source said.
“We can also optimize the ordering process by changing the quantities, simplifying the product range and perhaps changing the color and the packaging complexity. Still, when suppliers unilaterally impose surcharges and increases, that’s a problem. In this case, we’ve attempted different things, including going directly to the paper mill,” another market source commented.
But the situation is not the same for everyone and there are also those who admit that no tactic or strategy has worked when it comes to ensuring fair pricing.
“For years, contracts were very simple. We had an indexation mechanism that was 100% related to paper only. So, for any price increase that we saw on a monthly basis coming out of the Fastmarkets figures, we then applied that to our prices. But, since November 2021, most of our suppliers started to engage in monthly negotiations to revise what we call ‘extra cost’ and, unfortunately, we didn’t manage to mitigate anything. The market has really gone crazy since then, and if we’re not engaging in negotiations and are just declining the price increases, that’s when supplier relations come to a standstill,” one market source said.
In this situation, coping with price volatility and securing margins has become extremely difficult, and this is extremely visible today, when thousands of European companies are at risk of temporary or permanent closure because of high gas prices.
“Unfortunately, no one has the solution to volatility. There’s still a war going on and we don’t know when it will end. What we have tried to do is secure fixed prices for a certain time with our suppliers. Still, it happens now and then that the suppliers say they cannot hold prices any longer and then that’s the end of the discussion,” one source commented.
“Of all the price increases we have had to swallow during the last 18 months, not even half of them have been passed down to the retailers. Unfortunately, this has eroded our margins and continues to do so to a great degree,” another one added.
When budgeting starts to look a lot like guesswork...
When it comes to budgeting, most paper buyers would like to have a crystal ball, as they consider this exercise extremely difficult, if not impossible, due to the continuously evolving and volatile market and political situation. In fact, the last two years have been characterized by many crises, from the Covid-19 pandemic to the lack of raw materials, from rising input costs to the war in Ukraine and skyrocketing gas prices.
“This year, we were just working on the budgets when the war in Ukraine started. I was presenting something to my management on February 24, I sent them the draft and then, 30 minutes before the actual meeting, I came back with different numbers because of what had happened during the previous 48 hours, which completely changed the picture. In this situation, budgeting is extremely hard. Judging by how the scenario has evolved, it’s better to hope for the best and prepare for the worst, right?” one market respondent told Fastmarkets.
“We use price forecasts, monthly analysis and other insights, but nobody knows how the market situation is going to be by end of next year. It’s the most difficult budget session that we have had for years. We redo the forecasts every quarter, and each time we have done one over the last 18 months, we have failed at it. We always have a huge gap between the forecast and the actual market price,” another source added.
Still, not everyone is panicking when it comes to budgeting: some of those buyers surveyed said market intelligence has helped them a lot during this exercise, allowing them to better manage the situation. “We follow several market intelligence sources to gather information around what is forecasted both in terms of production capacity of packaging producers and in terms of predicted prices. We’ve established several different price matrixes and cost models with our customers to enable us to quickly pass through all those headwinds of price increases, and it’s been difficult to do that of course. At the end of the day, budgeting using several different intelligence sources that we stress-test monthly and monitor the forecast accuracy of is the only way we do it,” one source said.
“Using our market intelligence sources, we made an estimation of the impact of the price increases. But it’s something that must be constantly monitored. Budgeting is not so dramatic for us because we learned a lot from this crisis and now we have more confidence in the forecasts,” a second one commented.
There are no silver bullets; risk mitigation strategies matter more than ever
As we have seen from the responses above, there is no magic formula to ensure that packaging buyers can obtain their material on time and at a reasonable price, but there are a series of actions that can help face supply headwinds and make sure the product reaches the point of sale. Having a trusting relationship with suppliers is definitely key in turbulent times, as well as being flexible and able to move from one material to another quickly if the right product is not available.
The diversification of packaging suppliers and a medium-term purchasing strategy are also considered important by market respondents. When it comes to price increases, packaging buyers believe it very valuable to understand exactly the cost structure of what they are buying, instead of simply swallowing price increases and energy or transport surcharges. The optimization of the ordering process is also used in order to partly offset price increases. Finally, the use of different market intelligence sources is deemed very important by packaging purchasers, as it allows them to keep close tabs on the market and to produce better forecasts themselves. Many industry representatives believe the overall market situation will not improve in the short term as the reasons behind the current crisis – lack of containers and trucks, excessive raw material demand, energy prices, inflation, the war in Ukraine – persist, making risk mitigation strategies more important than ever.