Gustavo Gomez
GUSTAVO GOMEZ is president of Carlón de Colombia. This article is adapted from a paper he delivered to the FAO Expert Consultation, World Pulp and Paper Demand, Supply and Trade, held in Tunis in September 1977.
Needed: partnerships of governments, private investors at home, foreign companies and international funding agencies
To discuss the outlook for investment in the pulp and paper industry, we must obviously begin with the prospects for capital availability. Clearly these prospects are not, on the surface, particularly favourable. The entire world both developing and already developed has entered a period of serious capital scarcity. This has inhibited the undertaking of all but the most soundly based investment projects.
In the author's view, the single most practical avenue for capital formation in developing countries in the years ahead lies in the development of pragmatic working partnerships, based on the mutual fulfillment of complementary needs and goals. These partnerships will be most effective when they are composed of several very different major entities: First, a body of private investors native to the country in which the project is to be created, whose business interests will be served by successful development of the project. Second, the government of that country either providing temporary "seed" capital or inducing a positive economic environment. Third, a substantial private sector investor from one of the more developed nations - more probably, but not necessarily a major international paper producer or a leading financial institution. And finally, one of the worldwide or regional development agencies, such as the World Bank or Inter-American Development Bank, which are quasi-governmental in nature, but function in many ways like a private investor. These partnerships can be realized either through equity or debt financing, or through various forms of investment incentive available to government bodies.
Considering the over-riding factors of inflation and capital scarcity, it would appear that prospects are not encouraging for private sector investments businessmen native to the country in which the project is to be located, especially when the local capital markets are weak - as they always seem to be. Pragmatically, one would suppose that their personal objectives would be best achieved by liquid investments in secure financial instruments at inflated rates of interest.
But investors do exist in many developing nations who have viable profit motives for investing in their own country's development. Among these are paper converters who may presently be importing their paper needs, as well as local customers for converted paper products who have a direct practical interest in the establishment of an assured permanent domestic source of supply.
For this class of investor, return on investment may be calculated not only on the basis of financial return, but in terms of freedom from dependence on the vagaries of the imported trade, which is frequently adjusted to suit the needs of the exporter, rather than those of the importer.
Another type of compatible investor may be found in certain financial institutions, such as insurance companies and development banks, which tend to have long-term investment objectives.
I submit that, even in an area of scarse and costly capital resources, capital investments in primary pulp and paper capacity in developing countries are possible if an assured domestic market can be projected; and a partnership can be constructed between investors with truly complementary objectives and motives, resulting in an organization with a strong financial base and a well-structured, conservative balance sheet.
I believe that the soundest and most reliable market for the justification of a capital investment is a growing domestic economy in which paper products in the form of packaging or printing and writing grades have already begun to be established as an integral part of the economy of the nation.
This scenario can be based on either of two sets of circumstances. The country may already have the beginning of a domestic paper converting industry with paper needs being supplied by costly imports. Or, there may be virtually no internal converting industry at all, with customer's needs being supplied by cost imports of finished paper products.
In the first instance, where the beginning of a converting industry exists, the project may be started with the development of a paper mill and supporting raw material base. Or, when there is no domestic industry at all, the first investment may be in converting facilities, with the mill and raw material base to follow.
However, in either case, one critically important principle is met: the project is basically oriented to a domestic market. This forms the most viable basis for starting a pulp and paper industry in a developing country. The new industry becomes an integral element in the economic structure and strengthens the organic growth of the domestic economy creating a new technological and managerial class. In the case of packaging, which my company manufactures, the new industry provides the basis for the modern system of distribution, providing the essential link between producers and consumers, and permitting the economy to expand indefinitely in scope, variety and availability of products offered in the national market place.
And, of course, a domestic industry mitigates dependence on the uncertainties of the import trade, and provides lasting social and economic benefit in terms of an increased income base and supplier businesses.
The greatest pitfall for a growing business comes when some initial success has been achieved... the temptation to move too far and too soon is often irresistible.
One caution; to be sound over the long term, the initial investment has to be commensurate with the market, be modest in scope and responsive to immediately foreseeable demand, but expandable to meet future needs. In this way, a significant amount of the capital required to develop the enterprise can be provided through retained earnings and depreciation. While this is the soundest means of investment, requiring the smallest amount of outside capital and offering the greatest possibilities for long-term financial soundness, it also requires investment partners whose own objectives are compatible with a low initial pay-out and a consistently aggressive policy of profit re-investment during the early years of the project.
