Mid-Year Economic Report

July 20, 2005

Converters and suppliers are cautiously optimistic as the economy slowly improves.

By the second quarter of 2004, narrow web converters were humming in a major key. The recession is easing, and converters overall are enjoying an increase in purchasing. The difficult years left their marks, however, and the byword today is caution; plans for growth, or rebuilding, are being dusted off and retooled, but carefully. The same holds true for suppliers. Heavy machinery segments were hit hard, and manufacturers are relieved to be able to beef up the work force to some extent. Because the converters are more active, the suppliers are optimistic.

But the old days are gone, and nobody expects a return to the era of monumental margins and plenty of business for everyone. Competition is fierce, a profit point is a battleground, new technology is changing the industry every day, and costs keep going up.

Once again the editors of Label & Narrow Web have asked several converters and suppliers to share their views about the economy, the industry, their businesses and those of their customers. Our respondents, from North America and Europe, were asked to describe the economic performance of their company; to identify changes they have made or are making; to describe the purchasing patterns of their customers, and comment on the marketplace mentality of those customers; to discuss plans for investment in equipment, personnel, and space; to identify the major challenges facing the narrow web converter today; and to forecast the state of the industry in the future.

The Converters

Brian Weller, president, Precision Tag & Label Inc., Richmond Hill, ON, Canada

Performance: 2003 was kind to us and 2004 is showing us encouraging signs. Our profit was up dramatically from 2002 and we should maintain or even increase profit this year. We had to change our methods dramatically over the last few years and I can't say it was necessarily done willingly all of the time, but we had no choice except to react to a changing marketplace.

Changes: To meet our goals we had to adapt to the changing needs of our clients and enact a "Lean Manufacturing" strategy. We reduced our sales force and cross-trained our customer service with selected manufacturing personnel to better utilize this valuable resource. We found that our cross-training enabled our staff to learn more about our craft and thus make better decisions, and it enabled our supervisors to introduce improved time management to the entire operation.

Customers: Because of a dramatic increase in client M&A activity during 2002 and 2003, the number of our clients had decreased, but the purchasing patterns of our remaining clients has exploded. For these clients, service, service and more service is in demand. They all want to carry less inventory and they want delivery within days, not weeks, meaning that we must anticipate demand and carry customized items in our inventory and be prepared to ship within 48 hours or less.

Investment: We envision a move to larger facilities in the not-too-distant future. We are carrying far more pre-made customized labeling than ever. We will probably purchase a new press to replace our original press.

Challenges: The greatest challenge today is determining selling prices. Hidden costs, such as maintaining inventory, increasing insurance costs and taxes can be debilitating if they are not accounted for. Raw materials are not expected to decrease in cost, and finding and keeping quality craftsmen is always a challenge.

Future: For the astute narrow web converter who is on top of his costs and is not leveraged to the extreme, the future can be encouraging. The print industry has recently gone through a difficult period generally, with far too many presses chasing the same order. This has led to a number of marginal label converters simply closing down operations.

Michael S. Erwin, president, Tailored Label Products, Menomonee Falls, WI, USA

Performance: We have seen a sales increase of 15 percent over 2003, caused primarily by various industrial accounts returning to an improved production output. Most new sales are tied to existing accounts' return to pre-2001 levels, with some increase in new markets or account development.

Changes: We have invested in many new pieces of equipment, taking advantage of two enhancements in the tax laws (depreciation) that have a sunset this year. We have added to our employee base in manufacturing and marketing along with specific plans to enhance our market image.

Customers: We continue to see ongoing cost reduction expectations out of all of our key accounts in spite of three- to six-year price freezes. We have seen order sizes decrease and order counts increase as our clients strive to drive down inventories and increase their own response times.

Investment: We expect to continue to add to our operations staff over the next year (about 20 percent) to address new products in development. We will make some of our largest (ever) new equipment purchases in the next three to six months that tie into new product launches.

