Intrigued by the unusual proposal (which Verso was forced to reconsider last week), the bankruptcy experts at The Capitol Forum recently published comments from a federal prosecutor explaining why the U.S. coated-paper industry is prone to cooperation among competitors.
The U.S. Department of Justice’s likely presumption that the merger would encourage “coordinated interaction” of competing companies could be a stumbling block for the merger, according to The Capitol Forum (subscription only).
The article made me realize something I had never thought about: Though coated-paper companies have the means and the motive to cooperate on pricing, the same is not true for publication printers, even though they have a similar customer base. The anonymous prosecutor’s comments, The Capitol Forum’s analysis, and my own experience inspired this list of 10 reasons the U.S. market for coated paper is prone to collusion, both legal and illegal:
- Price transparency: The prosecutor, who participated in the 2006 prosecution of Stora Enso and UPM on price-fixing charges, noted that “coated paper pricing is very transparent—a firm will announce a price increase to take effect at a future date, and wait for other competitors to follow,” The Capitol Forum said. [Editor’s note: Paper companies rarely announce price decreases, which tend to occur in a less orderly fashion.]
- The tradition of quarterly price changes: Except for spot purchases, most deals for coated papers involve quarterly adjustments based on market conditions. That, coupled with those publicly announced price increases, means competitors can implement a price increase simultaneously without ever communicating directly with each other.
- Concentrated market: No company has a large enough market share to push prices up unilaterally. But, for most grades, it only takes about three major players acting more or less in unison for a price move to stick. The Department of Justice probably views a NewPage-Verso merger as making such pricing coordination even easier for the mills, according to The Capitol Forum. By contrast, the printing industry is more fragmented, despite massive consolidation.
- Mutually assured destruction: With stable supply and declining demand, paper companies are tempted to keep the machines running by pricing aggressively to grab market share. But they know that if competitors follow suit, they all lose. Paraphrasing the prosecutor, The Capitol Forum explained that “because declining demand can result in lower prices, firms in distressed industries may have the incentive to collude to stop further price declines. By contrast, when demand is steadily increasing, there may be less incentive to collude because coordination may not be necessary to make price increases stick.”
- Near commodity: Those price-increase announcements are meaningful because a statement about a “$60-per-ton increase for coated groundwood” is immediately understood by buyers and competitors. (Whether the price increase is fully implemented is another story.) Commercial printers make no such public announcements because there is no single price for printing; printing contracts often have multiple-page price lists.
- Not quite a commodity: Coated paper, however, is not such a commodity that it can be traded in the pits like soybeans or pork bellies. Varying roll sizes, basis weights, finishes, and transportation arrangements make each order a custom-manufacturing job. (There was one company that tried to create a futures exchange for pulp and coated paper. It was called Enron.)
- Built-in market intelligence: Mills sell much of their output through paper brokers that also represent competitors. Those brokers can provide insight into competitive pricing and act as an indirect communications channel if a mill wants to signal competitors that it will hold the line on pricing. Many major customers also buy from more than one mill, so mills can glean information about what their competitors are up to by observing customers’ order volumes and how they negotiate on pricing. By contrast, most of those customers buy printing directly from the printers and use only one publication printer.
- Stable demand: In the short run, demand for graphic paper is inelastic – that is, not affected by prices. It takes months for a major catalog or magazine to carry out a plan of reducing pages or copies, so paper companies assume a 5% change in prices will mean a 5% change in revenue. (Demand for paper is more elastic in the long run, but paper executives – like postal executives and politicians – don’t think about the long-term effects of pricing.)
- The uncoated freesheet example: The North American market for uncoated freesheet paper (copier paper, for example) is a near duopoly. Despite having low production costs, the two big players would rather shut down machines than chase market share. This “market discipline” strategy has been profitable for the mills, as both Wall Street and the coated-paper manufacturers know full well.
- Safety valves: Idling a machine during slack times is a money loser: Employees still have to be paid, and the bondholders still want their monthly payments. But mills have ways of keeping the machines running without flooding their markets, such as by making more paper for export markets or turning off the coaters to produce uncoated products. Printers don’t have such options.