In 1944, the year in which Cartón de Colombia was founded, no integrated paper or paperboard packaging industry existed in Colombia. There were some small converters of bags and writing papers, and there was some rudimentary production of folding cartons using imported board. Container Corporation of America also exported some finished corrugated containers and some boxboard to Colombian manufacturers but, for the most part, Colombia was wooden-crate territory. However, the economy of the country was sound and growing and appeared to be on the verge of increasing development as soon as the energies of the world could be diverted from World War II.
At the same time, some leaders in the United States were concerned that the high levels of production of all types of industrial products generated by the war economy would result in excess capacity and might precipitate a new depression similar to that following World War I. For this reason, efforts were made to plan the movement of some capacity and associated investment capital into traditional export markets.
It was in this environment that Walter P. Paepcke, founder and Chairman of Container Corporation of America, began to investigate the possibility of establishing a cooperative packaging venture in Latin America. He found that a group of the Company's export customers in Colombia were interested in establishing a local paper industry and were seeking Container's participation. He perceived that Colombia appeared to offer an attractive future market.
Mr. Paepcke's proposal to these investors was revolutionary in those days when much of the world was still in the grip of de facto colonialism. He suggested an even partnership, with 50 percent of the initial capital to be provided by Container Corporation and 50 percent by Colombian investors. It its perhaps worth noting that this type of partnership is today - 34 years later - expressed as a goal by the countries of the Andean Pact. Accompanying the formal agreement was an understanding that Container would provide training in management methods, finance, and technological expertise, as it was observed that there existed abundant and capable human resources. The Colombian group would adapt these skills to the Colombian environment, and would manage the legal, labour and social requirements of the business.
In line with the principles stated earlier, the Colombian investor group was composed in large part of local paper convertors and users, some of whom had been export customers of Container. They were extremely interested in developing an assured local supply of paper, and they brought to the partnership a sound knowledge of the local market.
For its part, the government of Colombia was highly receptive to foreign investment. There were no exchange or trade restrictions, and corporate dividends for all practical purposes were tax-free. So, while the government was not at that time an actual partner in the enterprise, it was instrumental in providing a climate conducive to private capital formation and investment in new industries of both foreign and local origin.
And, finally, in keeping with the realities of a moderate sized developing economy, the initial investment was kept small. For this reason, during the early years and even now, Carton consistently took advantage of the availability of second-hand equipment from North America and other developed economies. At the same time, the company and its investors made sure that earnings were retained in the business to finance development. This conservative policy was possible because the interest of the partners was centred on the long-term development of a Colombian pulp and paper industry with the minimum necessary investment of new capital, and with no frills allowed.
While the decisions made in the founding and organization of Carton de Colombia were made by managers and investors with no experience in international business, and certainly followed no preconceived plan, all of the above-specified preconditions for the success of such a venture today were present then.
First, there was an assured market for paper products in the domestic economy. It was apparent that, as the company grew, it could become a part of the Colombian economy growing with the development of the nation. A majority of the Colombian investors had personal objectives and motivations which coincided with those of the foreign investor, and were able to supply badly needed knowledge of the local market. For its part, Container was able to transfer to the Colombians the management expertise and technical knowledge which was missing in Colombia at that time. And finally, all partners were agreed that the new enterprise should begin with a modest capital investment and should finance expansion through the internal generation of funds whenever possible.
Perhaps the greatest pitfall for a growing business comes at the moment when some initial success has been achieved, and investors and managers see important new opportunities that seem almost within reach. The temptation to move too far and too soon is often irresistible, and Cartón company was no exception.
A growing industry in a developing economy must be ruthlessly realistic in the projection of market demands.
Colombia had had since 1939 one producer of multiwall bags who supplied the packaging requirements of the sugar and cement industries, using imported papers. A decade later these two customer industries were growing rapidly, and so were their needs for paper packaging. A group of Carton's shareholders, including some who were also investors in the growing cement industry, believed strongly that the company should enter into multiwall bag production and should also build a kraft mill to produce domestic kraft papers. At this time, the Korean War was at its height, the world market for paper products was extremely tight and prices were increasing rapidly.
Cartón, meanwhile, had pursued its determined policy of retaining all earnings in the new business and its financial position was sound. Therefore, no problems were encountered in the building of a multiwall bag plant, and operations began sucessfuly in 1950. In this spirit of optimism, plans also went forward for the construction of the country's first domestic kraft paper mill. The course of this decision, however, was not to be so easy.
