Key factors influencing processing investment
At the simplest level, investment occurs if an adequate rate of return can be made at an acceptable degree of risk. In the New Zealand forestry sector, there clearly exists confidence that some investments meet the risk/return investment criteria, as evidenced by the fact that investment has occurred, as well as the expression of a variety of intentions to invest in further mill expansions, or future new mills. Wood processors certainly see a suite of niche opportunities for future processing investment, while also recognising that wood processing is an extremely competitive industry – both nationally and internationally. Thus, in a number of instances interviewees noted that particular investment proposals had failed to fly due to economics. At the same time, there are a number of factors that constrain returns on investment and, consequently, act to dissuade investment in wood processing.
Without doubt, the single largest perceived obstacle to wood processing investment is the Resource Management Act 1991 (RMA). Almost every interviewee noted that the RMA comprised the most important regulatory barrier to investment, and some unequivocally saw the RMA as the principal constraint on investment in some regions. Various other pieces of legislation including the Commerce Act 1986, the Overseas Investment Act 1973, and compliance with taxation regulations, were cited by interviewees as being variously constraints on specific investment proposals, constituting a burden on potential investors, or merely comprising a bureaucratic irritation. A separate section deals with the various regulatory constraints on investment.
A broad range of other factors are perceived as constraints to investment, or at least, constituting a burden on investors. Among these, the most significant, and the most frequently mentioned relate to transport infrastructure and labour issues, though a variety of other spheres including market-based and market access issues, resource-based issues, and potential changes to the national operating environment were viewed as problematic.
Competition and competitive advantage
Since 1984 the over-riding thrust of New Zealand’s economic policy has been toward free-market concepts. A foundation of free-market principles is the theory of competitive advantage, which explains why that some countries are better than others at certain activities. The theory argues that competitive advantage is founded on a sector’s capacity to innovate and upgrade and derives from four core elements:
- Factor endowments.
- Firm structure, strategy and rivalry
- Demand conditions; and
- Related and supporting industries.
This suggests that discussion of the key factors influencing investment in wood processing can, initially, be put into a useful context by examining New Zealand’s performance across these core dimensions.
1. Factor Endowments
Factor endowments encompass a degree of natural advantage, such as a large natural resource or skilled labour. In New Zealand, the most evident factor endowment advantages are an ability to grow softwood trees quickly, and the maturing (largely) radiata pine resource deriving from this ability. It is fair to argue that a significant component of any competitive advantage the New Zealand wood processing sector holds derives from the forest growing sector.
It is difficult to argue that New Zealand holds a significant international advantage in labour and skills. While labour costs confer an advantage over many other developed countries, New Zealand labour is significantly more expensive than in developing countries. Conversely, New Zealand wood processing labour tends to have higher productivity than in developing countries, but it is difficult to argue that a significant competitive advantage exists compared to skills and productivity in other countries. New Zealand probably occupies a niche that confers cost of labour advantages in a first world economy, possibly creating a window of opportunity for the development of more labour intensive – as opposed to capital intensive – industry. The key issue is whether this will confer any long-run advantage in productivity (which is questionable). Labour issues are discussed in greater details in a following section.
2. Firm structure, strategy and rivalry
A cornerstone of the theory of competitive advantage is the need for strong domestic competition, which forces firms to develop efficient structures and strategies for success. In general, New Zealand performs well in this dimension. The privatisation of the forest estate encompassed major changes in log supply processes, and forced the processing industry to become lean to survive. A recurrent theme in the interview process was that processors are squeezed between log suppliers and final markets. Margins are slender and wood processing is a tough industry to operate in. For example, one processor noted that a tripling in capacity is returning the same net profit as a decade ago. While the large corporates with vertically integrated processing operations are perhaps less exposed to these immediate market realities, there is little doubt that the domestic market provides a strong competitive discipline on all players.
3. Demand conditions
Demand conditions refers to the concept that markets should be characterised by strong and efficient competition. The strong and efficient competition component is certainly a reality in New Zealand markets for wood products, with minimal government intervention and generally intense competition in most industries. In fact, domestic markets for many processed wood products are saturated and the need for new mills to immediately develop export markets for significant proportions of production provides a significant barrier to particularly, but not exclusively, greenfields investment. This issue is further discussed in the market development and access section below.
4. Related and supporting industries
The fourth core dimension of competitive advantage is the existence of strong infrastructure and related industries. As will be elaborated below, infrastructure supporting New Zealand’s wood processing industry is regionally variable. In many regions it is excellent, but in several regions infrastructure constitutes a significant constraint. Similarly, there is variability in the strength of related industries, particularly by region. For example, New Zealand is a world leader in softwood drying technology, and in general our softwood processing capability is competitive with anywhere in the world. These advantages have not to date, however, translated across all regions. For various reasons processing capacity has not evolved in Northland, the East Coast and the West Coast, and these are areas where infrastructure and supporting industries are similarly weak.
The following sub-sections provide more detailed discussion of specific issues identified by wood processors as being significant impediments to investment in New Zealand. It is, however, useful to bear in mind how each individual issue meshes with the framework for competitive advantage. Section II attempts some simple benchmarking of various issues against New Zealand’s principal competitor countries.
Transport infrastructure
Transport infrastructure is, naturally enough, an issue of variable concern in relation to wood processing investment dependent on region and mill location. A variety of issues and deficiencies were raised by respondents in regard to transport infrastructure. A recurrent point was that transportation is a variable cost dependent on government (and sometimes private sector) investment for its improvement. At least one interviewee suggested that the greatest incentive Government can provide to forestry processing investment is infrastructural improvement. In all regions continuous improvement will mean a continuous reduction in costs incurred through transport, but in some regions the scope for gains are greater than in others. Retaining a level playing field for forestry transport is viewed as an important issue in all regions.