Challenges: Accelerating the effective use of new printing and converting technology. In other words, take a leap of faith in the implementation of new processes to reduce overall lead time and inventory levels for our broad customer base, so we continue to invest in employee training and the evaluation and adaptation of new technology.

Future: We believe there continues to be a case for the use of digital technology and feel that will be the leapfrog more for our specific industry. We certainly see equipment evolution and automation as our best bet to remain competitive and flexible.

Scott Pillsbury, president, Rose City Label Co., Portland, OR, USA

Performance: This year started slightly worse than last year, but things have picked up the past few months. Lower gross sales were the main driver, due mostly to a significant decline from one major customer in financial difficulty. Now that situation has been resolved and things are looking up.

Changes: We have streamlined operations and invested in Lean Manufacturing training. Being faster and more efficient will be the key to our continued success.

Customers: As mentioned above, one major customer has had difficulty recently but seems to be making a comeback. No other major patterns; we have a diverse customer base so they are not all affected by the economy in the same way.

Investment: We are adding equipment in prepress to provide better quality and quicker turnarounds, supporting the Lean Manufacturing program. With faster deliveries from material vendors, we should be able to continue to improve performance without adding square footage.

Challenges: The biggest things I think we are facing (in a macro sense) are shrinking margins and lead times.

Future: I think we will be working harder and making less money than ever before. To survive we need to be smart about how we do business and challenge the old assumptions. There are always better ways to produce our products.

Thomas Spina, president/CEO, Luminer Converting Group, Lakewood, NJ, USA

Performance: Sales for the first quarter of 2004 were 9 percent higher than that of the first quarter of 2003. Net earnings were significantly higher. This is due to cost-cutting, changes in our product mix, and revenue growth in our satellite operations.

Changes: Our company was overstaffed when the economy turned downward. We chose not to lay off but to take other cost-cutting measures. Now that there is significant revenue growth again, our people are all in place and can handle the new business. During the last two years, our company achieved ISO certification, which allows us to enter a new market segment, including pharmaceuticals. Although the cost is high, the reward can now be felt.

Customers: They simply do not project out as far in terms of their usage over the next six months. We used to have a four- to five-month back-order for our major accounts; now we are lucky to have one month. This means we must react faster to their needs.

Investment: We will invest in new equipment, definitely finishing equipment, and press auxiliary equipment over the next nine months. In the next 24 months we see the need for a major plant renovation.

Challenges: The biggest challenge is for companies to reinvent themselves from being label manufacturers to being converters. To do this it takes foresight and reinvestment of profits. Owners must learn to do other things with the equipment they own. Sales people must learn not just to ask what labels people buy, but what else they buy in the packaging arena that we can make.

Future: I see large amounts of consolidation over the next several years. Owners who are nearing retirement age are thinking about selling or shutting down their companies. As this happens, overcapacity in the industry could slowly disappear.

Cezar Cuc, owner/manager, Eltronis, Oradea, Romania

Performance: We are a small, young company in an area where pressure sensitive technology is still new. We hope to achieve double digit growth by the end of 2004, for several reasons: Customers are more educated about the advantages of PS versus wet glue; new regulations require more data on packaging, making PS the logical choice for many products; and we are more active locally and internationally through trade fairs, the Internet, and public relations.

Changes: We have become more active from a marketing point of view, both regionally and abroad. Our long-term strategy is to export as much as we can from our range of products. We try to take advantage of the big difference in production and preparation costs between Western countries and Romania. We feel price pressure, but in many cases we can offer unbeatable prices.

Customers: On average, customers are placing larger orders or bigger orders. Their expectations are higher: We used to promote extremely fast delivery for repeat orders as a premium service; now it is considered the usual.

Investment: We are trying to attract partners for a major investment. Our plans include moving to a new location, and investing in our converting and printing capabilities.

Challenges: By far it is the lowering of profit margins. More and more, customers tend to see labels and packaging as commodities, and they care less and less that the converters distinguish themselves by added services.

Future: One reason there are many small converters today is that they can provide a level of flexibility that a bigger company cannot, yet. But in time we will see global converters, among global paper/film/ink suppliers and global customers.

