Competitive Actions and Profitability in the U.S. Forestry Industry

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University of Tampere

Department of Management Studies

COMPETITIVE ACTIONS AND PROFITABILITY IN THE U.S. FORESTRY INDUSTRY

Management and Organization Master’s Thesis

November 2009

Supervisor: Kalle Pajunen

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ABSTRACT

University of Tampere Department of Management Studies, Management and Organization

Author: TUOMAINEN, EMMI

Title: Competitive Actions and Profitability in the U.S. Forestry Industry

Master’s Thesis: 85 pages, 12 appendix pages

Date: November 2009

Keywords : competitive actions, profitability, forestry industry, fuzzy- set analysis

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Profitability is an extremely important issue for every company as it is an essential part of its continuity. Competitive actions taken by a company have an influence on the company’s performance and thus its profitability. It is not, however, clear what kind of actions promote and what kinds of actions, on the contrary, hinder the profitability of a company.

In this study, I made an effort to examine the effect of competitive actions on profitability in the U.S. forestry industry during the period 1998-2005. In particular, it was examined if certain actions or combinations of actions led to exceptionally good or alternatively exceptionally bad profitability. The study was conducted by first examining the literature on competitive actions and forestry industry. The empirical part was conducted by selecting 13 companies with either exceptionally good or exceptionally poor profitability and the actions they had taken were identified mainly from the annual reports of the companies.

The actions were then coded according to the following dimensions: capacity growth versus capacity decline, organic growth versus mergers and acquisitions, diversification versus concentration on the core sector, internationalization versus concentration on domestic markets and cooperation versus no cooperation. The analysis of the connection between these dimensions of competitive actions and the company’s profitability was done using fuzzy set method.

The results of the study support earlier studies stating that competitive actions of a company have an effect on its profitability. The findings of the study reveal, that mergers and acquisitions (as opposed to organic growth) seem to be an important part of a profitable strategy. Capacity reductions, on the contrary, seem to have a negative effect on the company’s profitability, except when combined with a high degree of diversification. In this case capacity reductions seem to lead to profitability. Diversification and internationalization, on the other hand, seem to have a slightly negative effect on the profitability. This might, however, be explained by the greater action - profitability lag caused by the time needed to adjust to the new sector or geographical markets. The level of cooperation amongst the companies under scrutiny was low, so no deductions about the relation of cooperation and profitability could be made.

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TIIVISTELMÄ

Tampereen Yliopisto Johtamistieteiden laitos, yrityksen hallinto

Tekijä: TUOMAINEN, EMMI

Tutkielman nimi: Competitive Actions and Profitability in the U.S. Forestry Industry

Pro gradu -tutkielma: 85 sivua, 12 liitesivua

Aika: Marraskuu 2009

Avainsanat: kilpailutoimet, tuottavuus, metsäteollisuus, fuzzy set-analyysi _________________________________________________________________________

Kannattavuus on oleellinen osa liiketoiminnan jatkuvuutta ja näin ollen hyvin keskeinen asia kaikille yrityksille. Yrityksen kilpailutoimet vaikuttavat sen toimintakykyyn ja sitä kautta myös sen kannattavuuteen. Ei ole kuitenkaan selvää, millaiset kilpailutoimet edistävät, ja millaiset kilpailutoimet estävät yrityksen kannattavuutta.

Tässä tutkielmassa tutkin kilpailutoimien vaikutusta kannattavuuteen USA:n metsäteollisuudessa vuosien 1998–2005 aikana. Erityisesti tutkin, johtavatko tietyt kilpailutoimet, tai niiden yhdistelmät erityisen hyvään tai vaihtoehtoisesti erityisen huonoon kannattavuuteen. Tutkielmassa käsittelen ensiksi olemassa olevaa kirjallisuutta kilpailutoimista. Empiiriseen osioon valitsin 13 yritystä, joilla oli joko erityisen hyvä tai vaihtoehtoisesti erityisen huono kannattavuus. Identifioin kilpailutoimet, jotka yritykset olivat tehneet pääosin yritysten vuosikertomuksista ja koodasin ne seuraavien ulottuvuuksien mukaan: kasvu vs. kapasiteetin supistaminen, orgaaninen kasvu vs. kasvu fuusioin ja ostoin, diversifiointi vs. keskittyminen omalle ydinosaamisalueelle, kansainvälistyminen vs. keskittyminen kotimaan markkinoille ja yhteistyö vs. ei yhteistyötä.

Analysoitaessa kilpailutoimien vaikutusta kannattavuuteen käytin fuzzy set – analysointimenetelmää.

Tutkimuksen tulokset tukevat aikaisempien tutkimusten tuloksia, joissa todettiin yrityksen kilpailutoimilla olevan vaikutusta sen kannattavuuteen. Tämän tutkimuksen tuloksista käy ilmi, että fuusiot ja yritysostot (vs. orgaaninen kasvu) näyttävät olevan tärkeä osa kannattavaa strategiaa. Kapasiteetin supistamisella sitä vastoin näyttää olevan negatiivinen vaikutus yrityksen kannattavuuteen, paitsi jos se on yhdistetty korkeaan diversifiointiasteeseen jolloin se näyttää johtavan hyvään kannattavuuteen. Useimmiten diversifiointilla ja kansainvälistymisellä taas näyttää olevan hieman negatiivinen vaikutus kannattavuuteen. Tämä saattaa olla seurausta suuremmasta viiveestä kilpailutoimien ja kannattavuuden välillä johtuen pidemmästä ajasta, jonka uuteen sektoriin tai maantieteelliseen alueeseen sopeutuminen vie. Yhteistyö muiden tahojen kanssa tutkittujen yritysten keskuudessa oli hyvin alhainen, joten sen suhteesta kannattavuuteen ei voitu päätellä mitään.

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ACKNOWLEDGEMENTS

This study is part of the GloStra (Global Strategy) project funded by TEKES. The financial support is gratefully acknowledged. I would also like to take the opportunity to thank my supervisor, Kalle Pajunen, for his valuable advice.

