From the President's Desk

Economies of Scale: Once an Advantage, Now a Detriment?

In the 1860s, logging and lumbering were the biggest combined industries in Wisconsin and the second largest in the U.P. Unarguably, logging has built our communities what they are today. Lumber to be shipped out east for urban expansion and the advent of the sulfite pulping process in the paper industry led to our natural resource being one of the top sought-after commodities on earth in the early days of our two states. Early industry barons grew profits and wealth by creating economies of scale.

Economies of scale were once beneficial to capital-intensive industries such as logging, sawmilling, and paper production. For one hundred years, domestic markets were more diverse and abundant. Expansions allowed the forest product industry to optimize supply chains, run at full capacity, and spread fixed and marketing costs.

However, there are downsides to economies of scale. The following list is some of the detriments to having economies of scale in a business:

1. Disruptions in the supply chain.

2. Changes in the marketability of products produced.

3. Regulations that affect the business cycle.

4. Environmental challenges.

5. A significant capital investment where debt is necessary.

What has happened to using economies of scale as a competitive advantage in the forest products industry? The first I remember in my career was listing the Spotted Owl as a threatened species in 1990. Logging was particularly singled out as the reason the bird population decreased. This is not an environmental article, but it was later disclosed to the public that the Barred Owl is an aggressive bird that was killing Spotted Owls. However, this threatened designation of the Spotted Owl shut down logging, and the supply chain disruption made it impossible for mills to stay in business where the Spotted Owl habituated.

Next, the advent of digital business practices and e-commerce in the 1990s affected the demand for newspapers, magazines, and legacy paper products used in our offices. These changes in the marketability of paper products have disrupted our entire forest products industry, leading to the economic condition we are in today.

At the same time, digitization began impacting the paper industry; furniture production was moving to China from all areas of the country that had a vital hardwood timber resource in the U.S. It took sales operations in hardwood-producing companies five years to catch up with this trend and create markets in China. Now, the Chinese housing market is in decline, combined with high-interest rates and substitute products available to consumers, and the hardwood industry is once again searching for market opportunities. In the meantime, production is scaled back, and the logging industry is affected by this market phenomenon. I can go on, but it would only be redundant rhetoric of prior articles.

The bottom line is as markets have declined and regulation combined with environmental pressure continues to mount on the industry, opportunities to increase margins, much less have margins, have become increasingly difficult to achieve using economies of scale.

What is the answer? First, always be on the look-out for niche markets. Scaling a business with niche markets is hard to achieve but margins can be strong with these products or services. Second, reduce debt to match available cash flow. Third, limit capital purchases to only the necessities of staying in business. Lastly, get involved with the GLTPA. They are constantly on top of environmental issues, and pushing back on unnecessary regulations that affect timber harvesting.

Troy Brown

GLTPA President