Cost Drivers in Packaging & Packaging Material

This is a transcript of the Cookware Manufacturers Association podcast interview with Mike Smith– a respected packaging industry veteran. Through his unique approach to sourcing and his CFO orientation, he’s saved tens of millions of dollars for his employers.  In this interview, he shared details on cost drivers in packaging and his cost-saving knowledge.

If you would like to know more about Mike   – You can contact him directly via his email.

The interview:

Penny: Tell us how you came about your approach to packaging procurement?

Mike:  “I started my career in finance with a Fortune 500 food company and was pulled into some mergers and acquisitions projects, and later in my career, as a CFO, I completed an M & A transaction that created significant value, at a very low cost.

During my 13 years with a leading global packaging manufacturer, one of my roles was M & A integration and synergy achievement.  On one single M & A project, we had an initial target of $52 million in synergy savings, we achieved $104 million in savings two years ahead of schedule.  A significant portion of those savings came from Procurement projects.  We would bundle up the spend and get better pricing, and we’d also look at creative approaches to value drivers and how we could leverage those value drivers to increase our savings.”

Penny: You mentioned “Value Drivers,” for listeners that might not be familiar with the term – would you explain?

Mike:  This is where my CFO training and experience has proven to be a differentiator with regards to my approach to Procurement.

I completed the Mergers and Acquisitions certificate program at the Wharton School at the University of Pennsylvania.

I also had negotiations training with Max Bazerman, from the Harvard business school and Stuart Diamond from Wharton, both very accomplished leaders regarding negotiations and strategy.

One of the key learnings regarding acquisitions and negotiations was understanding the different value drivers for both the sell side, andthe buy side, and then framing your negotiation strategy around creating value for both organizations, maximizing the size of the pie.

In simple terms, value drivers are the different levers that influence value. One might be volume.  Increased volume could create value for both sides, conceivably a better price for the buyer, and increased total gross profit for the seller.

Penny: The next pressing question is – how did you find value drivers impact packaging?

Mike: This is where having a CFO perspective can create significant value or identify opportunities that a normal procurement professional might overlook, or feel they can’t influence because that’s not how they were trained in Procurement.    When a CFO looks at packaging, he or she would start with a review of the market, prior to pulling together an RFP.

3 Main Cost Drivers in Packaging

Penny: How do market conditions impact the cost of packaging?

Mike: It will directly impact your negotiations strategy. With regards to packaging, there are three main cost drivers,

  • The substrate,
  • The specifications and
  • The performance attributes

The substrate for corrugated packaging is the liner and medium, virgin or recycled, and for folding cartons, its typically CRB, SBS or CUK.

Typically, the cost of the fiber substrate might be between 60% and 70% of the total cost of your package.  For plastic packaging, the cost of resin and crude oil influences the cost of the packaging.

This is where market demand comes into play.  During a tight market, packaging companies will be coming at you with price increases, or your contract might even include language on automatically absorbing substrate inflation. This is procurement 101.

Conversely, they aren’t as eager to reduce pricing when the demand is soft and pricing is retreating.  At that point, the discussion will be around how much value they are creating for you through their R & D and customer support. 

Penny: This makes sense Mike.  I’ll take a moment to remind everyone Cookware Manufacturers Association provides the monthly commodity report exclusively to our members. The report includes data for key cost drivers in the CW BW industry  Metals, Oil-based Material [polystyrene, polypropylene] and liner board as well as international currency.  If you are not a CMA member and would like more information go to becoming a member on cookware.org.

Penny: Where does your CFO background and influence come into play?

Mike: It’s having a CFO level understanding of the market and the cost/value drivers in play.

For instance, you need to understand if your supplier is integrated or not, meaning, do they manufacture the substrate that is used to make your packaging?

Right now, almost all of the paper and paperboard substrate markets are soft, SBS especially, as well as liner and medium.

You could delink your substrate buy from your packaging buy in order to drive significant savings during periods of market softness for the substrate.

Penny: How do you delink your substrate cost from your packaging cost?

Mike: You can do it, if you have a significant amount of purchase volume.  You can also accomplish this by converting from an integrated supplier to a non-integrated supplier, or by dealing directly with the substrate manufacturers regarding your price for the liner or paperboard.

Penny: How does that create value?

Mike: Integrated suppliers typically hold their substrate pricing firm and fixed at a price that’s higher than the floor, (the lowest price they will sell their substrate at in the open market).