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1 INTRODUCTION

1.1 Background and Aim of the Study

The primary objective of almost every company is to generate profits for their shareholders and, in any case, no company should be operated in such way that profit is considered unimportant (see e.g. Bhatia, 2000) as it is one of the requirements for the company’s continuity. That is why it is of paramount importance to study the factors that affect companies’ profitability. Firm-level competitive action is at the core of business strategy and competitive positioning (Young, Smith and Grimm, 1996) and thus competitive actions matter to the firm’s performance (Chen and Hambrick 1995; Ferrier, 2001). In fact, it has been demonstrated that there is a link between a firm’s actions and its profitability (Ferrier, 2001). This is why it is important to investigate firms’ competitive actions when a deeper understanding of firms’ performance and profitability is needed.

The forestry industry is an interesting field, because even if it is classified as a mature industry some fundamental changes are happening there, too. For example the emerging markets, like China, Latin America and Russia are becoming even more important players in the global scene. Also changes reflecting the current issues, like climate change, are taking place in the forestry industry. On the other hand, in the USA, as in most of the traditional markets, newspaper readership and advertising is in a downward trend because of the substitution by alternative media. (PwC, 2008)

How do competitive actions affect the profitability of companies in industries like the forestry industry? There exists relatively a lot of literature on competitive actions in general, but not so much on the relation between certain types of competitive actions and profitability. The existing literature on competitive actions and their influence on profitability is, in fact, rather scattered in nature and none that I know of analyzes directly forestry industry. This study is conducted in order to contribute to filling in this gap.

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The aim of this study is to examine the competitive actions of two sets of U.S. forestry companies during a period of eight years (1998-2005). The first set consists of companies that have been relatively profitable during the eight years under scrutiny, and the other consists of companies that have had poor profitability during the same years. If some similarities amongst the competitive actions or configurations of competitive actions within the groups and differences between the two groups can be found, this may imply that some particular actions or configurations of actions foster profitability in the U.S. forestry industry and other actions or configurations of actions on the contrary defer it.

This study is thus conducted in order to find answers to the following questions:

-Do competitive actions seem to affect the profitability of companies in the U.S. forestry industry?

-What kinds of competitive actions or configurations of competitive actions have the more profitable firms under scrutiny taken?

- What kinds of competitive actions or configurations of competitive actions have the less profitable firms under scrutiny taken?

- Can some general patterns of competitive actions be detected which seem to lead to superior profitability or alternatively to inferior profitability with respect to other firms in the same industry?

1.2 Structure of the Study

This study is composed of six sections: introduction, theoretic background, methodology, company profiles, empirical analysis, and concluding discussion. The structure is illustrated in Figure 1.

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Figure 1 Structure of the Study

In the theoretic background section, I will have an overview on what has been said about competitive actions in general in previous literature and what definitions for competitive actions have been proposed. In the same section, I will also describe the U.S. forestry industry and the forestry industry in general. Subsequently, I will identify a definition and categories of competitive actions that suit the forestry industry and that will be used in this study. In this section, I will also discuss the relation between profitability and competitive actions, and the theoretic framework for this study will be constructed.

In the methodology section I will, among others, describe the characteristics of this study, and discuss why the fuzzy-set method suits this study. I will also introduce the fuzzy-set method of analyzing data in detail. In the same section, the Fs/QCA tool and data that will be used in this study are introduced. Also the reliability and validity of the study are discussed.

In the company profiles section of the study, I will introduce the thirteen companies included in this study and describe the actions taken by them during the eight-year period.

In the empirical analyses section, I will analyze the empirical evidence regarding the

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method. In the final part of this study, I will review and discuss the results obtained from this study and answer the questions posed in the beginning of the study (see 1.1 Background and Aim of the Study). In addition, the limitations of the study and suggestions for further studies are discussed.

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2 COMPETITIVE ACTIONS, PROFITABILITY AND FORESTRY INDUSTRY

2.1 Competitive Actions

Definitions of Competitive Actions

The concept of competitive action is one of the founding pillars of this study. But what actually is a competitive action? It is known, that the firm’s strategy is represented by its competitive actions (see, e.g., Ferrier, 2001; Ferrier, Smith & Grimm, 1999; Lamberg &

Ojala, 2006, and Lamberg, 2005), and it is also known, that there is a link between a firm’s actions and it’s profitability (Ferrier, 2001). There is not, however, a universally accepted definition for the concept of competitive action (see, e.g., Nokelainen, 2008).

There are many different ways of naming the concept, I will call in this study, competitive action. I assume that when talking about competitive actions (see, e.g., Nokelainen, 2008), competitive action events (see, e.g., Ferrier, 2001), competitive moves (see, e.g., Young et al., 1996), strategic actions (see, e.g., Lamberg & Ojala, 2006), organizational actions (see, e.g., Miller & Chen, 1994), actions (see, e.g., Smith, Grimm, Gannon & Chen, 1991), and so forth, the authors mean fundamentally the same thing here referred to as competitive action.

There is a fair amount of articles and other literature on the competitive actions of firms.

Chen has been especially active in contributing to this when it comes to the U.S. domestic airline industry and its competitive actions (see, e.g., Chen & Hambrick, 1995;

Chen & MacMillan, 1992 and Miller & Chen, 1994). In particular, Chen and MacMillian (1992) engage in research of action-response dyads from a game theoretic point of view.

Studies on competitive actions of other industries like the U.S. software industry (Young et

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al., 1996), U.S. based internet companies (Kotha, Rindova & Rothaermel, 2001) and multi- industry studies (Ferrier et al., 1999 and Ferrier 2001) have also been conducted.

In many articles that use the concept competitive action, however, this concept has not been defined at all, or alternatively only a set of actions that the authors consider competitive actions in that particular situation has been listed. For example, in their study of competitive moves in the U.S. software industry, Young et al. (1996) considered competitive activity to include product introductions and announcements, as well as marketing and promotion campaigns including price cuts, but no further explanations on the reasons for selecting those particular competitive actions were given.

