Inflation & Pricing Strategies – Packaging

Interview Transcript

Article | Inflation & Pricing Strategies – Packaging
15th June 2021 Atheneum Team

Expert Profile




Coveris Group


For the last 26 years, Laurent has worked with various packaging companies such as Amcor and Danaflex in creating new products and partnerships. As the Executive Vice President of Danaflex he was involved in driving the growth and international business development especially for high end market segments and was a crucial figure in establishing the R&D/Technology agenda towards Innovation and Plastics.

Section 1: Input Cost Variability Strategies

1.1. What are the most price sensitive costs in your industry?

If you consider flexible packaging products, a large part of them is constituted of packaging. So, the major cost in pure plastics-based films are plastic resins or plastic films.

That is the major input in the cost of the end product, which is sold to food manufacturers or personal care manufacturers. So, the final cost is related to the plastic resins cost or sometimes the plastic films where there are some commodity priced films.

If you consider some specific sub-segments of the flexible packaging, you have two types of materials which are somehow commonly used. Aluminum films are used in certain applications when you need some barrier properties or some high preservation or resistance properties.

For example, for coffee packaging or certain pet food packaging, or in medical or in pharma, there is a use of aluminum film, and it is here that the price or the cost of the aluminum metal could be a key factor for certain applications.

A third part of flexible packaging, which is paper based. And in that case, the input cost is related to paper and pulp. But the majority of the applications are related to plastic resins and plastic films.

1.1.1. Have these costs been rising? Why?

Yes, in fact, since the beginning of 2021, there is a raw material crisis in the industry. It can happen every 10 years or so and this year it has been even stronger than the precedent. What is happening is that there have been different elements in 2020, which have led to a significant reduction of supply of plastic resins, either polyethylene or polypropylene.

At the same time, there has either been a stability or rise in demand in the market, which has led to a very significant price increase on the raw material, up to 20 and 30% to give some examples on some of the PE resins, or polyethylene resins, or polypropylene resins, which are widely used in the industry.

At the same time, transport and logistics costs are increasing, which is not directly to the first factor, but is indirectly related due in part to the COVID crisis and some complexity in the global supply chains, and in Europe. The supply chains are increasing to a lesser extent, but prices are still increasing.

To come back to the point of resins, as this resin, supply has been limited due to two factors. At the end of 2020, in the US, they had poor atmospheric conditions and cyclones which have been impacting the production of resins, this reduced the supply capacity of some large plastic polyolefin-based plants in Texas and some other regions in the US. That had an impact on the overall worldwide supply chain because some of these plants were exporting to Europe or Asia, and they have been reducing their supply to these regions and instead concentrated on the US market. That has really reduced our ability to supply the market.

And of course, this event added to inquiries of the US supply of resins, and all these factors came almost at the same time, end of last year and beginning of this year. So we are really facing a very difficult situation today in Europe and other parts of the world.

1.2. What are some of the current strategies you employ to manage this variability?

There are two different approaches most of the industry players tend to use. You can either price the materials you supply to your customer on a spot basis, so when they order, they will get the price at the time of the order of the raw materials, plus the conversion cost.

So usually it’s a conversion cost, which is a transformation, printing, lamination, cutting to make it adaptive to the end use, which is agreed upfront. And on top of that, they will have the cost of materials (films or resins).

So they have a live update of the raw material price impact in the price at the time of the order. That’s usually the approach with small to medium-sized customers, which have relatively irregular demand, who order 3-4 times a year. So, these types of customers don’t need to have fixed conditions and stable pricing structure.

The second approach is to have an indexation close. I would say this is popular for larger customers, when you speak with brand owners like PepsiCo, Mondelez, Nestle, they are plastic-packaging manufacturers, who are applying for contracts, usually for 1-3 years duration.

The price is structured with a cost model, which is separating the cost of the materials and the cost of the transformation, conversion, and supply. These contracts are based not on a live update of prices, but on indexation closes. So, the cost or the price of the raw materials is following an index, which is updated every 3 or 6 months, depending on the type of agreement which can be made with the brand owner.