The electronic market place is hated by most of the converters because it is impersonal, and emphasizes only price. But they cannot change the trend, and they should try to adapt to it. For a low cost producer like us, the electronic marketplace is a huge opportunity to gain access to new markets, and we try to use it as much as we can.

Bob Biava, president, Driscoll Label, Fairfield, NJ, USA

Performance: 2003 was a very good year for us, as witnessed by our winning the Best Managed Company Award from TLMI. 2004 appears to be on track to equal or surpass 2004. New customers, new applications and a general upturn in business have helped.

Changes: No real changes so far this year. We continue to reject business that does not offer acceptable margins, and focus our energies on profitable opportunities.

Customers: Quoting has picked up significantly with broader spreads in quantities and number of options. (Do the customers really know what they want or need?) Timing is becoming more critical than a low price: "Why can't I have it yesterday?"

Investment: We are seriously considering adding a new press with multiple screen heads and UV flexo to enter a market we currently are not serving, but which is not so much price sensitive as quality oriented.

Challenges: The greatest challenge continues to be people: quality press operators and quality sales people.

Future: If we don't constantly renew ourselves, small converters will not survive. Digital printing will remain a niche market well into the future, and globalization will have minimal impact on the small converter.

Elisha Tropper, president, Prestige Label Co. Inc., Burgaw, NC, USA

Performance: We had a banner year in 2003, experiencing incredible growth and overall strong economic performance. Sales continue to grow, but we find that rising costs and increased price competition affect our margins.

Changes: We upgraded our middle management and recruited several production and shift supervisors. We made significant equipment purchases, most notably the HP ws4000 digital press and computer-to-plate in 2003, and upgraded our prepress and digital workflow software and infrastructure in 2003 and 2004.

Customers: Customers continue to grow more cost-conscious, while increasing expectations for product quality and services. They are seeking more involvement — meaning contribution — from us to house inventories and provide quicker turnaround time. They still seem wary of the economy, and cutting costs to them always seems to begin with the least expensive component — the label!

Investment: We are going to try hard to maximize our existing equipment before purchasing anything else. We are adding 20,000 square feet of production, office, and warehouse space, and we continue to add personnel as the business demands it.

Challenges: Pressure on margins: Customers are demanding lower prices, while raw material costs, employee costs, and, in the imminent future, interest rates, are all rising. Maintaining profitability and trying to grow profitably has never been harder, at least in my experience.

Future: We will see an increase in the level of M&A activity at the small to mid-sized company level of label converters. It is getting harder to grow a small label company profitably, and the traditionally regional nature of the business is slowly dissipating. Small companies may find themselves needing to double or triple in size to achieve the economies of scale and geographic dimension that will be demanded by a continuously consolidating customer base.

The Suppliers

Marc Fioravanti, VP sales & marketing, Cortron Corporation, Minneapolis, MN, USA (Manufacturer of platemaking equipment)

Performance: To date 2004 has been steadier than 2003. We saw an initial rush to our new eXact technology and then it leveled off to an adequate volume. We attribute this to the general shyness in the economy towards capital spending, but was somewhat balanced against the excitement of a new technology. The fourth quarter of 2003 saw capital spending begin to loosen and this has continued into 2004. International sales have been strong throughout in all regions of the world in 2003 and 2004.

Changes & investment: We have added employees, both in engineering and manufacturing. The types of jobs will be highly skilled assemblers. Suppliers of ours are hungry for work and others are knocking on our doors, which makes it a buyer's market.

Challenges: Containing costs is the greatest challenge. Customers continue to demand higher quality and the investment of new and more technological advanced products to meet their needs, but they want to pay less for their products rather than more.

Future: The globalization of the narrow web market continues. The weaker dollar should help this scenario in the short term, but most recently the dollar has regained some of its weakness, which will tip the balance back to the emerging markets.

Gerald Clement, president, Computer Productivity Services Inc., Oakville, ON, Canada (Print business management systems)

Performance: 2003 was a really outstanding year. So far 2004 looks promising but it's still too early to say how 2004 will compare with 2003. We have been successful by investing a great deal in product development.