However, many researchers have built definitions of competitive actions that differ to some extent from one to another. The following are some examples of these: Chen and Hambrick use the following as a definition for competitive move: “[a move] that has the potential effect of enabling acquisition of rivals’ market shares or reducing their anticipated returns.” (1995, 464), whereas Miller and Chen (1994) define competitive action as a specific and observable competitive move, such as a new product introduction, an advertising campaign, or price cut, initiated by a firm to improve or defend its relative competitive position. In turn Smith et al. state: “Consistent with Schumpeter's analysis, we defined an action as a specific and detectable competitive move, such as a price cut or a new product introduction, initiated by a firm to defend or improve its relative competitive position.” (1991, 61) Ferrier et al. state, instead, that: “We define competitive action as any newly developed market-based move that challenges the status quo of the market process.”

(1999, 373) Nokelainen, in turn, has defined that: “Competitive action is an intentional action which is performed by a company, because it desires to achieve or maintain competitive advantage and believes that the action will contribute to the fulfillment of this desire.” (2008, 68)

These five definitions might initially seem similar, but there are some fundamental differences in them. In the comparison represented in the Table 1, I have observed the presence or absence of the following components or requirements in the definition: Does

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the definition require 1) intentionality, 2) that the action is initiated or performed by the company, 3) that the action potentially contributes to achieving competitive advantage, 4) that the action is taken in the believe that it contributes to the achievement of competitive advantage, 5) that the action is observable or detectable and 6) that the action is market- based?

Table 1 Comparison of the Definitions

Requirement /

Author (s) Intentionality

Performed by the Company

Achieving Competitive

Advantage Believe¹ Detectability

Marked Based Smith et al.

(1991) X X X X

Miller & Chen

(1994) X X X X

Chen &

Hambrick (1995)

X

Ferrier et al.

(1999) X

Nokelainen

(2008) X X X X

The only definition to require intentionality in the comparison is by Nokelainen (2008).

According to him, for example, an accidental information leak that later turns out to be profitable to the company does not qualify as a competitive action as it was not intended to be a competitive action. In the other definitions this component of intentionality has not been mentioned. When it comes to the requirement that the action, in order to be competitive, has to be initiated or performed by the company, Smith et al. (1991), Miller and Chen (1994) and Nokelainen (2008) require it. For example, if the action is taken by government or some competitor, according to these definitions it does not qualify as a

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competitive action of the firm. In turn, all of the definitions, except for that of Ferrier et al.

(1999), define that in order for the action to be competitive, it has to potentially contribute to the achievement of competitive advantage, that is, advantage over the competitors.² Only the fact that the action “challenges the status quo”, as in Ferrier et al.’s (1999) definition, is not enough according to these definitions. In addition, Smith et al. (1991), Miller and Chen (1994) and Nokelainen (2008) require that the action is believed to contribute to the achievement of competitive advantage. For Chen and Hambrick (1995) it is enough that the action “has the potential effect”³ of contributing to the achievement of competitive advantage. The distinction could be made, for example, in a situation where a company would give out large cash discounts to its customers. This, unquestionably, could potentially increase the competitive advantage of the firm (happier customers and thus more orders). On the other hand, if the management does not think it actually would increase the competitive advantage, but it believes, that on the contrary, it would be more likely that the action destroys the competitive advantage (less profit margin), according to Nokelainen (2008), Miller and Chen (1994) and Smith et al. (1991) would not qualify as a competitive action.

The fifth component of the definitions under scrutiny is the fact if they require that the competitive action is detectable or observable. Smith et al. (1991) and Miller and Chen (1994) require detectability, whereas Chen and Hambrick (1995), Ferrier et al. (1999) and Nokelainen (2008) do not. Nokelainen (2008), in fact, asks to whom the competitive action should be observable? If the action should be detectible to the firm in question, it does not bring any additional value to his definition as in order to be a competitive action, the action already had to be intentional. And obviously if the action is intentional, it is detectible at least to the representative of the company who conducts the action. The question if the action, in order to qualify as a competitive action, has to be detectible also to external observers in addition to the firm (or representative of the firm) is discussed by Nokelainen.

2 “…enabling acquisition of rivals’ market shares or reducing their anticipated returns.” (Chen & Hambrick, 1995),

“…to improve or defend its relative competitive position.” (Miller & Chen, 1994),

“…to defend or to improve its relative competitive position.” (Smith et al., 1994),

“…to achieve or maintain competitive advantage…” (Nokelainen, 2008)

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He claims that there is no theoretical ground to require that the action should be observable to external actors, such as competitors or researchers. In fact, in most cases it might even make the action more powerful if the competitors are not able to respond to it, as they are not aware of the action (Nokelainen, 2008). I agree with Nokelainen in that there is no theoretical ground to demand that the competitive action should be observable to the external actors. For example, the decision of a company to initiate a research and development project that has been kept secret from the external actors might well be a very powerful competitive action. On the other hand that kind of action could in practice be virtually impossible for a researcher to detect at least from publicly available data. The last component of the definitions under study, namely the fact if the competitive action should be market-based, is supported only by Ferrier et al. (1999). This requirement excludes organizational restructuring and other actions internal to the company from the definition of a competitive action as they are not market-based.

The definition by Nokelainen⁴ (2008) is the most complete of the definitions discussed above, so I shall use it as my benchmark when identifying competitive actions with a slight modification. It must be acknowledged that in order to use the companies’ annual reports as source from which to identify the competitive actions, for practical reasons the requirement of observability must be added to the definition of competitive action. Also, as Nokelainen states, virtually all empirical studies must have this requirement incorporated in the definition either explicitly or implicitly as it would be challenging to study something that cannot be detected (Nokelainen, 2008).

Classifications of Competitive Actions

As seen earlier, there is no consensus on the definition of competitive action. But as one might assume, there is even less consensus when it comes to the variety of competitive actions which the firms can choose from (see also Nokelainen 2008). Here are two

4 “Competitive action is an intentional action which is performed by a company, because it desires to achieve or maintain competitive advantage and believes that the action will contribute to the fulfillment of this

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examples of how researchers have categorized the range of competitive actions (for more examples, see, e.g., Nokelainen, 2008, appendices 1 and 2):

In a research conducted on the European mobile phone industry, Fjelsdtad, Becerra and Narayannan (2004) have categorized strategic actions relative to the primary activity categories in the following way:

1. Competitive Actions:

Infrastructure operations: investment in fixed assets, buy spectrum, bid for license or spectrum, extend coverage.

