Major Factors to be Considered
PAUL GIBSON
Chief, Forest Industries Department,
The Swedish Match Company, Jönköping,
THERE are strict limits to the price at which boards find a market, since they merely replace other materials or add dispensable comfort. The use of boards is favored by expensive substitutes, a high standard of living, and a cold climate.
Freight and packing add much to the cost of manufacture; they limit exports and offer a considerable degree of natural protection to any domestic board industry. Customs duties further limit demand to such an extent that a mill which utilizes protection to the full may find no outlet for its production except in large and wealthy countries.
Integration with an industry producing suitable wastes to be used as raw materials is a conspicuous advantage. Since small board mills are penalized by high costs, it would be more profitable to start on a large scale provided that the conditions justified such an enterprise.
Even large mills employ few hands, and the increasing use of boards in building and other industries effects an economy of labor. In other words, a board operation releases more workers than it employs.
Time and money are saved by entrusting the task of projecting, planning and starting up operations to a competent firm of consultants. However, the technical part of the project is the most secure because its details are well known, whereas local conditions always vary. The latter have a decisive influence on the success or failure of a project and are much more difficult to assess. Weighing their relative importance is a hard task for anybody and well-nigh impossible for potential investors lacking previous experience in board production.
Numerous advantages are obtained if prospective manufacturers in undeveloped markets join hands with a manufacturer in a leading board producing country. His co-operation can be secured only if solid facts indicate that his experts and capital may expect fair treatment in the country concerned.
Selling price of boards
Probably no other factor has a more decisive influence on consumption than selling price. In an undeveloped market a reduction in price can multiply the use of boards; in a large market an increase in price can considerably reduce it. The simple explanation is that substitutes for boards exist, namely, those materials which were used before boards were introduced.
Apart from low manufacturing costs, the following factors exert a substantial influence on the selling price of boards:
(a) Inland transport. Since boards are bulky, adequate means of transport to ensure country-wide distribution are a prerequisite for their maximum utilization.(b) Cost of freight, insurance and packing for export. If boards are to reach a foreign market, costs of freight, insurance and packing are an important item. In the following Table these costs are expressed as a percentage of " normal " manufacturing costs:
TABLE 1. - COSTS OF FREIGHT EXPRESSED AS A PERCENTAGE OF "NORMAL MANUFACTURING COSTS"
|
Type of board |
Distance |
Route |
Packing |
Percent |
|
Hardboard |
Near overseas |
Sea |
Little or none |
26 |
|
Hardboard |
Far overseas |
Sea |
Solid |
80 |
|
Particle board |
Up to 1,000 km. |
Rail |
None |
26 |
Selling price of substitutes
If the prices of substitutes (mainly sawn lumber, plywood and blockboards) are low and the supply of these materials is abundant, the market for boards may very well be small. In countries where furniture is made from solid timber and no veneer industry exists there would be no market for particle boards as furniture cores. On the other hand, this market is increasing steadily in those countries where solid timber is scarce and expensive, and where consumers are prepared to pay for high-class furniture made with particle board ax a base.
Handling, cutting to size and fabricating
Boards are easier to handle, to cut to size and to fabricate than any alternative material. This means an economy of labor on building sites, in carpentry shops and in door and furniture factories. High wage level increases the monetary value of these facilities.
Their ease of handling renders boards highly suitable for amateur carpentry. It is difficult to estimate the percentage of total board consumption that such jobs represent, but manufacturers agree that it is significant.
New uses for boards
The properties of boards have been found to be more diverse than those of the materials that they were originally intended to replace. New uses for boards have been discovered as users have become increasingly " board-minded ", and manufacturers, in their turn, have been stimulated to make special qualities for such purposes. This interaction between production and consumption appears to be a slow but continuous process. It is accentuated wherever high purchasing power has permitted consumers to become more and more selective as regards quality and comfort.
High standards of living
A large floor surface in every home favors the use of all kinds of boards for doors, fittings, cupboards and furniture, in addition to actual house construction.
Cold climate
Low external temperatures encourage the use of insulation boards as a means of heat retention, and of hardboards for keeping out drafts, while particle boards are to be recommended since both dampness and the dryness resulting from central heating play-havoc with furniture made from solid timber and have an extremely deleterious effect on block boards.
