Minding My Own Business

The new equilibrium

January 11, 2007

"Close your eyes when you don't want to see.
Stay at home when you don't want to go.
Only speak to those who will agree.
And close your mind when you don't want to know."

Billy Joel might not be Peter Drucker or W. Edwards Deming, but there's no denying the validity of the criticism unleashed by this lyrical verse, nor its fundamental relevance to every business person. This quatrain is particularly prescient at this time to owners and managers of narrow web label converting companies.

As a consequence of numerous factors, the label converting business is changing, and changing more dramatically and at a more rapid pace then the industry has ever experienced. Technology is, of course, a critical element. Nothing brings about change faster than technology (think cellphones in unwired Third World countries), and in the label industry, any discussion of the ramifications of change must begin with an acknowledgement of the impact of technology, which has been monumental these past few years.

It certainly would not be overstating the point to represent today's label production facility as the USS Enterprise in contrast to the Sputnik-like technology that was the pressroom standard of just a few years ago.

Narrow web flexography has taken that giant leap forward, as evidenced by the widespread implementation of servo technology, quick-change stations, inline multi-process capabilities, multiple webs, automated vision inspection, and expanded color gamut printing, to name just a few advances.

Prepress technology has similarly taken giant leaps forward, as software driven processes and the mainstreaming of computer-to-plate digital platemaking have simultaneously improved the print quality and production efficiency of the label printing operation while rendering all but the smallest handful of prepress service providers obsolete.

Digital printing has emerged as far more than a niche curiosity in the market, as the continuous improvement in print quality, production and material flexibility, and production speed has enabled the still-mainstreaming technology to take an increasingly significant share of new presses and label printing jobs.

There have also been remarkable improvements across the board, including inks, substates, finishing equipment and techniques, and ERP software. Today's label converters print more than just tags and pressure sensitive labels; they print and convert sleeves, decals, stickers, inserts, coupons, booklets, wraps, comps, blister cards, folding cartons, and a whole lot more.

All of these technological improvements contribute to ever increasing quality, service capabilities, and efficiencies - as well as capital expenditures. But as with any developing technology, the costs of these advances to label converters seeking to implement them drops dramatically over time. So while today's latest and greatest may be beyond the reach of many converters, what was at the high end just a couple of years ago is on this month's discount rack, reducing previously formidable barriers to entry across the board.

But technology is just the most visible indicator of change within the industry. Another significant factor is the rising role of Lean Manufacturing and other quality and efficiency initiatives which have, for many label companies, driven significant organizational and philisophical changes in pursuit of growth and enhanced profitability. It is easy to underestimate the impact that process improvement has had on the industry as a whole, but operational best practices have a way of shifting the cost curves across the board - and doing so rather quickly.

The financial markets have also had an impact on our industry, as capital has been more easily attainable and, in general, available at a lower cost than any time in recent memory. This has further spurred more and more label converters to upgrade and update their equipment and facilities, further complicating the competitive landscape. In addition, the availability of capital has greased the wheels for many of the acquisitions and consolidations within both the converting industry as well as those of our suppliers and customers.

I like to off-handedly describe the state of competition and differentiation between label converters as having reached a point where 90 percent of the converters can print 90 percent of the jobs well enough to satisfy 90 percent of the customers. If these gut-driven numbers are even close to accurate, then that means that approximately 27 percent of the business out there requires premium-generating specialization, while 73 percent can arguably be considered commodity. Differentiation for this commodity share of the market must consequently be pursued along non-production lines, in areas such as service, ancillary product offerings, and more in-depth customer/vendor relationships.

The result of this multitude of capable competitors has had a direct impact on the performance of converters across the industry. First and foremost, the breaking down of barriers to entry and the subsequent commoditization of an increasing portion of manufactured product has greatly hindered the ability of converters to achieve the kind of incremental organic growth that is fundamental to healthy businesses. This forces those companies to pursue the non-commodity business or to develop services to more effectively compete in the commodity market, either option requiring significant capital commitments and their drain on earnings. And all the while, today's label converter continues to feel the squeeze resulting from the combination of raw material cost increases and continuous downward pricing pressures from a consolidating and offshoring customer base. In a nutshell, costs are rising, prices are falling, the market is shrinking, and competition is growing.