For example, it stays fixed during a six-month period, and every six months it is updated based on the most recent price indexation trends. And this index is a commonly used and shared index within the industry, made by independent organizations like ICS or Platz, thus it is transparent.

Those are the two main approaches. I think, and we believe the indexation is a relatively structured one, the issue is that when you have a very important and significant price increase of the ratio, sometimes you need to change these rules and you may need to go into direct negotiation, and are inevitably breaking or changing the contract to explain to customers that the situation is slightly different.

We have lots of cases, related to forced measure today from our resin suppliers, which forces us to change the pricing situation.

1.2.1. What are their strengths & weaknesses?

Looking at the strengths of spot pricing, it really protects the converter from the high fluctuation of the cost of materials. I would say it’s relatively easy and protective for the packaging supplier.

On the other hand, it doesn’t provide strong visibility to the customer to have spot prices, especially when there are changes from 5-15%. So, it can create some problems in terms of supply and liquidity, and it means sometimes there’ll need to be a renegotiation every time.

The situation of the spot basis contract is not always the most durable and it may create some uncertainty on both sides.

The second approach, which is a 1-3 year contract with the indexation close is a more stable approach, giving visibility to both parts, both the customer and the packaging supplier, and allowing both to absorb costs and smooth the price variation without too many positives or negatives on both sides. But it allows both to benefit from the price increase or decrease in certain periods.

The issue of the indexation close is when you have, and it is the exceptional situation that is being faced today, a very important price increase of the raw materials, like 30% as we see for certain P resins, plus the transport. Then it creates some liquidity issues on the converters.

So, the question is about the frequency and to have a sufficiently frequent price provision to allow the stability. So, three months is something we’ll say is reasonable. One month would be ideal. Six months is probably a little bit too long.

These closes of indexations are recent stand outs in the industry. I would say 10 years ago, or 15 years ago, they were not so well-implemented. And when there were no price indexations and prices were fixed for one, two, three years, then it really created problems for converters. So, I would say this indexation today is more balanced and beneficial for both parts. There’s still certain risks which you have to face during exceptional situations.

1.3. How have these strategies changed in the last few years? How do you expect they will change?

This system with long to medium term duration contracts with indexation closes, have become more frequently implemented in the industry. 5-15 years ago, the price of the raw materials were more stable, so the indexes weren’t really implemented.

I would say both sides of the industry, the packaging suppliers and the packaging users have recognized that there is a need to put in place, these indexes, which I think is positive.

Going forward, I don’t see so many, additional elements to it. There are some other strategies, such as hedging, but it is only applicable to certain raw materials. So, today only for the aluminum materials, you have the ability to hedge the price of aluminum.

This is used very widely in the aluminum-based industry and the pure aluminum packaging industry, for example, with metal cans. Hedging strategies allows you to have a certain period of fixed prices, which is, I would say covers both sides as a converter and as a customer.

It has of course, a cost and the necessity of an open market to hedge on, so that’s a strategy which is today used for aluminum, which cannot be used today for the other materials, neither plastics, nor paper, because these materials don’t have an open market.

One of the underlying elements is the price of oil, but it’s only a minor part of the plastic resins and plastic films price. So, oil is part of the indexation, but there is no way to hedge the transformation price of the resins.

Hedging could become more popular, but for the time being, there is no real market for that. One very early additional input cost, and I think it will emerge in the coming in the next 5-10 years is the integration of recycled content.

There is a big trend in the plastic industry to integrate more recycled materials. Recycled materials are following a transformation trend in the sourcing of materials, of course sourcing waste and conversion of waste is a different dynamic and changes the overall plastic market.

That may as well trigger some new closes in the pricing to include, 10-30% recycled content with a slightly different pricing strategy, with a slightly different way of updating the price and to connect or disconnect from the hedge in material prices.

Section 2: Inflation Management Strategies

2.1. Do you anticipate inflation impacting your business? If so, how?

My current focus is mostly on the European scope and in most European countries, inflation has not been a topic for many years.

We hear of inflation, but there is still not yet a clear view on what will be the inflation in the main European countries in France, in Germany, in UK, in the coming years or months. But we feel there is something coming, in fact.