As mentioned above, the use of boards is favored in countries with a high standard of living, a cold climate, and highly developed forest industries and means of transport. But countries in which one or more of these conditions are absent might still be able to produce boards at an equally low - or even lower - manufacturing cost. Normally, a well-equipped and well-managed full-size mill in any country should be able to undercut the price of imported boards by at least 20 percent. Examples of a 40 percent cut - and more - are known. This in itself does not, however, justify the establishment of a board operation. A suitable market must be found. If the boards are to be exported, packing, freight and insurance costs, as well as customs duties, are an important consideration.. Those countries which can maintain their export markets have either a solidly established home market or exceptionally low manufacturing costs; usually they have both.
Basic raw materials
The safest and cheapest source of raw material is abundant mill waste which has previously been used only as fuel or which may even have cost money to dispose of. Some examples are the waste in big sawmills and in plywood factories; chestnut, wattle or oak; chips remaining after the extraction of tanning, and flax strives (for particle board). Other waste, such as bagasse, reeds and straw may turn out quite expensive before being available for processing in a board mill.
Once started, a board industry may soon outgrow the availability of mill waste and have to add forest waste from other species or from better grades of timber. The demand for better quality boards may lead to the replacing of waste by roundwood. This has happened in the manufacture of particle boards for furniture core. Technical progress, however, tends to make it possible to revert roundwood, a material which might have more profitable uses.
Abundance of waste is the best stimulus for starting a board operation. The more substantial the fraction of cheap waste the better is the guarantee of low manufacturing costs and the less likely is the individual manufacturer to be the first victim of an economic crisis.
It is an error to assume that the present prices of raw materials available in the neighborhood of the projected site will remain unchanged when the mill is in operation. The price of the raw material may increase considerably if the mill's requirements represent a substantial fraction of availabilities. In practice, part of these requirements may have to be brought over long distances at high cost, or it may even be necessary to replace the raw material hitherto in use by a different commodity. Such a development is an indication that the mill has been wrongly located, a not uncommon occurrence.
Water
A sustained and adequate supply of sweet water, even in the driest years, is necessary for the manufacture of hardboard and insulation board. The disposal of the effluent might create difficulties. If, as is generally the case, official authorization is required to use the water and to dispose of the effluent, any contravention of regulations can be very costly. Consultants should be engaged to analyse the water and to advise on methods of purification.
Size of mill
Most investors would prefer to start on a small scale and to finance extensions out of profits. However, what may be considered as the economically smallest, respectively optimum capacity has been increasing ever since the manufacture of boards started and is now rather considerable. The following Table gives an idea of this trend.
In the leading board producing countries economically optimum capacities per factory may be twice as high or more. Local conditions such as size of market, raw materials available, level of wages and possibilities of integration can make smaller units remunerative. This is particularly true in the case of captive plants, for example a particle board plant owned by and integrated with a furniture factory sufficiently large to absorb all or a substantial part of the boards produced. Mills making hardboard or insulation board must work 21 hours per day, but particle board plants can operate only 16 hours per day without being heavily penalized in manufacturing costs.
TABLE 2. - OPTIMUM CAPACITY OF MILL
|
Type of board |
Tons per hour |
||
|
Some years ago |
Today |
||
|
Hardboard |
3.0 |
3.7 |
|
|
Insulation board |
1.5 |
2.5 |
|
|
Particle board |
1.0 |
1.5 |
|
The capital required for a mill with 50 percent of the capacity indicated in the above Table usually averages 75 percent of the capital required for a full-size operation but the smaller mill generally has manufacturing costs which may be higher by some 25 percent. Integration of a small mill with an existing industry, or other favorable circumstances, might result in seemingly reasonable manufacturing costs, but if the potential demand for boards and the availability of raw materials justify a full-size mill, the risk of starting on a small scale is that sooner or later a competitor will build a bigger mill and produce at lower cost.
Therefore, lack of capital should not be allowed to reduce the capacity of a new plant below what would have been the most economical unit if enough capital had been available. If potential demand does not justify a full-size mill, second thoughts should be given to the establishment of a board operation.
Site of mill
The selection of site depends on the location of the principal raw material, means of transport, and distance to centers of consumption, possibilities of integration with other industries, availability of labor, housing, suitability and cost of land - to mention only the most important factors. The factory compound should be extensive enough to provide for expansion to at least twice the original size. There should be adequate accommodation for stocks of raw materials. If the purchase season is short, this storage space represents a considerable part of the factory compound.
