Packaging economics: integration, the cycle and passing on costs
Why owning the mill and the box plants together pays, why price rises and cost rises do not arrive at the same time, and what one thousand drink cans earn.
Industry brief, with a one-minute summary: Paper and packagingKey takeaways
- Most of what a packaging company pays for is its raw material.
- Many packaging contracts link the selling price to an index for the main input (resin, aluminium, board).
- Worked case: Integrated versus non-integrated box maker.
- Worked case: What a three-month delay costs.
Key idea
Most of what a packaging company pays for is its raw material. So profit depends on two things: having lower-cost material than rivals (often by owning the mill), and getting changes in material cost into the selling price before they eat the margin.
Worked case
Integrated versus non-integrated box maker
The prompt
Two fictional box makers in the United States sell corrugated boxes at USD 1,100 per tonne of board used. BoxCo buys its containerboard on the market at USD 650 a tonne. MillBox owns a recycled mill whose cash cost of board is USD 480 a tonne. Both spend USD 300 a tonne to convert board into boxes (labour, starch glue, ink, energy) and USD 60 a tonne on freight to customers. What is each one's cash margin per tonne? All figures are illustrative.
The structure
- Cash margin per tonne = box price minus (board cost + converting + freight)This comes from the goal: compare profit per tonne for the two ways of getting board.
- BoxCo: market price of board
- MillBox: its own mill's cash cost of board
Working it through
1. BoxCo margin
Price 1,100 minus board 650, converting 300 and freight 60.
BoxCo cash margin (USD per tonne):1,100 - (650 + 300 + 60) = 902. MillBox margin
Price 1,100 minus board 480, converting 300 and freight 60.
MillBox cash margin (USD per tonne):1,100 - (480 + 300 + 60) = 2603. Gap
The extra margin from owning the mill.
Advantage of integration (USD per tonne):(1,100 - (480 + 300 + 60)) - (1,100 - (650 + 300 + 60)) = 1704. If board prices fall 100 dollars and box prices fall 50
BoxCo now pays 550 for board and sells at 1,050.
BoxCo new cash margin (USD per tonne):1,050 - (550 + 300 + 60) = 140
The recommendation
MillBox earns about USD 260 a tonne against USD 90 for BoxCo, so owning a low-cost mill is worth about USD 170 a tonne at today's prices. First, the gap is simply the market price of board minus the mill's cash cost. Second, this means the advantage shrinks when board prices fall: BoxCo's margin then rises to about USD 140 while the mill earns less on its board. The risk for MillBox is the mill's own fixed costs and its exposure to fibre and energy prices. As a next step, test both margins across the board price cycle, not just at today's price.
Risks: The mill's depreciation and maintenance are not in its cash cost; at low utilization they weigh heavily; Recovered paper prices can jump when demand from other countries rises.
The pass-through delay
Many packaging contracts link the selling price to an index for the main input (resin, aluminium, board). But the price usually changes only after a delay, for example the next quarter. When input costs rise, the converter pays more at once and gets paid more only later, so margins dip. When input costs fall, the converter keeps the gap for a while, so margins rise. Reading a packaging company's results without knowing where input prices moved in the last few months leads to the wrong conclusion.
Worked case
What a three-month delay costs
The prompt
FlexiPack (fictional), a flexible packaging maker in India, uses 100,000 tonnes of resin a year. The resin price rises by USD 200 a tonne. Its contracts pass the change on to customers, but only after three months. How much margin does it lose before prices catch up, and what share of its yearly EBITDA of USD 40 million is that? All figures are illustrative.
The structure
- Margin lost = tonnes used during the delay x cost increase per tonne
- Tonnes used in three months = yearly tonnes x 3 / 12
Working it through
1. Tonnes used during the delay
A quarter of the year.
Resin used in three months (tonnes):100,000 × 3 ÷ 12 = 25,0002. Margin lost
25,000 tonnes times USD 200.
Margin lost (USD):100,000 × 3 ÷ 12 × 200 = 5,000,0003. Share of yearly EBITDA
USD 5 million out of 40 million.
Share of EBITDA (fraction):5,000,000 ÷ 40,000,000 = 0.125
The recommendation
FlexiPack should explain to investors that the dip is timing, not lost business, and shorten its delays where it can, because the three-month delay costs about USD 5 million, 12.5 percent of a year's EBITDA. First, it pays the higher resin price on 25,000 tonnes before customers pay more. Second, this means the same delay gives the money back when resin prices fall. The risk is a customer refusing the full increase when the delay ends. As a next step, list contracts by delay length and renegotiate the longest ones.
One thousand drink cans
A drink can maker shows the same logic. The aluminium in the can is most of the cost, and contracts with drinks companies pass the aluminium price straight through. So the can maker earns its margin on converting: running lines that make thousands of cans a minute, keeping them full, and holding down waste. That is why can makers report volume growth and profit per can, not just revenue, which rises and falls with the aluminium price.
A can maker sells 1,000 cans for USD 85. The aluminium in them costs USD 39 (passed through to the customer), converting costs USD 30 and freight USD 4. What is its margin per 1,000 cans, in USD? (Illustrative figures.)
A paper machine has fixed costs of USD 60 million a year and capacity of 400,000 tonnes. By how much does fixed cost per tonne rise when output falls from 95 percent to 80 percent of capacity, in USD?
Sources for this lesson (1)
- Recognized public explanations of case-interview concepts and terms
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