Network promotion: price cut, new schemes or promotional add-ons, marketing campaign, sign up large customers, free airtime, refund for dropped calls, improve retail coverage, contract management.

Service provisioning: new technical features, new services, drop services, simplify billing, change interconnect terms.

2. Cooperative Actions:

Infrastructure operations: stake in another firm or joint venture to physically enter a new market.

Network promotion: strategic alliance with other network firms with promotional goals.

Service provisioning: strategic alliance with network firms of any nature to provide new services or enhance them.

3. Other Moves:

Resell capacity, reduction of workforce, restructuring, regulatory action, divestment.

Chen and Hambrick (1995, 464) have, instead, categorized types of competitive moves in the following way when studying the U.S. airline industry:

Price cut, promotion, service improvement, new service, increase in commission rate for travel agents, feeder alliance with commuter airline, cooperation with another major airline, merger and acquisition, co-promotion with non-airlines, increase in daily departures, exit from a route, change in ticket purchase

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requirements, entry into a new route, frequent flier programs, change in fare structure, decrease in daily departures and hub creation.

It is clear that not all categories of competitive actions can make sense in all situations or in all industries. Take, for an example, competitive actions like “decrease in daily departures”

or “frequent flyer programs” (Chen & Hambrick, 1995). These competitive actions, while highly relevant in the context of the airline industry, would most probably not make any sense when categorizing competitive actions conducted in the forestry industry. The same applies to competitive actions like “free airtime” or “refund for dropped calls” in the mobile phone industry (Fjelsdtad et al., 2004). Here the problem of industry specificity of the typologies of competitive actions can be seen (see, e.g., Nokelainen, 2008).

Nokelainen (2008) tried to overcome the problem of industry specificity by constructing a typology of competitive actions which should be applicable to all industries. He introduces eight elementary actions from philosophical theory and eight domains of actions mainly from the general theory of competition, a combination of which adds up to 64 different types of competitive action (see Figure 2).

Figure 2 A Typology of Competitive Actions (Nokelainen, 2008)

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The eight elementary actions from philosophical theory include: bringing about, suppressing, preserving and destroying, as well as forbearing or refraining from these actions.

Referring to forbearance, Nokelainen makes a clear distinction between two different types of “inaction” as contrary to action. Nokelainen states that the difference between forbearance and negligence is that forbearance is intentional (as required by Nokelainen’s definition of competitive action), whereas negligence (or “omission”) does not involve intention. Thus refraining from taking some action (e.g. decision to not introduce a new type of wood-plastic composite to the market because it has too many defects, by which the launch would harm the company) is considered a competitive action whereas negligence or omission is not. (Nokelainen, 2008)

In order to shed light on the elementary actions from philosophical theory, here are some examples of each. Bringing about, for example, could be introducing a product to the market, and forbearing to bring about would be on the contrary choosing not to introduce the product to the market (after considering it some way harmful to the company like in the previous example of defective new wood-plastic composite). Suppressing (or preventing something from happening), instead could be preventing the employees from giving excessive cash discounts to customers. Forbearing to suppress in this case would be considering the costs and benefits of suppressing the allowing excessive cash discounts and deciding that there are more costs than benefits attached to preventing this and as a consequence choose the “inaction”.

Preserving, for instance could be the action if a product lacks some information in the description of the product and the company is being given two options from the authorities:

add that information to the description or withdraw the product from the market.

Preserving would occur if the firm chose to add the information and thus keep the product on market. Forbearing to preserve, instead, would happen if the firm would think that, for some reason, it would be more beneficial to the company to not add the information and as

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a consequence withdraw the product from the market. Finally, destroying could take place, for example, if the product is making losses and the company would withdraw it from the market. On the other hand even after considering the losses, if the company elects to keep it on the market as opposed to withdrawing it, the company would forbear from destroying.

In addition to the eight elementary actions from philosophical theory, Nokelainen introduces eight domains of actions from the general theory of competition, namely:

financial resources, physical resources, legal resources, human resources, organizational resources, informational resources, relational resources and product attributes. The seven formerly mentioned domains come from the resource-advantage theory, and the latter, has been added by Nokelainen as the marketplace position cannot materialize without a product or service. (Nokelainen, 2008)

The typology created by Nokelainen is most likely the best framework when one wants to compare the competitive actions of multiple industries, as the typology is not industry specific. But is it the best categorization for the competitive actions in the forestry industry?

In order to find that out, the characteristics of the forestry industry must be examined.

2.2 Characteristics of the Forestry Industry

Forestry Industry in General

The forestry industry is an archetypical example of a mature industry characterized by incremental development in technology, and cyclical nature due to the fluctuation in prices for end products and raw materials. In addition, the industry has been divided into relatively separate market areas like the USA and Western Europe. (see, e.g., Lamberg and Ojala, 2006) Vertical integration is a typical feature of the forestry industry, meaning for example, that companies have moved from only sawmilling to also pulp and paper production or otherwise expanded their scope. This may be partly because of the respectively large dependency on raw materials and the high cost of moving them, for

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is very important as it is typical for the paper and pulp industries to have huge investments in production technology. (see, e.g., Lamberg and Ojala,. 2006)

Historically, the development of the paper and pulp industry has been dependent on the population characteristics ( population growth, literacy rate and consumption rate), raw materials supply (a large and accessible supply of wood, water and energy were of paramount importance until the 1960-1970’s, when the recycled waste paper has become a more important substitute for wood), and international business cycles. (Lamberg, 2005)

Major factors affecting the forestry industry and the companies’ results on a shorter term include foreign exchange rates, energy, transportation and raw material costs (especially fiber), in addition to the macroeconomic factors. Also climate change is another key factor starting to shape the industry. The availability of fiber resources is crucial, also because the providers of renewable energies are competing over the same fiber and the prices are rising. Exchange rate fluctuations are essential, instead, when the costs incur in one currency and the sales are conducted in another currency (usually in U.S. dollars). Also, the shift of production capacity from the traditional regions, like Europe and North America, towards the emerging markets such as Asia (especially China), Latin America and Russia, is visible. South America is strong on the supply side (it has lots of fiber resources), whereas China is strong on the demand side (the demand of the products is rising fast there).