For instance, liner may be priced at $750 a ton right now, but liner manufacturers may be selling liner for export at only $400 a ton.

Those same liner manufacturers won’t sell their liner to you for less than $750 a ton in the box price, but they will sell liner to other converters for pricing north of the export market.

So, a liner manufacturer, with excess capacity who are exporting at a low price, will typically sell to independent converters at a price between the ceiling (the $750 a ton) and the floor, the $400 ton in the export market.

How close to the ceiling or the floor depends on the volume, the complexity of the business, etc. but that’s a large range for value creation.

If you’re paying $750 a ton for the fiber used to make corrugated boxes, and you can get that fiber for $550 a ton, that’s almost 30% savings.

Penny: Ok. Beyond the substrate integration, can you explain a little more about the cost drivers in packaging?

Mike: I mentioned earlier the three main cost drivers in packaging, the substrate, the specifications, and the performance.

I’ve talked about the substrate.

Specifications or the design of the packaging and the amount of raw material used to create has a significant impact on the cost.

In the corrugated market, for instance, integrated converters want to sell you as much fiber as they can in the boxes they are supplying.

Any box specifications they recommend may be heavier than what is really needed.

Most companies can take anywhere from 10% to 20% additional cost reduction by right-sizing their material specifications, for instance moving from 33# to 26# fiber, without impacting the performance.

Penny: You mentioned performance as a cost driver.  Can you explain what you meant?

Mike: When I talk about performance as one of the cost drivers in packaging, I’m talking about understanding how your specific packaging performs while it’s being manufactured and also while it’s being utilized.

So, performance on the manufacturing side, are you placing long-running orders for thousands of units that provides for manufacturing efficiencies and optimization, or is your order pattern choppy and tend to be small runs.

Those boxes will cost more, because of the poor performance/efficiencies experienced by the manufacturer.

By the same token, with regards to cost drivers, does the packaging run well on your equipment, or does it cause equipment downtime and costly customer damage issues?

Those again are cost drivers in packaging that need to be understood and considered when evaluating your packaging spend and your suppliers.

When I talk about performance as one of the cost drivers in packaging, I’m talking about understanding how your specific packaging performs while it’s being manufactured and also while it’s being utilized.”

Penny: What about e-commerce – we had a conversation earlier – how is e-commerce having an impact on corrugated packaging?

Mike: First of all, I think the 10% annual growth in e-commerce has pushed the producers to invest heavily in both fiber capacity and converting capacity.  The US market capacity has grown substantially, and it’s expected to continue to grow for the next two to three years. I think most of this investment has been driven by the growth in E-Commerce.

Well, E-commerce shippers are getting smarter.  They aren’t using as much corrugated.  They are using more mailers and they are using the right size packaging to reduce the logistics cost and reducing dunnage and other waste. This means the overall demand for corrugated may not support the capacity growth that’s planned.

Companies like Packsize, based in Salt Lake City, Utah, have developed equipment to manufacture right sized boxes on demand.  They supply the equipment, and you buy the fiber from them, in bulk, to make the needed corrugated boxes on site.  This different model wipes out an entire layer of the supply chain and that layer of cost.  It also provides the following typical benefits:

  • 30% to 40% reduction in cube volume (and dimensional freight savings)
  • 50% increase in the quantity of orders filled per plane or truckload
  • 60% decrease in void or filler reduction
  • All of these things benefit the environment and support sustainability initiatives, but they are also great for the bottom line, by providing significant savings.  If you utilize e-commerce to sell your products, you need to explore companies like Packsize and make your own boxes.

Even if you don’t use E-Commerce, making boxes on site is a great solution if you have a lot of small run orders, 1,000 boxes or less.

Penny: What can you tell us about other market influences – like China coming into the market

Mike: China and other foreign countries have raised their quality requirements on imported fiber.  Recyclers are having a hard time meeting those standards, so the export demand is soft, driving down the market value of recycled fiber, and the cost of recycled liner and paperboard.  I think ultimately, you will have countries that need low cost recycled fiber sources, like China, will eventually set up their own fiber operations in the US, where recycled fiber is cheap and plentiful.  They will make their own substrates and will export it back to their home country.  So over time, you’ll see recycled fiber regain some of its lost market pricing as demand for this fiber increases.

Penny:

Thank you, Mike for the information and your insight today.

Reminder to CMA members –

If you would like to know more about Mike   – You can contact him directly at his email.

Also, remember to approach every negotiation from 2 Views – yours and our counterpart.

For more information contact Penny Rosema

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