{"id":22526,"date":"2017-11-14T16:46:12","date_gmt":"2017-11-14T21:46:12","guid":{"rendered":"https:\/\/digital.hbs.edu\/platform-rctom\/submission\/unpacking-the-effects-of-brexit-on-one-of-europes-largest-paper-packaging-businesses-the-smurfit-kappa-group\/"},"modified":"2017-11-14T16:46:12","modified_gmt":"2017-11-14T21:46:12","slug":"unpacking-the-effects-of-brexit-on-one-of-europes-largest-paper-packaging-businesses-the-smurfit-kappa-group","status":"publish","type":"hck-submission","link":"https:\/\/d3.harvard.edu\/platform-rctom\/submission\/unpacking-the-effects-of-brexit-on-one-of-europes-largest-paper-packaging-businesses-the-smurfit-kappa-group\/","title":{"rendered":"\u201cUnpacking the Effects of Brexit on one of Europe\u2019s Largest Paper & Packaging Businesses: The Smurfit Kappa Group.\u201d"},"content":{"rendered":"

The geopolitical tides have dramatically turned, with nations eschewing globalization for the more inward-facing stance of isolationism<\/em>. The effects of this paradigm shift are far-reaching, touching the supply chains of organizations globally. In examining the magnitude of this impact, there is one organization that is facing an existential crisis induced by Brexit \u2013 the Smurfit Kappa Group. \u00a0More specifically, Brexit is forcing the Smurfit Kappa Group to face some very difficult decisions regarding its supply chain, capital allocation and overall corporate strategy. Yet, management\u2019s current response may not be sufficient long-term when dealing with the global scope and supply chain logistics of the company and a more comprehensive response is indeed merited for the company\u2019s long-term success.<\/p>\n

The Smurfit Kappa group is amongst the largest producers of corrugated paper and packaging in the world, with mills throughout Europe and the UK[1]<\/a>. Because the company sources recovered fiber and containerboard from its mills across Europe, Brexit had the immediate impact of increasing raw materials costs. More specifically, the company saw a nearly 21% drop in Net Income in the first half of 2016, driven almost entirely by a \u20ac182MM increase in cost of sales[2]<\/a>. This profitability decrease was entirely driven by the increase in the price of recovered paper fiber, which is the largest input in the company\u2019s raw material production process. Given the limited supply of European paper mills, which at present time are operating near full capacity[3]<\/a>, and added costs associated with sourcing these raw materials outside Europe, the company faced few alternatives. What is more, on the 2Q2016 earnings call, CEO Tony Smurfit addressed the impact of this increase with surprise, as he had initially argued that \u201cAny effect (of Brexit) on Smurfit Kappa Group will be as a result of the withdrawal having a knock-on impact on UK\/European gross domestic product\u201d[4]<\/a>. While valid, his thesis was largely driven by the observation that the paper and packaging industry tends to track global GDP growth as it is a staple material input in many global businesses[5]<\/a>. Thus, if UK GDP begins to decline with businesses fleeing, this should impact businesses like Smurfit Kappa that are directly tied to GDP growth. What management failed to anticipate, however, was the additional impact of the raw material costs and currency headwinds.<\/p>\n

Fortunately, despite this initial miscalculation, management has taken proactive measures to minimize the economic impacts of Brexit on the company\u2019s supply chain and profitability, since the first half of 2016. Due to Smurfit Kappa\u2019s scale and pricing power, the company has been able to offset the impact of rising raw material costs by increasing the prices of their finished goods to end consumers. Indeed, according to a 2016 Bain Report (see figure below) many UK based manufacturers are expected to offset the increased raw material costs with price increases, in a similar strategy[6]<\/a>.<\/p>\n

\"\"<\/a><\/p>\n

This pricing power was reflected by a nearly \u20ac60\/tonne increase in recycled containerboard prices (the largest price increase in several years), effective in February of this year. The increase in pricing helped Smurfit Kappa Group return to record profitability, with Net Income rising in the first quarter of this year by nearly 20% despite the increase in Cost of Sales attributed to raw material and input costs. On the earning\u2019s call, CEO Tony Smurfit again stressed the resilience of the business going forward, arguing that further price increases in the next 2-3 years would follow \u201cif and where necessary\u201d[7]<\/a>. Nonetheless, the company\u2019s absolute reliance on pricing power to offset rising raw materials costs raises some serious questions and concerns about future competitiveness. Particularly in the paper and packaging industry, where gross margins are notoriously low, product differentiation is unperceivable, and consumers are generally very price-sensitive, I am concerned about the long-term (3-10 years and beyond) viability of this strategy as consumers may opt for less-expensive alternatives.<\/p>\n