In fact, the rise of production in emerging markets has also contributed to the rise in demand of energy and subsequently also to the rise of prices. The rising energy costs generally favor the plants with modern, less energy consuming machinery as opposed to machinery which is not as updated and consumes much more energy. (PwC, 2008)

Forestry Industry in the USA

There are some features, which characterize the forestry industry, especially in the USA.

The strong supply of the basic raw material, wood, is one of the main reasons why the industry has flourished in North America. Also huge domestic markets, a common language and business friendly institutional environment (see e.g. Lamberg, 2005) have

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shaped the industry. In the United States, antitrust laws have traditionally created a non- protected system in contrast, for example, to the Scandinavian system. Because of this, instead of cartelization, firms grew in size. In addition, in the United States, companies have been encouraged to maximize their short-term profits, to compete openly and to reduce investments for shorter-term profitability. (Lamberg, 2005)

However, in the USA, like in most of the traditional markets, the newspaper readership and advertising is in a downward trend because of the substitution by alternative media (PwC, 2008). On the other hand, consolidation in the US markets as well as reduced competitiveness of imports due to the US dollar’s weakness and high transport costs, adds up to quite a solid position for US companies (Gail Glazerman in PwC, 2008, 30).

2.3 Competitive Actions in the Forestry Industry

In order to decide which categorization of competitive actions best suits this study, the characteristics of the forestry industry and the characteristics of this empirical study must be taken into account. First of all, as mentioned earlier, it must be acknowledged that it is hard to identify empirically, and especially only through the companies’ annual reports, some of the competitive action types Nokelainen (2008) proposes in his typology. Thus, for practical reasons some categories should be excluded, for example: “forbearing to bring about” (in the majority of cases it would be hard to find evidence that for example the company did not launch some new product or buy a new facility etc.). It would be the same case also with the competitive actions of the type forbearing to suppress (how does one know that the company or the representatives even know about the issue?), preserve (if nothing changes as the company maintains the status quo, it could be hard to detect this action.) and forbearing to destroy (the same as for forbearing to suppress).

Moreover, the domains of actions (financial resources, physical resources, legal resources, human resources, organizational resources, informational resources, relational resources and product attributes) are not all well represented in the forestry industry. Being an

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machinery and also informational resources, such as technology (processes and knowledge) , I assume all the other categories would remain largely ignored. Nor does Nokelainen’s (2008) typology take into account the significant amount of vertical integration in the forestry industry. It would be useful to know if an action has been taking place in the sector of sawn timber, pulp production or perhaps in paper production as it might have completely different implications for the study.

There is, in fact, a typology that answers to these concerns. Lamberg, Laurila and Nokelainen have created a typology or a codification for the competitive actions especially in the forestry industry (2006). The codification consists of four parts, namely:

1) The general nature of the action,

2) The functional business area the action is concerned with, 3) International expansion, and

4) Cooperation.

The general nature of the action (1) has been divided into four categories, namely buy/acquire, build/expand/refurbish, sell/divest, and close.

Buying or acquiring takes place when the company acquires (or increases its ownership in) for example land or a production unit from another company. In this case the total production capacity of the whole industry does not increase, only the owner changes.

Building, expanding or refurbishing, instead increases the total production capacity of the industry, for example when the company builds a new production unit. A change in the nature of a production unit belongs in this category, too. Selling or divesting, like acquiring, does not change the aggregate production capacity of the industry. In this case the company sells or decreases its ownership in some entity. Closing happens when the company closes, for example, some of its production units. In this case, the aggregate production capacity of the industry naturally decreases.

The functional business area action is concerned with (2), has been divided into 11 different categories: 1. wood and recycled fiber resources, 2. sawn timber and wood products, 3. pulp, 4. paper production, 5. cardboard and containerboard production, 6. sheet products

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7. packaging and converting products, 8. selling and distribution, 9. other related activity, a. several, and b. unrelated (for more detailed descriptions, see Appendix 1).

Field three (3), namely “international expansion” can be assigned one of the two values:

1. “International expansion”, where the action takes place, or is targeted at outside the home country of the company, or 2. “no international expansion” where nothing permits the assumption that the action takes place in or is targeted outside the home country of the company.

The last field, (4) “cooperation” likewise yields two alternatives: 1. “cooperation”, when the action has been conducted in collaboration with some other company or other entity, or 2. “no cooperation”, where nothing indicates that the action would be a joint-venture, an alliance or some other form of cooperation with another entity.

Defining these four fields, one will get a four digit/character code for every single action identified. For example a code 3722 would mean that the company in question has sold or divested (the general nature of the action 3) some unit, facility or similar of packaging and converting products (the functional business area the action is concerned with 7) in its homeland (international expansion 2) by itself without collaboration with other companies (cooperation 2).

These dimensions correspond well to the purposes of the study as they take into account, for example, the fact that the information to be analyzed is to be obtained from public sources (usually the most significant acquisitions, divestments, expansions and closings should be well reported in the annual reports of the companies). In addition, the different business areas in the forestry industry have been taken into consideration.

The categorization of Lamberg et al. (2006) will thus be used in this study with a slight modification. Instead of defining in which of the 11 functional business areas the action has taken place, in this study it will be defined, if the action has taken place in the core functional business area of the company (which will be defined later on in the “company

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profiles”- section of the study) or in some other functional business area. In this way, the dimension of diversification of the companies’ operations can be taken into account.