During the wartime economy, it was difficult to find adequate equipment for the new mill, particularly since initial projected capacity was to be quite small. However, it appeared that fortune was continuing to smile on our young enterprise, and we discovered the availability of a paper machine being made for a North American company which had encountered financial difficulties. The fact that the designed capacity of this machine was substantially above the projected requirements of the Colombian economy at that time was considered another plus in view of the current world-wide scarcity of papers. At the same time, we had - we thought - an assured customer base for the bag papers to be produced on the new machine, and we made plans to adapt the machine for the production of kraft liner and corrugating medium - following the theory of developing sound domestic markets.
However, in our enthusiasm, we overlooked some of the principles which had gained us our early success. We embarked upon a large investment which was beyond our means and could not be financed from internally generated funds, for which new capital was not available from the original investors, and which necessarily weakened our balance sheet.
We entered the project without an assured realistic domestic market, relying on unproved assumptions about our ability to expand in the domestic market beyond the original concept of the mill as a producer of bag papers - for which there was a demand. Finally, our foreign partner, Container Corporation of America, had no experience in the production of bag papers and, thus, could not offer us the expert technical assistance which had played such a large role in our early achievements. This turned out to be a critical problem.
Nevertheless, we made the investment, financing it 40 percent from internally generated funds and 60 percent with short-term bank borrowings within Colombia. This ignored the principle that the financing for a capital investment project should, under normal circumstances, be roughly commensurate with the expected pay-out period of the project.
The mill was completed in late 1952, and our troubles began. Initial demand was only 12 percent of installed capacity, making efficient operation impossible. Even though we used entirely imported pulps, the quality of our paper was very low, due to lack of technical know-how, and bag rejects increased at an alarming rate.
At this time, the Korean War came to an end and so did the world-wide paper shortage. Faced with our low quality and the sudden availability of imported bag papers, the customers who had assured us of their business rapidly abandoned us for the competing bag converter, who used high quality imported papers. The move back to imported bags was accelerated by a rise in coffee prices, which increased Colombian foreign exchange reserves and made imports more viable.
During this period, as a result of our earlier optimism, we were faced with the necessity of repaying our heavy short-term borrowings while the project was losing money. We were able to survive as a company only because of the soundness of our original human and financial structure, which allowed us to pour all of the energies and earnings of our other operations into the support of our kraft mill for a period of at least four years. This is an option which may well not be available to future enterprises in developing nations, and it certainly curbed our growth during the middle years of the 1950s.
Our efforts to enlist government aid to raise import tariffs as an effective protection against foreign papers were unsucessful and we were caught in a drastic price competition in order to increase sales volume of the mill. During this period we were also working intensively to solve our technical problems, but the mill did not become truly operational until 1956, when a new foreign-exchange crisis forced the Colombian government to prohibit imports.
In the long run our initial optimism about this project was justified, and today bag papers and multi-wall bags are one of our most profitable lines of business. Colombia today needs these bags, and most of the country's agricultural supplies move in these versatile containers. However, it must be admitted that we were simply very lucky. The chance that the mistakes we made in incorrect evaluation of this project would destroy our enterprise was great, and even the rewards that were eventually gained do not justify the risks of the mid-1950s.
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Cartón de Colombia, S.A. Cali President: Gustavo GOMEZ PAPER Cylinder: 210 cm & 215 cm MAJOR PULP MACHINERY Six batch-type digesters, one continuous digester PRODUCTS Bag paper; Corrugating medium; Enamelled; Folding boxboard; Kraft linerboard; Kraft unglazed, unbleached; Semi-chemical (N.S.S.C.) pulp; Sulphate unbleached pulp ANNUAL PRODUCTION Paper and paperboard: |
In short, the point I wish to leave with you here is that a growing industry in a developing economy must be ruthlessly realistic in the projection of market demands. If a really valid sensitivity analysis is made of an impending investment, it will indicate that the worst possible outcome will very likely become future reality.
Assumptions must be based on a tough-minded evaluation of long-term market developments. Proper technological and marketing expertise must be assured before entering into the market - particularly if the product must compete to some extent against imports from more developed countries. Furthermore, a clear understanding of the long-term financial climate of the project is indispensable. Even if the project is internally profitable, this may be negated by unattractive financial terms, as happened to us when 60 percent of the investment came due within one year.
Although they may appear simplistic at first glance, I believe it is dear that this review of our mistakes serves to demonstrate the validity of some of the conclusions on capital investment discussed earlier in this report.
During the late 1950s we had another nearly disastrous experience. It demonstrated the need to select partners for a capital development project with a view of the long-term compatibility of their investment objectives with those of the project itself.