I therefore think the company has to consider several other alternatives going forward to address the potential issues that will arise from its Brexit-induced supply chain disruption. My first recommendation is to invest in lower cost mills throughout Europe (predominantly in the North-West where most corrugated pulp is sourced) and also establish longer-term contracts with its suppliers to lock in lower prices (the typical tenor is 1-2 years). What is more, Smurfit Kappa typically spends around \u20ac500MM per year on acquisitions, and it should therefore strategically seek assets that lower its production costs and increase efficiencies in its supply chain.<\/p>\n

These recommendations aside, I remain concerned about the long-term competitiveness of Smurfit Kappa in an increasingly commoditized and price-sensitive industry. While their strategy is predicated on price hikes, there is a limit in their end consumer\u2019s flexibility, and I fear this may be coming to a head.<\/p>\n

(Word Count: 793 Words)<\/p>\n

[1] Smurfit Kappa Group Annual Report, December 2016.\u00a0<\/a><\/p>\n

[2]Smurfit Kappa Group 2q2016 Quarterly Earnings Report, June 2016.\u00a0<\/a><\/p>\n

[3]”Global Forest, Paper & Packaging Industry Survey: 2016 Edition”. Price Waterhouse Cooper, December 2016.\u00a0<\/a><\/p>\n

[4] Smurfit, Tony. “Bloomberg Morning News: Market Watch.” September 29th, 2017.\u00a0<\/a><\/p>\n

[5]<\/a>“Global Forest, Paper & Packaging Industry Survey: 2016 Edition”. Price Waterhouse Cooper, December 2016.\u00a0<\/a><\/a><\/p>\n

[6] “Is Your Supply Chain Ready?”. Bain Capital Briefing. February 6th, 2017.\u00a0<\/a><\/p>\n

[7] Smurfit Kappa Group 1Q2017 Quarterly Earnings Report, February 8th, 2017.\u00a0<\/a><\/p>\n","protected":false},"excerpt":{"rendered":"

Brexit’s impact on UK manufacturing is so significant that it is even impacting one of the most basic and commoditized industries; pulp & paper. Learn more about one of the biggest paper & packaging players – the Smurfit Kappa Group – as it grapples with the effects of Brexit on its supply chain and overall business strategy. <\/p>\n","protected":false},"author":9579,"featured_media":22527,"comment_status":"open","ping_status":"closed","template":"","categories":[3230,690,1190,1189,1827],"class_list":["post-22526","hck-submission","type-hck-submission","status-publish","has-post-thumbnail","hentry","category-brexit","category-consumer-products","category-packaging","category-paper","category-pulp","hck-taxonomy-organization-smurfit-kappa-group","hck-taxonomy-industry-pulp-and-paper","hck-taxonomy-country-united-kingdom"],"connected_submission_link":"https:\/\/d3.harvard.edu\/platform-rctom\/assignment\/rc-tom-challenge-2017\/","yoast_head":"\n\u201cUnpacking the Effects of Brexit on one of Europe\u2019s Largest Paper & Packaging Businesses: The Smurfit Kappa Group.\u201d - Technology and Operations Management<\/title>\n<meta name=\"robots\" content=\"index, follow, max-snippet:-1, max-image-preview:large, max-video-preview:-1\" \/>\n<link rel=\"canonical\" href=\"https:\/\/d3.harvard.edu\/platform-rctom\/submission\/unpacking-the-effects-of-brexit-on-one-of-europes-largest-paper-packaging-businesses-the-smurfit-kappa-group\/\" \/>\n<meta property=\"og:locale\" content=\"en_US\" \/>\n<meta property=\"og:type\" content=\"article\" \/>\n<meta property=\"og:title\" content=\"\u201cUnpacking the Effects of Brexit on one of Europe\u2019s Largest Paper & Packaging Businesses: The Smurfit Kappa Group.\u201d - Technology and Operations Management\" \/>\n<meta property=\"og:description\" content=\"Brexit's impact on UK manufacturing is so significant that it is even impacting one of the most basic and commoditized industries; pulp & paper. 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