2.4 Profitability and Competitive Actions

In this study the dimensions introduced in the typology of Lamberg et al. (2006) will be used to reflect the following characteristics of the companies’ actions: 1) expansions of capacity versus decline of capacity, and organic growth versus growth by mergers and acquisitions (“the general nature of the action”), 2) diversification versus concentration on the core sector (“the functional business area the action is concerned with”), 3) internationalization versus concentration on domestic markets and 4) cooperation versus no cooperation. In this study the companies’ ROCE (Return On Capital Employed) will be used as a proxy for profitability.

Expansions of Capacity and Organic Growth

In this study, expansions of capacity are defined as actions which include acquiring, building or refurbishing plants, equipment or similar (general nature of action 1 or 2) as opposed to competitive actions which reduce capacity like selling or closing units, plants or similar (general nature of action 3 or 4). Organic growth, has instead been defined as actions which expand the production capacity by building or refurbishing (general nature of action 2) as opposed to growth by mergers and acquisitions (general nature of action 1).

Expansions of Capacity Versus Reductions of Capacity As Joyce (2006) states, growth remains one of the most intriguing organizational objectives. In recent decades there has been huge pressure for growth in many companies (Kazanjian, Hess & Drazin, 2006) and business growth has been the most heavily used performance measure in business (Weinzimmer, 2001). But does growth reflect the company’s performance? Research in organizational science has examined growth both as a means to profitability and as an alternative to profitability. In this study growth is examined from the first perspective,

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of the many objectives that can be pursued by organizations, and its relevance lies mainly in enabling profitability. However, growth is not the only way of achieving profitability, there are alternative ways of obtaining it without growth (ibid.).

Hitt, Ireland and Tuggle (2006) state that growth can benefit an organization in many ways like by creating value through strategic learning, increased firm knowledge, innovation and further utilization of its resources and capabilities. According to them (ibid.) firms grow profitably when they are able to “exploit”, i.e. to further leverage their current value- creating skills or to “explore”, i.e. to add value to the organization’s current products by developing new skills and contribute to the ability to offer completely new products in the future that create value to the customers (see also March, 1991). According to Weinzimmer (2001) growth that improves the bottom-line profitability and shareholder value is the outcome of proper balance among markets, strategies, organizational capabilities and leadership.

Market share leaders and big companies are usually more profitable than smaller companies because they exploit economies of scale and market power, as well as possible first mover and reputational advantages. Kärri states that the managers of forest companies seem to believe, that their companies would be more competitive if they were a little bigger because of the scale advantages (1999, 11). In fact, advantages of scale and scope would lead towards the favoring of bigger companies because of the more efficient use of the huge investments in plants, machinery and technology that characterize the forestry industry.

The bigger size of the companies enables them to carry out, for example, larger and more expensive investment projects (see e.g. Ojala, Lamberg, Ahola & Melander, 2006). When a company expands its production it can better exploit also the learning curve effects.

Exploiting economies of scale, economies of scope and learning curve effects contribute essentially to lowering the production costs per unit as the fixed costs are being distributed to larger amounts of output. Other things being equal this should lead to increases in profitability. Also one of the most important cost items, namely raw materials, can, at least in theory, be diminished utilizing the increased bargaining power against the suppliers because of the greater size. Following these statements, it seems that growth should

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enhance the profitability of a company. In fact, also Geroski, Machin and Walters (1997) report the existence of a positive, statistically significant and robust correlation between growth rates and changes in the stock market valuation of the company, which reflect naturally expectations about long run profitability.

Growth doesn’t necessarily have only positive effects, however. According to Hitt et al.

(2006) growth may sometimes mask organizational inefficiencies. Bigger organization can, for example lead to more complex and heavy administrative structure, and the company might lose some agility in responding to customers’ needs. The company might also encounter some difficulties in making the personnel committed.

Too heavy emphasis on company growth can also have surprising negative effects.

Through much of the 1990’s, corporations realized extraordinary growth in revenues and earnings. As this trend unfolded, executives began to experience significant pressure from other stakeholders for continued growth. But after the technology bubble burst, and as the financial scandals of the beginning of the decade surfaced, it became clear that a portion of the earlier reported growth was a product of widespread earnings management and financial engineering, serial acquisitions, and the utilization of accounting and tax manipulations to create specific financial results. (Kazanjian et al., 2006).

Firms may have developed innovative strategies or products that lead to high growth, but as the firm matures and approaches market saturation, growth naturally slows down and firms

“hit the wall”, experiencing flat revenues after a period of high growth. (Kazanjian et al., 2006) According to Anderson (2006) when a company “hits the wall” with growth there are three possibilities to resume growth, namely to revitalize and renew its core business, acquire other companies, or grow organically by extending today’s business.

Organic Growth Delmar, Davidsson and Gartner (2003) point out that there might be significant differences in growing organically and growing via mergers and acquisitions. I think that is true not least because of the completely different mechanisms in which the growth occurs. Although there is a lot of literature on growth via acquisitions, there is little

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literature on organic growth (Kazanjian et al., 2006 and Drazin & Kazanjian & Hess, 2006).

Mergers and acquisitions are, in fact, also in real life much more common than organic growth (McGrath, 2006). McGrath (ibid.) examined growth patterns of over 900 large companies and found out that only approximately 6% of all companies which were growing even at a modest rate could be described as growing organically. This means that relatively few companies appear to rely on internal development as their primary vehicle for growth.

Much of the existing perspective on organic growth has emphasized geographic market expansion (that will be discussed in more detail later on) and innovation in products and services. Very few references are found that relate efficiency to organic growth. (see e.g.

Kazanjian et al., 2006). Hess (2006), however, states that companies that generate organic growth earnings are more likely to be sustainable high-performance organizations.

According to Navis, Glynn and Hargadon (2006) institutional environments place pressures on organizations that can enable or constrain opportunities for organic growth. Hence, understanding the institutional environments in which organizations operate is important to understand how organic growth can occur. It must be understood, for example, that growing organically takes more time than growing by acquisitions (see e.g. Hitt et al., 2006) because of the fundamental differences in the growth mechanisms. When growing organically the company must start building from scratch the same thing it could buy ready if it were growing via acquisition and thus the impact on the actual sales figures come with a delay. However, when growing organically cultural clashes between the different organizations can be minimized, if not eliminated, and the new part of the organization is easier to build in line with the parent organization, than what it would be to change the existing architecture of the acquired organization. Despite these good qualities of organic growth, the rise in sales volumes when acquiring still exceeds substantially, at least initially, the growth in sales volumes when growing organically, and it seems that that is what matters for the executive managers in a lot of the cases.