Clearly, without substantial improvements to their business models or operational efficiencies, today's label converters will face significantly lower profit margins in the near future - if they aren't already. And to top it all off, it is obvious that the pace of change is not slowing down.

One need not be clairvoyant to understand that the next five years will see an acceleration of market and technological changes cutting across a wide swath of the industry, including:

- The ongoing development and deployment of RFID and other types of smart labels;

- The broader demand for "green" and recyclable materials, products and processes;

- The further narrowing of the gap between digital and conventional printing; and

- The emergence of raw materials, including inks, coatings and substrates that will enable product designers and engineers to find increasing uses for labels and label production technology.

Nowhere has the impact of the recent and impending changes been greater than at the mid-sized companies, which for the purposes of this column we will consider as those with annual revenues between $10 and $70 million. With the sharp increase in the number of very large label companies (those with annual revenues in excess of $100 million), the competitive dynamics for these mid-sized companies has been significantly altered.

It is the rare business that can succeed without growing; the traditional axiom insists that if you are not growing, you are shrinking. The simple fact is that for a mid-sized label company to effectively grow, it cannot do so on the backs of $25,000 and even $50,000 accounts. It needs to secure six and seven figure accounts - that is, customers who will regularly purchase at least $100,000 and even north of $1,000,000 annually. Given the altered character of the competitive arena, landing those accounts is far more difficult, for those are the very accounts that the large companies are targeting as they pursue the hard-to-find growth opportunities in a slowing-to-non-growth industry.

Even keeping in mind niche market positioning, mid-sized companies are at a very real competitive disadvantage when stacked up against the large companies. The large companies have economies of scale that enable them to purchase raw materials at lower costs, offer a wider array of both production capabilities and services, and in many cases have multiple locations that provide large customers with their desired geographic coverage. In fact, not only are mid-sized companies finding that landing new major accounts is a great deal tougher, they are beginning to comprehend that many of their existing large accounts are in jeopardy as well.

Ironically, our industry's smaller companies are in fact less vulnerable to the changing tides, because they primarily service the smaller customers, a market that the large companies don't want - and are ill-constructed - to engage. The long term danger to small companies is that shrinking mid-sized companies will begin to pursue these smaller accounts, but it is hard to imagine any similar intensity in battles over accounts of $25,000 and under.

This resounding dynamic is hardly unique to the label industry. Similar factors are transforming many different industries across America, all of whom exhibit analogous symptoms: fragmentation without dominant market leaders, a history of predominantly local customer bases, consolidations among end users of their products, and slowed industry growth or shrinkage due to offshore outsourcing.

In the simplest of terms, the situation reads as follows: Oversupply and Underdemand. There are too many label converters to succeed in a consolidating customer market and slowed (or nonexistent) industry growth. Savvy managers will instantly recognize the solution: converter consolidation. Such consolidation is already in full swing at the large company level. It is the mid-sized companies who are at the beginning of what I foresee to be a major wave of mergers and acquisitions, and who now have to confront the single most important reality of industry consolidation: Are we a buyer or a seller? Or, in rare instances, are we capable of a merger?

The label industry has a great deal of promise and potential, and the future is bright. However, regardless of whether you are a buyer or a seller, without a significant competitive advantage going forward, being really good just won't be good enough. A new equilibrium must establish itself in order to take full advantage of the advances in technology, products and processes. It is this new equilibrium, an industry state of being, that will hold businesses to a considerably higher financial performance standard than in the past.

This new state-of-the-industry will be a far cry from the mid- to late 1990s, when 3,000 or so label converters populated and propagated the industry. It will undoubtedly consist of a top tier of powerhouse players, producing as much as 65 percent of total US label consumption. A second tier of large, mid-sized companies will probably account for the next 15 to 20 percent, with the remaining 15 to 20 percent or so divided up among the hundreds of small converters that dot the industry's landscape.

As the new year dawns, the timing is perfect to take a long, critical look at your company and assess for yourself, for the good of your company and its future, whether (in the words of folk singer Harry Chapin, another lesser known business consultant):

"I've got this problem with my aging I no longer can ignore:
A tame and toothless tabby can't produce a lion's roar."

Elisha Tropper is president and CEO of T3 Associates, a New York based strategic consulting firm, and the former president of Prestige Label, a North Carolina converter.
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