Changes: We consolidated different versions of our product to be more efficient, and improved support and service. As our client base grows, we shift more resources to support them. We emphasize mid to large new client projects.

Customers: We have noticed that many clients have reduced cash flow in late 2003 and early 2004. Money is tight. Users are looking to finance rather than purchase. Clients are paying poorly. Expectations are sometimes unreasonable. But purchase activity is increasing.

Investment: We moved to a bigger office. We might add another consultant, another programmer and inside salesperson this year.

Challenges: Attracting, hiring, paying, training and retaining well trained professionals such as managers, pressman, sales people, accountants and artists to work in manufacturing. Costs of people and high end equipment are increasing; converters are financing more finished goods inventory, and working on thinner margins. We are providing competitive pricing, financing, more flexible payment terms.

Future: Globalization will result in a great deal of price pressure for vendors and converters as offshore production is less expensive. It also requires that more and more converters use ERP systems than can support multiple currencies and languages.

Ed Dedman, business manager, narrow web & energy curable group, SICPA North America, Brooklyn Park, MN, USA (Printing inks)

Performance: 2004 has produced increased sales over the same period in 2003, although at a slower rate.

Changes: We worked hard to control and/or decrease raw material costs. We also looked hard internally at reducing controllable costs like freight, overtime, and the like.

Customers: Purchasing patterns remain fairly constant. We are often under pressure to reduce prices, while our own raw material costs are usually on the rise. We prefer instead to offer technical assistance to our customers.

Investment: We plan to invest in both equipment and personnel — better lab and quality control tools, improved manufacturing and blending technology, and newer IT equipment.

Challenges: The greatest challenge today is to learn how to increase predictability and repeatability if we want to gain market share from other print markets. Our customers struggle with reducing job setup times, only to discover that they can't match the proof on press. They fight to optimize their print process, only to discover that someone else can beat their price because they can run faster with newer equipment. These challenges will continue until the label printer learns to treat the entire operation as one interconnected workflow.

Jakob Landberg, sales director, Nilpeter A/S, Slagelse, Denmark
(Narrow web presses)

Performance: Gross sales are up by 15 percent, and gross earnings by 8 percent. It has become harder to make money as the level of competition has increased, and at the same time the dollar rate has been low.

Nilpeter has an advantage in having both European and American products, which eliminates the currency issue somewhat. We have seen the market move from standard presses to customer specific applications, and this is our core competency in Europe.

Customers: The order horizon is shorter: Customers push decisions to the last moment. No one invests in equipment until they have a solid order or commitment from their end user. It's a buyer's market, and the expectations for discounts, service, financing and performance has increased.

Investment: We have invested in a new US factory and increased personnel. We are reorganizing our European plant by adding new equipment for automatic parts production.

Challenges: Keeping margins is an increasing challenge. The industry has been innovative by focusing on adding value rather than cutting sales prices.

Future: Globalization and localization: Some large printers will focus on delivering the global end users a world wide quality — but do it locally — with mergers and acquisitions following. At the same time the smaller player will perfect his ability to take over more functions in the value chain locally.

Ken Meinhardt, president, Tailored Solutions, Milwaukee, WI, USA
(Print business management systems)

Performance: We had a good first quarter: 20 percent over the same quarter last year. The last quarter of 2003 was a record for us, possibly due to a boost in the economy, increased depreciation schedule for 2003, and converter procrastination: They are good at this. They decide early in the year that they are going to implement, and then when the year is ending they purchase.

Customers: We see the usual erratic purchasing patterns. We rarely see a well planned or scheduled purchase of our software.

Challenges: Competition between converters is increasing. Converters need to monitor their pricing and eroding margins closely. They need to know their costs of production, customer service and sales for every job.

Future: More consolidation of converters. Trends in overseas packaging will continue. Converters will see a tighter integration with suppliers and customers. More online information for customers to get details on their orders and inventory.

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