Competitive Landscape of Paper Manufacturing Industry and Household Appliance Industry

Previously we've talked about Porter's Five Forces and how they impact industry profitabilities. In this episode, let's pick two completely different industries and see how the different industry dynamics impact financial performances of companies in each industry.

The two industries we chose are paper manufacturing industry and household appliance industry. To facilitate a better understanding of our discussion, let's first establish some basic understandings of these two industries.

Paper Manufacturing Industry

The paper manufacturing industry is not unfamiliar with most people. Almost everybody is a consumer of the paper manufacturing industry. For example, we may read newspaper, use notebooks, read magzines, etc., all of which are different kinds of paper products. In our daily lives, we may also use tissue, toilet paper, etc., and both belong to the household paper products. In addition, every day we buy all kinds of products, and they usually come in packaging, which of course is a type of paper. Therefore, everyone is a consumer of the paper manufacturing industry, but generally speaking, we don’t go to a paper manufactory to buy paper ourselves. By purchasing other kinds of products, we become consumers of paper indirectly. This may also be the reason why we don’t know that much about the paper manufacturing industry.

Put it in another way, the paper manufacturing industry has several different customer bases, i.e. buyers, such as newspaper and press, individual consumers, manufacturing companies, etc. 

Where do the raw materials of paper manufacturing come from? A really important material is wood. Most paper is produced using wood pulp. One example is toilet paper. We always see on toilet paper packaging saying "made of 100% original wood pulp". This means the raw material of the toilet paper is wood pulp, which comes from wood.

As we know, forest resources are pretty limited worldwide. Therefore, sometimes we may not only use original wood pulp, but also recycled wood pulp, like recycled paper. It also matches the concept of being environmentally friendly. Additionally, the paper manufacturing industry worldwide also uses straw pulp or other non-wood pulp in production. 

The paper manufacturing industry is a capital-intensive industry. To build a paper manufacturing factory, every 10,000 tons of paper production capacity requires about 14 million dollars of investment. For a typical paper factory, the industry standard can reach hundreds of thousands of tonnage, resulting in a total investment of several hundreds of millions of dollars. This is why the paper manufacturing industry needs large amounts of capital.

Now let’s use the five forces model to check the paper manufacturing industry’s overall environment. 

First, we are going to look at two things, the competitiveness of the industry and the threat of new entrants. The threat of substitute products will be discussed later.

Now let’s look at this graph, which describes how the paper manufacturing industry progresses in the past 60 years in China. From this graph, we can see that the output is relatively stable from 1950 to 1990, but starts to climb really fast from 1990 to 2008, especially between 2000 and 2008. After 2008, the growth rate starts to slow down.

Even though this graph is about output in the paper manufacturing industry, it actually also shows a similar trend of investment into the industry for the reason that output comes from additional investment. So investment in the paper manufacturing industry is really hot between 1990 and 2010.

But why is there a turning point in 2008?

Well in 2008, Chinese paper manufacturing entered the phase of excess capacity. Excess capacity happens when the production capacity of the industry exceeds its demands, and when it happenss, the competition will be brutal.

Now let's take a look at this table. The table lists the cost structure of raw materials and labor to produce one ton of paper in different area in the world. 

Producing one ton of paper in different areas across the world can have drastically different costs. In some areas, raw materials are relatively more expensive, and labors in some others. Remarkably, China is a rare exception. We can see that the labor cost in China is really low; but this is consistent with our commonsense - China is still developing and labor costs are relatively low compared with other developed countries. However, raw material cost is really high in China, or about three to four times the price of those of other developed countries. 

Why is that?

Well we mentioned which raw materials the paper manufacturing industry need. First of all, we need wood. Forest resources in China are relatively scarce compared to a lot of countries. For example, the forest coverage rate in certain countries can reach 80%. But in China, it’s less than 30%. Because of this, the Chinese paper manufactory companies have to import wood pulp from other countries.

On the other hand, companies also try to use some substitute materials, such as non-wood plants, or straw pulp. However, producing straw pulp is a serious cause for pollution, and the government has put down serious restrictions on such method. Another source is recycled papers. Since recycled paper are from waste paper, and the paper manufacturers in China have to rely on waste paper import from other developed countries, which will inevitably increase prices. 

Knowing all these, we can come to the conclusion that Chinese paper manufactories have to face suppliers with stronger bargaining power. For a really long period, competition in the industry wasn’t intense. However, it lacks bargaining power against its suppliers, or its upstream.

Household Appliance Industry

The household appliance industry refers to house appliance manufacturers for things like TV, air conditioner, or washing machine, etc. It is one of the first industries to enter into intense competition in China. As competition becomes more and more fierce, we can imgaine that profit margins will become lower and lower. Therefore, the household appliance industry possesses relatively weak bargaining power against its buyers.

Another feature for the Chinese household appliance industry is that for a very long time, the industry has a really specialized sales channel. This channel is centralized under two or three companies’ control, aka. a high market concentration. This gives buyers even stronger bargaining power. Therefore, the household appliance industry is very different from the paper manufacturing industry, as it lacks bargaining power against its buyers, or downstream.

These are the basic conditions of the paper manufacturing industry and the household appliance industry. Understanding this, we will further explore how companies in these two industries perform financially.