Strength in Numbers

customer packaging that has a basis weight of 100, then the change in the raw cost of paper is (($50/ton x 100 lbs./msf)/2000 lbs./ton) $2.50 per msf. If you are running your own corrugator, then these calculations are real and second nature to you. If you are a sheet plant purchasing sheets, the pass-through of the paper decrease may vary from these calculations, but you need to understand them in order to negotiate a reasonable deal with your supplier.

Your customer probably doesn’t fully understand these concepts and is trying to somehow extrapolate between the percent change in the price of containerboard to their packaging. The waters are muddied even further by how you approached prior increases or decreases with them and your need to recoup nonpaper costs in these inflationary times. Notwithstanding any of this, you need to have the following information before you begin to negotiate these kinds of terms with a customer:

1. What is the average basis weight of the packaging you are selling that customer?

2. What will your cost of sheets be before and after the published change in the price of paper?

3. What is the current sales price per msf of the packaging you are selling this customer?

If you know these three things, then you can compute what percentage price change to this customer would be “neutral” to your existing material margins. Let’s look at a hypothetical example. You have a customer whose average sales price per msf is $100, and you are selling them board that has an average basis weight of 120 lbs. If the price of paper goes down $50/ton, then to break even, the sales price of their packaging needs to go down by 3%. The calculation would be as follows:

($50/ton x 120 lbs./msf)/2000 lbs./ton = $3/msf

So, if your material cost is going down by $3/msf, and the current sales price is $100/msf, then you need to reduce your price by $3, which is 3% of the current sales price to maintain your existing material margin. As you can see, both the concepts and the math are fairly simple.

From November 2020 to March 2022, the published price of linerboard went from $765/ton to $935/ton—a 22% increase. From November 2022 to February 2023, the price has come down $70/ton to $865/ton—a 7.5% decrease. As I stated earlier, larger integrated companies have a longer history of using customer contracts, and a larger portion of their business in general is tied to customer contracts. The other thing we know about the integrated companies is that they ship more footage than independent converters do and generally sell it for a lower price per msf. Mill-based companies are more concerned with selling their mill output because it is enormously profitable and trying to set up extremely high yield plants that maximize throughput. Independent converters generally do more of the business that requires multiple machines, handwork, inventorying of goods, and tighter delivery times, and consequently, they charge more for their output. So, a pricing factor in an integrated customer’s contract probably needs to be higher than the same factor in an independent customer’s contract.

This is precisely where the problem arises. Customer A is doing business with a large integrated company for most of its packaging needs but also buys some packaging regionally from some independent converters. Their contracts with the integrated company call for 1.5% change in price for every $20/ton change in the price of paper. That may be an entirely appropriate percentage for the contract with the integrated producer, but when applied to the independent producer’s pricing, it will yield way too much gain when prices rise and way too much loss when prices drop. Let’s stay with our hypothetical customer and his $100/msf sales price and 120-pound basis weight. And let’s say that the same customer is doing a bunch of high-volume business with an integrated producer at $60/ msf. Both integrated and independent producers have the same $3/msf change in the cost of paper. For the independent to create a neutral contract, the change in sales price needs to be 3% as we have already calculated. For the integrated company to craft a fair contract, the change for that $50/ton needs to be 5% ($60/msf x 5% = $3/msf).

What I have seen in my travels is that many independent companies have been using pricing adjustments based on contracts their customers had with larger integrated producers. To the customers, it seemed fair to have the same price adjustment mechanism in all of their packaging contracts. For the independent producers, this was a real moneymaker when the prices were going up and contributed to the stellar performance we have all noted in the past two years. Now that prices are going down, it could have a severely negative effect on many companies.

I strongly urge anyone who is entertaining doing a contract with a customer to think these pricing mechanism clauses through and do the basic math on basis weight, material costs, and overall sales price per msf. Unless you have a crystal ball and know which way paper prices will be moving over the contract term, try to craft a price that is neutral on margins and thus fair to both parties.