The majority of our Colombian investors were customers for the products of Cartón, and they were in full agreement with our decision to retain all earnings in the business in order to finance growth. Their primary interest was not in immediate financial return, but in the development of a sound paperboard packaging industry as a vital part of the Colombian economy. Clearly these are the kind of partners needed for the success of the type of capital investment in the paper industry under discussion here.
However, some 15 percent of our original investors had no connection with our business and were motivated largely by the normal desire for an early return. Reacting to pressure from this group, a small dividend was declared some years after the company was organized, but it was clear that the financial policy of the company would continue to be oriented toward growth and the dissident investors decided to sell their shares. It was impossible however to find new Colombian investors who shared our conservative attitude toward profit reinvestment. At this point we were very fortunate that our foreign partner, Container Corporation, and some related shareholders, were willing to buy back these shares, with the result that ownership of the company is today 34 percent Colombian and 66 percent foreign.
INSTRUCTIONS TO SUPPLIERS OF THE PULPAPEL MILL Warning: some wood may be rejected at the gate
It is unlikely, however, that a new enterprise could depend on such support from one of its partners in the future. It is most probable that such a divergence of interests among the partners would have serious consequences for the enterprises.
Since inadequate and imperfect capital markets in developing countries make it difficult to depend on substantial equity investments from local investors, it may become necessary to consider the government as a potential partner in the planned capital project, particularly during the initial stages of development.
Governments frequently have social motivations for investment participation and this can make them desirable and complementary investment partners. We have had direct experience with the government as a partner in a major investment and we owe a great deal of our present strength as an independent company to this partnership.
As with pulp and paper enterprises in most developing countries, one of our chief problems in the building of a fully integrated operation was the lack of an adequate domestic fibre supply. Tropical hardwoods, with which our country abounds, had never been pulped in commercial quantities. In part, this was because hundreds of different species grow side by side in the mixed rain forest. Furthermore, there were no available long fibre species native to the country.
The Colombian Industrial Development Institute had been discussing with Cartón since 1953 the possibility of entering into a joint venture in the Magdalena area of Colombia in an effort to find productive uses for the nation's substantial unused forest resources. We formed a joint venture between Cartón, Container Corporation of America and the Industrial Development Institute, and feasibility studies were begun.
By 1959 these studies were completed, calling for an investment of $20 million, and technical research and development had progressed to the point where three old rotary digesters at Cali were producing 1500 tons per month of pulp from mixed tropical hardwoods.
However, since we had just recently recovered from our nearly disastrous experience with a too-hasty investment in our kraft mill, we took the time to reevaluate this new project. This, combined with some lingering doubts about the availability of appropriate human resources as well as about the market assumptions of the project, caused us to terminate our involvement in Magdalena, at that time.
But our interest and that of the government in the pulping of tropical hardwoods did not diminish. We promptly embarked on a somewhat less ambitious pulping project next door to our existing mills in Cali, utilizing fibres from the adjacent rain forests of the Pacific watershed. In this new project, higher wood costs were more than offset by the lower capital investment required, by the existence of an adequate infrastructure, and by the government's recently instituted ten-year tax exemption for newly created basic industries.
Governments frequently have social motivations for investment participation, and this can make them desirable and complementary investment partners.
"Pulpapel" was created in 1960 as an equal partnership between the Industrial Development Institute, Container Corporation and Carton de Colombia. Over the past decade and a half, this organization has pioneered in the development of the technology needed for the pulping of mixed tropical hardwoods. While these fibres cannot match the quality of long fibres from softwoods, we have been able to develop a homogeneous pulp which is usable in the production of packaging grades of paperboard. The government's objectives and ours have also been realized in the development of an indigenous fibre resource base through the utilization of native hardwoods.
Following the normal practice of the Institute, once the success of the enterprise was assured, its shares of Pulpapel, as well as those of Container, were purchased by Cartón.
Having achieved its objective and created a lasting social benefit for the nation, the government was thus able to redeploy these investment funds into other new industries which could benefit from a partnership with the government.
For our part, it is unlikely that we would have been able to consider such an initially risky investment had it not been for the partnership and support of the Colombian government.
While this last example demonstrates the desirability of government partnerships in terms of initial equity investments in a project, governments also have the ability to participate actively in developing an industry by means of various methods of indirect and perhaps intangible investment. This type of "partnership" is well illustrated by another of our investments in Colombia.
Banana exports have long been an important factor in Colombia's export trade, but traditional methods of shipment without packaging were wasteful. Packaging of export bananas in corrugated boxes had been experimented with and found to produce great savings in terms of the increased percentage of better quality fruit delivered to foreign markets. In 1969 Cartón built a corrugated container plant in Turbo, in the heart of the banana growing region and this plant has contributed significantly to the increased sale of Colombian bananas in world markets.