Marketing possibilities
Many investors seem to be more willing to stake large sums on a new plant than a small sum on examining if such a plant is justified. However, a new factory's chances of success can be fairly well ascertained if a couple of percent of the capital required for a new mill are spent on market survey and market research. The approach to this investigation will differ according to the stage of development of the market.
1. In a country with a well-established market the potential investors can concentrate their investigation on determining their competitive power. The main elements of the costs of production and sales can be fairly accurately estimated for the weaker competitors as well as for the new mill. It is no secret to anyone if a competitor's mill is unfavorably located from the points of view of supply of raw material, power or fuel, in relation to markets, or if the equipment has become old-fashioned. That the new mill will have higher costs of depreciation than the competitors need not alarm potential investors, because these costs will take care of themselves under normal conditions.
The cost of inland freight, commission, discount, rebates, salaries and overheads for salesmen, sales office staff and publicity can also be estimated fairly accurately. It is not so easy to assess the percentage of lower quality boards, the proportion of which may be fairly high in the early days of production. Nor is it easy to estimate the odd dimensions which remain after cutting to size in compliance with customers' orders. Heavy rebates may be necessary to get rid of such stocks, especially if they are allowed to accumulate. The real loss resulting from these factors varies from enterprise to enterprise, depending on the sales and the manufacturing standards.
In one instance, where these factors were overlooked in an estimate, the actual break-even point was found to be 2/3 of capacity instead of the 1/3 that had been estimated. Profit was some 60 percent lower than expected, and loss would have resulted had not the estimate of profit been exceptionally high in the first place, and otherwise correctly computed.
It seems to be common practice to base estimates of costs and profits on the possibility always to utilize the mill's capacity to the full. The real average over a number of years may differ in different countries but will hardly exceed 250 working days per annum in any free market.
2. In a country to which either hardboards, insulation boards or particle boards are imported in quantities representing say 1/3 or more of the capacity of a full-size mill, demand will increase if a new mill can sell at the f.o.b. price of the imported boards. In this case, the establishment of a full-size mill for making the kind of board most in demand would be justified, but the estimates of manufacturing costs plus ample marketing costs must be reliable. If investors are hesitant, a thorough investigation of the market should be made before it is decided to establish a small-scale operation. Such a mill would always be burdened with high manufacturing costs, and to double capacity would call for an outlay of capital which would be disproportionate to the increase in production.
3. In areas where there is little or no market for boards, a solid piece of market research is called for. Experts in this field should be of help. The following is one line of approach. Estimate the lowest profitable selling price of board manufactured within the country. Compare that price with the selling price of the goods which the board would replace. Assess to what extent it can replace these goods. A check on that estimate and some indication of potential demand for new uses might he obtained by importing fair quantities of board.
Degree of rationalization
Authorities in countries with unemployment would no doubt wish to see many hands occupied in a new board operation. However, from the point where the raw material enters the mill to the point where the finished boards leave it, it is hardly possible to employ more than the very few hands which are normally required.
The high degree of automation reached in the manufacturing processes of all kinds of boards has been sponsored not only by a natural trend in highly developed countries towards reduced labor costs, but also by the desire to avoid waste and to maintain a consistently high standard.
In a country where wages are low it may be justified to rationalize handling in the factory yard and workshops to a lesser degree than is now usual in the leading board-producing countries. Investors in a new mill will have to estimate the precise degree of mechanization of handling which is required in their mill.
Employment
Very few hands are employed in a board operation and many more workers become redundant with the increasing use of boards in building and other industries. Since the manufacture of substitutes is less rationalized than that of boards, an economy of labor is also effected by the reduction in the use of substitutes provoked by the introduction of boards. In other words, the board industry sets more hands free than it in fact employs. This has always been one of the chief justifications for setting up the industry. To plead the contrary for obtaining authorization to establish a board operation would be a gross misrepresentation of the facts. Besides, in order to reduce unemployment, no country can afford to spend from U.S. $10,000 to $40,000 per capita employed.
Customs duties
The value of fostering an infant industry by the imposition of customs tariffs on the imported article is largely dependent on whether or not substitutes exist for the goods thus protected.