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Acquisitions As discussed, many firms engage in acquisitions because of the huge pressure for growth (Kazanjian et al., 2006). Acquisitions provide a rapid means of achieving significant growth (Hitt et al., 2006). According to Anderson (2006), however, there is considerable evidence that the majority of acquisitions probably destroy economic value. Also King, Dalton, Daily, and Covin (2004) have found that in general, and on average, the research evidence suggests that acquisitions produce small negative returns (see also Hitt, Harrison and Ireland, 2001). In addition, in a study of Hitt, Hoskisson, Ireland and Harrison (1991) only 4.3% of acquisitions were highly successful. Other acquisitions resulted in positive but normal returns while many others led to unsuccessful outcomes in terms of the performance measures used in the study.

Hitt et al. (2006) propose, that acquisitions do not create value, amongst others when too high a premium is paid, the firm has difficulty achieving integration or when the company is overdependent on debt for finishing acquisition. It is most of the times difficult to know exactly the actual value of the target organization for the acquiring company and thus determine the maximum premium to be paid as it depends amongst others on the value- creating nature of the organization and the transferability of its assets, both tangible and intangible. These difficulties might lead to accepting a premium, and thus price which is too high. These kinds of acquisitions instead of increasing the value of the acquiring company, destroy it.

One of the major barriers to successful acquisitions is, in fact, the difficulty in integrating the two firms. The integration difficulties reduce the probability that the newly created company will achieve the expected or desired synergy. It is natural, for example, for the two companies to have different organizational cultures. These differences contribute to resistance by employees of the acquired firm to adopting the style and value set of the acquiring firm. Additionally, different information systems and policies greatly complicate the ability of the two firms to integrate their operations. Without integration, however, it is more difficult for the merged firm to achieve the economies of scale desired and synergy needed for the firm to produce returns above the premium paid and to offset the other costs of the merger (e.g. debt costs, costs of layoffs) (Hitt et al., 2006). As an example of these

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problems, Hitt et al. (ibid.) use the case of Daimler-Benz acquiring the Chrysler corporation and creating DaimlerChrysler. Many analysts believed, that DaimlerChrysler had potential to create synergy, but the substantial differences in organizational culture and operating styles between the two firms led to significant conflicts, resulting in a loss of much of Chrysler’s human capital and failure of the merger.

What comes to being overdependent on debt for finishing the acquisition, Hoskisson and Hitt (1994) found that firms with high debt costs invested less in R&D. As a result, highly leveraged firms engage in less internal development. Also, debt limits future acquisitions as well as the strategic flexibility the firm needs to cope successfully with unexpected environmental opportunities and threats. As a result, leverage can be useful to finance growth, especially growth by acquisitions, but it may significantly limit the flexibility required to pursue future growth by any means (Hitt et al., 2001).

Growing through acquisitions may, however, produce a number of positive outcomes including providing an infusion of ideas, knowledge and competences for the firm seeking to grow, and of course, the benefits of synergy and economies of scale. Often, in fact, mergers between highly related firms create opportunities to reduce overall costs through economies of scale. However, these economies of scale are rarely enough to offset the acquisition’s costs (Hitt et al., 2001) and the same economies of scale could be attained eventually via organic growth, too. Synergy, instead, is possible when the firm acquired has resources and capabilities that are complementary to those held by the acquiring firm (Hitt et al., 2006). When capabilities of new sector must be acquired, acquisition of another organization might make sense because of the learning effects (see e.g. Vermeulen &

Barkema, 2001). There are two types of learning that can occur. The first type is learning new capabilities for enhancing operational effectiveness of the merged firm, for example when the researchers of the other company bring in new ideas to the acquiring company.

The second type is learning skills to enhance the effectiveness of acquisitions, for example, by enhancing the capabilities in negotiation, financing and integration. This way they will make more effective e acquisitions in the future. (ibid.)

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Organic Growth versus Growth by Acquisitions Organic growth is usually better in respect to growth via acquisitions when cultural clashes want to be avoided, because it preserves, or gradually evolves, the company instead of changing it all at once as in the case of mergers and acquisitions. On the other hand, growing organically is much slower than acquiring or merging with other companies. Sometimes growing organically is not even possible if a company wants to acquire a certain unique non-imitable resource another company possesses. In this case acquisition or merger is the only option. Even though growth by mergers and acquisitions is quicker to implement as opposed to organic growth, it must be noted, that the structuring is a long process and some cost savings may not come out immediately (Kärri, 1999).

Joyce (2006) has studied companies and their profitability, and in the study it emerges, that

“winner”-companies (companies with strong performance throughout the period under examination) have usually a high emphasis on balanced growth, meaning that the company engages in both, organic and inorganic growth. “Climbers” (companies with weak start, but which have good results at the end of the period) seem to first have negative growth when divesting all the unprofitable and non functional parts of the business. After the negative growth period climbers, however, begin to grow organically and only when they have built their competences slowly and carefully, they engage also in inorganic growth leading to balanced growth pattern. “Tumblers” (companies which start out well, but end up with poor performance) usually tend to start with a balanced growth including both, organic and inorganic growth, but then shift the focus to inorganic growth. “Losers”

(which have poor performance throughout the period) usually start by trying to achieve inorganic growth with no success and then continue with attempts at organic growth, which usually fail, too. According to Joyce (2006), in fact, growth should not be objective for all firms as in the case of climbers. According to him, inorganic growth seems to make less sense for loser and tumbler firms than for climber and winner firms that have developed skills for managing organic growth over time.

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Diversification Versus Concentration on Core Sector

In this study diversification is defined as actions expanding the production capacity in a sector other than the core sector of the company as opposed to actions which enhance the capacity in the core sector of the company.