The decision to build this plant was heavily influenced by the actions of the government, which instituted favourable tax incentives in order to promote the country's export business. When the project was begun, the tax benefit consisted of a credit against income taxes amounting to 40 percent of exported value.
By offering this incentive, which greatly reduced our risk in the new investment, the government (although its investment was indirect) became in effect a partner in the venture.
Soon after the Turbo plant was completed, government policy shifted and the tax incentive was reduced to 15 percent - still welcome, but an incentive of a different order of magnitude.
Closely associated with the decision to build the corrugated container plant at Turbo was our plan to construct a fifth paperboard mill at Barranquilla on the north coast. This mill was intended to supply paperboard for the banana-export boxes, as well at to an existing container plant at Barranquilla.
Even though the government subsidy had already been reduced before construction could be started, the remaining tax incentives plus the projections of market demand and the fact that the production of this mill would reduce dependence on imported papers, provided sufficient justification to carry out the project.
Despite their action in lowering tax incentives, the Colombian government still wished to encourage the building of the new mill, and was instrumental in helping us to obtain a substantial long-term loan from domestic and international financial sources at favourable interest rates.
While this is not the proper place for a detailed discussion of Mill Number Five, it may be worth pointing out that it does provide a good example of the type of mill that may be well suited to developing countries. In building it we adapted the latest technology from all parts of the world, including a specially designed Japanese Ultraformer. One result has been that this relatively small mill delivers a high degree of efficiency at a low overall investment.
Mill Number Five was completed late in 1975, based on assumptions which included export tax incentives. However, the mill was built basically with the objective of supplying the local market, which was fortunate, since the government virtually eliminated paper-export incentives soon after mill started operation.
We have also helped to develop human resources. Nearly all of our senior management and all of our technicians are Colombians - and the workers of the company are truly its most important partners.
It must be made clear here that the author fully understands that government policies, which must be closely responsible to changing social and political realities, are at least as unstable as are the vagaries of the market for private business.
Governments can be effective investment "partners" through their inducement of investment through incentives. However, our experience suggests that it is healthy either to have some initial direct equity participation as well, or to obtain truly realistic guarantees from the government that the effects of the incentives will be continued for a definite period of time. The tax exemption enjoyed by Pulpapel during the first 10 years of its life represented such a guarantee.
It is the social and economic benefits - the human side of the equation - that are the real purpose of a capital investment project in a developing nation.
Recently, in the development of Cartón, we have come to the threshold of yet another decision, one which probably will face any new capital project in the developing world. It is a dilemma caused by the desire of many developing nations to limit foreign investment-participation to less than 50 percent. In our case, the problem is whether or not our foreign partner is willing to reduce its participation. In the case of new foreign investment this limitation may make it very difficult to raise sufficient capital from local investors motivated by the kind of long-term investment that is required by the pulp and paper industry.
This concept of proportionality adds an additional constraint which might make it impossible to obtain local partners in certain countries. In addition, I have serious reservations that capital proportionality will render the results those governments are seeking.
President Alfonso Lopez of Colombia shares this scepticism about making proportionality of capital a matter of national principle. "Can you really call a company Colombian, "he says," simply because it was formed with Colombian capital and sells, say, watches here, but assembles the watches with movements it has to import from Switzerland? And, "he continues," can you really call foreign a company which has more than 50 percent of its capital in the hands of foreigners, but which is reforesting vast regions of Colombia, converting the wood to pulp and the pulp to paper, and which supplies a packaging industry and gives employment to Colombian farmers workers, technicians and managers?"
We have built a large and viable industry in a nation that badly needed that industry. The partners who provided us with the initial capital have received a handsome return on their investments, and they have also realized the business objectives which attracted them to the partnership in the first place, things that are very meaningful in a business sense. It is also true that because of the packaging products we have made available to our national economy, Colombian industry and commerce have been able to grow to an extent that was only a dream when Cartón was founded. It is as good or better in quality than that of any other developing nation, and has made possible a significant expansion of Colombian exports. In fact, today fully one-half of all the country's exports are "non-traditional" - exports made possible in part by Cartón de Colombia.
We have also helped to develop human resources. Nearly all of our senior management and all of our technicians are Colombians and the workers of Cartón are truly its most important partners.
I confess that it gives me enormous pride to realize that because the partners who organized Cartón de Colombia achieved some success in the prudent management of a capital investment, my country and its people have received substantial social and economic benefits. It is these social and economic benefits the human side of the equation, if you will - that are the real purpose of a capital investment project in a developing nation.