In countries where salaries and wages are low, consumers are sometimes forced to pay 3 or 4 times more for paper than the price paid in the leading paper-producing countries, where salaries may be 3 or 4 times higher. The consumption of paper per capita in the latter countries will probably be a hundred times greater, but if the former countries cannot afford foreign exchange for paper purchases, a domestic industry might be protected to the point where its production would help to reduce illiteracy and be of some use in the packing of goods for distribution.
This is not the case with boards, however, simply because substitutes do exist, i.e., those materials which have been used hitherto. Owing to the very high natural protection offered by packing and freight charges, even seemingly reasonable customs duties easily bring the selling price of boards in importing countries up to twice the price paid in the leading board-producing countries. Such a high price level would substantially reduce the demand in any country; it will certainly do so in those countries with low purchasing power or where cheap substitutes are available. The apparent lack of potential demand will frighten investors or induce them to establish a small, inefficiently managed mill requiring still more protection.
When substitutes for boards are scarce and expensive, the levying of customs duties on imports can facilitate the establishment of a board mill, but the boards will be expensive and the estimate of potential demand at the resulting high selling price must be made with the utmost care.
Customs duties are of course useful as an ultimate weapon against persistent dumping.
Capital requirements
Consultants' estimates comprise expenditure on factory buildings and equipment, their own fee, and usually also the cost of administration, salaries and interest on capital during erection. To this total, potential investors must add the cost of land, of layout, and of office facilities, as well as expenditure on equipment for transporting raw materials to the factory and distributing the finished goods; automobiles, the cost of preparing the project; local consultants' fees; legal costs, and, depending on local conditions, perhaps many other items. If the board mill is not integrated with an existing industry and has to be located in a remote district, additional capital may be required for roads, railway sidings or quays; a power station; a more than usually well-equipped repair shop; houses with running water, drainage and light, at least for the senior staff if not for all personnel. In adverse circumstances, even more facilities may have to be provided.
Contingencies are usually estimated at 10 percent of the cost of equipment. This may cover extras when the purchasing power of money remains stable, but as long as prices continue to rise at the rate that has prevailed during the post-war era, it would be advisable to estimate contingencies at 20 percent of total fixed capital.
Since working capital varies from country to country and from industry to industry, an estimate based on rules of thumb would be extremely unreliable, It is in fact equally rapid to estimate working capital item by item; annual maximum and minimum stocks of raw material; annual maximum and minimum stocks of boards, if demand is seasonal; annual maximum and minimum stocks of spare parts, as indicated by the consulting firm, due regard being given to possible delays in delivery from supplier countries.
Influence on the balance of trade
In most countries, the establishment of a board operation is subject to government approval. The authorities concerned often demand a detailed justification of the venture, expressed in terms of money. They nearly always require some indication as to the amount of foreign exchange needed for equipment purchases, as well as information on the chances of saving foreign exchange on imports and of export returns. The latter point is extremely difficult to estimate. A newcomer cannot even correctly estimate the cost of packing and marketing expenses abroad, and it takes a great deal of intimate knowledge both of the marketing and production of boards to be able to judge what margin competitors have for fighting a newcomer. Unless the new mill has exceptionally low manufacturing costs, it would be as well to estimate the probable proceeds from exports and then divide by ten.
Interrelation of factors
If a board operation is to be financially sound and economically justifiable, the interdependence of certain factors must be taken into account. For example, the type of board to be manufactured must be determined by marketability and the kind of raw material available. Similarly, the choice of process is intimately linked with the raw material selected, and the size and site of mill with the type of board to be manufactured, its market prospects, and raw material availabilities. Capital requirements, manufacturing costs and profitability will depend, in their turn, on all the foregoing factors. In brief, it is the sum total of these factors which determines whether or not the venture is a sound business proposition. Thus, all-round planning cannot be dispensed with.
Projecting
The cost of establishing a complete project is considerable. It is useless to attack the blue-print stage and to give the project its finishing touches unless preliminary investigations indicate that the venture can be considered sound and the necessary capital can be mobilized. Given the interdependence of all factors, the best approach is to prepare a very preliminary but complete project and find out if and how the most glaring difficulties it reveals can be solved. If the venture then looks promising, a more complete project is established. If such an approach is adopted, an unsound project can be written off quickly, while a sound one can be established with the minimum of effort, time and money. In this respect, contact with a competent consultant from the very beginning will be of immense help.