According to Weinzimmer (2001) many companies focus too much on core competences.

He states that “core competencies tend to force us into a shell, to give us tunnel vision”

(2001, 7) Markides (1995), on the other hand, claims that refocusing by the over- diversified firms is associated with profitability improvements. In fact, Wernerfelt and Montgomery (1988) argue that firms diversify to exploit their excess assets, but as they diversify away from their core, their assets lose some of their efficiency and start to lose profitability. According to them, there is thus an ambiguous relation between profitability and diversifying: up until a certain point the relation is positive, but when there is too much diversification the company loses its focus, and thus profitability declines. As discussed earlier, the forestry companies are already fairly well diversified. In fact, most of the companies under examination in this study operate in at least two different sectors, for example, owning timberland and producing pulp or producing pulp and manufacturing paper. This would lead me to think that diversifying further would hinder the profitability.

In his article Ng (2007) makes a difference between “related diversification” and ”unrelated diversification”. He discusses how and why an organization diversifies into related and unrelated businesses. He claims that related diversification, for example from producing only paper to also producing pulp, is the dominant mode of organizational expansion and superior in performance compared to unrelated diversification, for example, if a paper producer started to operate in a beverage market as well. This is natural if economies of scope are taken into consideration: for example, the usage of the same raw materials and the use of the by-products of the production to produce something else create additional value to the company. Usually diversification in the forestry industry, at least in the case of the companies under scrutiny in this study, is in fact, “related diversification”.

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Internationalization

In this study internationalization has been defined as expansive competitive actions directed outside the USA as opposed to expansive competitive actions directed to the U.S. domestic markets.

A variety of degrees of internationalization for companies exist. Delios (2006) lists some of them: no international involvement at all, licensing and franchising, exporting, direct investment via a joint venture (minority-owned, co-owned, or majority-owned), or a wholly owned subsidiary. As Glaum and Oesterle (2007) state, the question of whether there is a systematic relationship between the internationalization of firms and their performance is central to the field of international business. There has been a lot of empirical studies on this matter, but the results have been heterogeneous, or even contradictory (ibid.).

Hitt, Hoskisson and Kim define international diversification as “expansion across the borders of global regions and countries into different geographic locations, or markets”

(1997, 767) and according to them the level of international diversification is reflected by the number of different markets in which it operates and their importance to the firm. In their study Hitt et al. (1997) provide evidence of the importance of international diversification for competitive advantage and thus to the profitability, although suggesting that there are complexities involved.

Operating in a mature industry, it is important for companies in the forestry industry, as it is for all companies that operate in saturated markets, to seek growth elsewhere. I would see internationalization in some ways necessary in order to do that: when the unexploited raw materials or the unsatisfied demand are somewhere else, like in Latin America and China in the case of the forestry industry, it could be beneficial to try to enter those markets. On the other hand, there are complications involved when starting to operate abroad: as discussed earlier the foreign exchange risk rises as most of the sales are done in U.S. dollars, but when operating abroad, the costs are incurred usually in some other currency. Also, other

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complications that arise, usually at least in the beginning, are the problems of finding a qualified workforce, problems with the foreign legislature and culture in general.

Cooperation

In this study cooperation has been defined as expansive competitive actions taken in collaboration (e.g. in strategic alliances, joint ventures, partnerships or consortia) with other companies or other entities as opposed to expansive actions taken independently by the company.

In recent years, cooperation has become increasingly important for business activities (see e.g. Casson and Mol, 2006). Quinn (1999) suggests that the reasoning behind the alliances is that firms can focus on a smaller set of activities while obtaining inputs from many specialized outside suppliers, and thus get the maximum result from their operations.

Based on this, Casson and Mol (2006) even suggest that strategic alliances have come to be seen as the main means to improve the output of the company.

It has not always been like that, however. Before the mid 1980’s joint ventures were seen more like “second best” solutions to overcome for example obstacles to market access or to comply with governmental regulations as opposed to the “first best” foreign direct investments or multinationality (Casson and Mol, 2006). It was also seen that no firm that dominated its market niche would ever cooperate with a potential rival; cooperation was only for companies that could not compete with the dominant firm by themselves (see e.g.

Porter, 1980). The general change in the mindset came in the 1990’s with the globalization and blurring of industry boundaries: Strategic alliances became an important mechanism for adjusting to these new challenges. The products now had to be sold at very competitive prices because of the globalization and because the blurring of industry boundaries necessitated acquiring knowledge about other industries’ processes and markets quickly.

Cooperation with other entities, in fact, can offer many possibilities to enhance business.

Ma (2004) suggests that cooperation offers at least the following possibilities: Setting

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foothold (gaining access to customers), pooling resources (gaining access to complementary resources and capabilities), sharing complementarity and learning from partners (learning and accumulating technical and organizational knowledge). Naturally collaboration also diminishes financial risk, if a project should fail.

Theoretical Framework

As seen, there are a lot of opinions about how the above mentioned causal factors potentially contribute to the outcome, namely profitability. In this study I make an effort to understand how these factors, or combinations of these factors influence the company’s profitability in the U.S. forestry industry, or if they have an influence at all. As will be discussed in the methodology- chapter of this study, the fuzzy-set method emphasizes the importance of configurations of the causal factors opposed to individual causal factors as in the traditional regression analysis. Thus, using the fuzzy-set method, I’m not necessarily after the effect one particular causal factor has on the outcome, but rather what combinations of causal factors create the outcome.

In this study my aim is, thus, to study how the before described dimensions of competitive actions, namely 1) expansions of capacity versus decrease of capacity, 2) organic growth versus growth by mergers and acquisitions, 3) diversification versus concentration on the core field, 4) internationalization versus concentration on domestic markets and 5) cooperation versus no cooperation, and configurations of those, affect profitability of a company. My aim is to find configurations of types of competitive actions that seem to lead to good profitability and those which, on the contrary, seem to lead to poor profitability. The theoretical framework for the study is illustrated in the Figure 3.

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Figure 3 Theoretical Framework

Competitive Actions and Profitability in the U.S. Forestry Industry