We hear that there are some inflation trends, especially in UK as well, related somehow to the Brexit. Russia is another example where inflation has always been a factor, there is something we can learn from that market.

Usually most of the contracts were negotiated without inflation clauses. In fact, most of the contracts were mostly focused on the pure price and then including some cost improvement opportunities, especially with the big players, but inflation has not been part of the discussion.

I assume that if inflation is coming back significantly in certain countries, the industry and the packaging converters will have to put that back in the discussion and somehow create an indexation closely related to inflation as one part of the necessary changes.

On the cost factors, which can be impacted by inflation is transport labor to a certain extent. So, that may be an additional part of the price with indexation close related to inflation. But it is still an early topic, and of course it could be a complex topic in the industry, especially after facing the significant price increase of the resins being faced today. So, it may come after the wave of pricing that we are currently implementing. It may come next year.

2.2. What will be your pricing strategy in response to cost push inflation?

We have had to pass an incredibly significant price increase onto most of our customers due to the increase in costs this year. Prices have increase 10-20% on some products.

The first phase that we will face will be to expect a recovery of the raw material pricing increase, there is a decrease coming, hopefully by the end of the year and beginning of next year. The question will be, how much will it decrease and what will cause the decrease, and the implementation of the decrease to the customers, depending on the agreements which have been made over the last months.

Potentially the strategy would be to reduce the prices once the raw materials will have reduced, but at the same time, keep a certain buffer or certain safety levels related to the inflation, if we start to see the inflation coming back in certain countries, such as in the UK, maybe France. So, I think it will be a dual strategy.

So, implementing the price reduction related to the stabilization of the raw material prices and at the same time, keeping a certain safety level related to increasing inflation rates. And again, it will depend on the markets. These strategies cannot be applied in the same way on all market segments.

It is for sure, much more difficult to establish these strategies on a very commoditized part of the flexible packaging markets like produce or snacks where the products are very commoditized, and you can switch from one supplier to the other.

That will be probably an area where the retention of the pricing will be very difficult to implement. While on more specialty markets like medical, pharma or baby food, where the qualification process and the input costs are related to very specific manufacturing process and quality process.

I think on this market, which are somehow more favorable to absorb part of the cost changes, will probably have different strategies. So, I think the overall market trends will be different depending on the segments.

2.3. How will changing prices impact your post Covid-19 recovery?

Until now the company has been able to protect itself from the situation and to implement the right strategies. I think the whole flexible packaging industry has been consistently implementing the right pricing strategy in a consistent way to ensure there was a long-term protection of the interest of the industry.

Post-COVID when the situation will be stabilized, both from the raw materials and the supply chain perspective, I think the industry, will come back to a more stabilized situation.

And relatively with quick implementation, I think within three, six months, once the post-COVID situation will have hopefully been fully implemented, this situation will recover and allows the industry to regain a certain level of stability.

Maybe as well as information, the packaging industry during the COVID crisis has been positively impacted because manufactured goods, especially on the food segments, have been increasing. So, the overall industry did not suffer in terms of volumes and has been able to protect itself and to continue with a certain level of stability. So, this level of stability should come back as well, post-COVID.

2.4. What public policies/government support could help your businesses with rising prices?

In different countries we have seen dedicated support from the governments, at least in France, in Germany, in UK to support our industry given that in that we were negatively impacted in terms of the changing work patterns.

I think it’s more a tax policy question, and our industry has to anticipate certain changes, it is more of a sustainability question where we see the plastic industry being highly in focus and we start to see some tax schemes, that are trying to negatively impact the plastic packaging because of the relatively negative image of plastic.

But some polices want to hurt the plastic compatibles and materials, while when you make an analysis of the plastic impact in terms of environment, and usually in most cases, plastic properties in terms of flexibility, weight, CO2 impact, are much better than glass, metal or paper.

There are lots of discussions today, either at European level and at different countries level in Europe to implement some taxes, I think where we need to have a certain harmonization of the ese policies as an industry and ensuring these policies are focusing on the right behaviors in terms of the packaging switch. That’s something that we are closely looking at and expecting support from the government.