Planning and starting operations
Progress is so rapid and the responsibility to be home by the prospective manufacturer is so heavy and complicated that even well-established board manufacturers prefer to seek expert advice. If a major mistake is made in planning, costly changes in equipment and commercial losses may result. Before the mistake can be remedied the ensuing losses may soon represent a sum which is many times greater than a reasonable consultant's fee.
The consultant's main job is planning and starting operations from the moment raw materials arrive at the mill until boards of good quality leave it. However, this highly technical part of a board operation is the most secure since the problems involved are well understood by competent consulting firms. Other factors, which all vary from mill to mill, are much more difficult to assess, and the penalty of misjudging their influence can be severe.
The following advantages might be gained by those investors who lack experience in board operations but who are willing to go into partnership with an established manufacturer:
1. opportunity to study an existing board operation in detail;2. help in assessing local conditions, consultants' suggestions, offers from machine suppliers, export opportunities, assistance in weighing up the pros and cons;
3. reduction in the "waiting-for-money" period caused by delays in planning. erection and commencement of operations;
4. facilities for training in an existing mill the personnel intended for key positions in the new mill;
5. competence in running the mill and marketing the boards;
6. an experienced partner, who is willing to share risks, and who is also capable of reducing them;
7. facilities for recruiting from that country experienced men for key positions, if the manufacturer is established in another country, for men are apt to believe that if a countryman of theirs holds a leading position in the firm it is a guarantee of fair treatment and of success for the new company;
8. saving foreign exchange, which would otherwise be required for equipment imports, provided that the manufacturer accepts shares in the new company for the value of such equipment. Even a minority shareholding by the manufacturer will be sufficient, since the total capital required for the establishment of a board operation represents twice the cost of equipment or more.
An established manufacturer will naturally be reluctant to help a newcomer. However, he knows that all new board mills that are economically justifiable will be established sooner or later, whether he likes it or not. If well managed, such new mills should be just as profitable as his own enterprise proved to be when board production forged ahead in his country. He will also quickly discern the new mill's export possibilities.
The securing of his collaboration is, therefore, largely a matter of offering him a fair deal and of winning his confidence in the future of the prospective manufacturer's country, and in assuring him that conditions are favorable for foreigners as regards both employment and the investing of capital.
An additional source of financial assistance is the International Finance Corporation, Washington, D.C., U.S.A. This organization is supported by a substantial number of governments whose aim is " to further economic development by promoting the spread of private enterprise in the developing areas of the world ". They intend to do this by " serving as a clearing house to bring together investment opportunities, private capital, both foreign and domestic, and experienced management ". The scope of their activity and their conditions for loans have been well defined.1 These conditions are so sound that they should be studied by potential investors, whether or not they seek assistance from this body.
1 See the pamphlet entitled The International Finance Corporation, Washington, D.C., 10 August 1968.
The foregoing paper and the paper that follows were contributed to the first world-wide consultation on insulation board, hardboard and particle board which, under the joint sponsorship of FAO and the Economic Commission for Europe, took place at the Palais des Nations in Geneva from 21 January to 4 February. Over 330 participants - technicians, manufacturers, equipment makers, and government specialists from 36 countries - exchanged information and experience on the technical and economic aspects of the industries and found widely different practices and applications in various regions of the world, many of them adaptable to areas where they are not now in use.
The information made available by the consultation will serve, on the one hand, to encourage the expansion of these industries where raw materials, marketing possibilities and estimated production costs warrant such expansion, and on the other hand to discourage ill-advised investment where economic and technical conditions are unfavorable.
The documentation of the meeting is to be published in two volumes. Volume I will contain the secretariat papers and appendices, revised and amplified in the light of the discussions which took place. Volume II will comprise the various background papers.
Production of board products is today highly concentrated geographically, principally in Scandinavia, North America and Western Europe. The Report of the Consultation says that:
1. "A trend towards a more even geographical distribution of these industries in the coming years is inevitable."2. "It is in the interest of both new and established producing centers that in planning new developments full regard be paid to their economic viability and that account be taken of the best technical knowledge currently available."
The consultation agreed that while the long-term view of these industries is assured and their products are destined to make a growing contribution to rising living standards throughout the world, it is in the interests of all concerned that severe imbalance between production capacity and effective demand should not arise.