A central issue raised by interviewees is that Transfund New Zealand (Transfund) funding criteria for roading are generally not favourable to the forestry sector, particularly in terms of reducing the costs of delivering logs to mills. At present, Transfund evaluates all road construction projects on the basis of their benefit to cost ratio (BCR). The benefit parameters used in these assessments do not, however, specifically encompass facilitating economic or industrial development. Consequently, the (generally rural) roading requirements of the forestry sector are likely to be subordinate to specified parameters such as savings in travel time, increased comfort, and environmental considerations such as reducing carbon dioxide emissions. Transfund is presently reviewing its project evaluation benefit parameters. At the same time, Government is reviewing policies that might, in future, enable debt-funded roading and therefore increase the rate of investment in roading.
Transport infrastructure is perceived to be weakest in Northland and on the East Coast, though isolated areas in other regions were also mentioned as being of concern. For the East Coast, these issues will be dealt with specifically and at length in the forthcoming transportation study commissioned by the Tairawhiti Taskforce and consequently it is not proposed to discuss them in detail here. As well as the absence of adequate road access for transporting logs, existing bridge payloads in some areas are a constraint on transportation and this was mentioned as a specific issue for Northland. A national requirement for investment in around 600 new logging trucks to cope with increased woodflows was also raised as an issue that industry needs to be conscious of.
A number of issues were also raised in relation to ports and sea-freight. It was noted that shipping links to second-tier emerging markets are generally poor. Shipping small volumes of processed product tends to be uneconomic and so a "chicken and egg" situation evolves in respect to market development. This is particularly an issue for independent processors selling into niche markets. One interviewee suggested, for example, that on the East Coast, only shallow-draft vessels destined for Asia presently call at the Port of Gisborne. This implies that, given the relative inaccessibility of the region and the costs of road transport to other ports, the area is currently unattractive to any processor without an established market in Asia. (This point is anecdotal and has not been verified). For other ports other specific issues may arise. For example, traffic congestion in Auckland creates a significant obstacle to shipping through the Port of Auckland and was cited by several processors as a reason for diverting freight to Tauranga. Other Ports may suffer from congestion, limitations on access or storage facilities, and restrictions on delivery times (heavy night traffic through built-up areas).
The NZ Timber Industry Federation has attempted to lower shipping costs by chartering a freighter on behalf of a consortium of its members. It is estimated that this service, calling at three New Zealand ports and three on the US West Coast has resulted in freight cost savings of around 15 percent.
Electricity infrastructure
Significant changes have been made in the structure and distribution of electricity in New Zealand during the past decade. The principal concern in the interview process was that electricity prices remain stable and within international norms. As Figure 5 shows, prices of energy supplies to industry during the past decade have been stable – as well as being internationally competitive.
Figure 5: Electricity prices by sector (1979-1999)
Source: Ministry of Economic Development
A second concern, in some regions, is the accessibility of adequate electricity loadings to sustain international scale mills. By way of example, during December 2000 Canterbury electricity lines company Orion requested that farmers planning dairy conversions on the northern side of the Rakaia River advise the company of their plans. Large dairy farms pumping irrigation water from deep wells are likely to require around one megawatt of power – the amount of power used by a town of about 1000 people. Orion reported that the situation would require careful monitoring or capacity would run out very quickly. Installing distribution capacity requires a long lead time and Orion estimated investment of NZ$3-4 million would be required in its rural Canterbury network if current rates of development continue. A similar vulnerability applies in the installation of large wood processing facilities.
Labour issues
In 1999, employment in forestry and first stage processing in the New Zealand forestry sector totalled 21 350 full time equivalent workers (FTEs). Of this, 8 351 FTEs were employed in forestry and logging activities, while 12 928 FTEs were employed in first stage processing activities.
Figure 6: Employment in forestry and first-stage processing by wood supply region in 1999
Source: MAF
A notable trend in employment during the past five years is that, despite significant increases in roundwood removals and processing production, employment has actually declined. For example, employment in forestry and first stage processing in 1995 was 23 967 FTEs, but declined to 21 350 FTEs in 1999, a decrease of 10.9 percent. Employment in forestry and logging activities actually increased during this period, and consequently employment in first stage processing activities declined from 14 603 FTEs, to 12 928 FTEs, a decrease of 11.5 percent. The bulk of this decline occurred in the sawmilling and pulp and paper industries, though modest decreases were also recorded in timber re-sawing and dressing and fabricated wood manufacturing industries. This is clearly indicative of a trend towards increased mechanisation in the wood processing industry and employment forecasts deriving from future wood supply projections should clearly take this trend into account.
Figure 6: shows a breakdown of employment by wood supply region. Two particular features are outstanding in this graph. Firstly, the dominance of the Central North Island in national wood production is clearly reflected in employment data. The Central North Island accounts for almost 40 percent of forestry employment in New Zealand. More revealing, however, is that in only three regions, Northland, East Coast and West Coast, is employment in first-stage processing exceeded by employment in forestry and logging. While in part, this disparity reflects the relative maturity of regional forestry resources, it also provides a clear indication of relative underdevelopment in three regions already identified as being at an economic disadvantage.
Labour availability in the forestry industry is an issue that has received significant attention in the sectoral media in recent times. In some regions significant shortages of labour to carry out, particularly, silviculture and harvesting activities have been reported. In general, however, the problem appears to be a lesser issue currently for wood processing, but could be significant if there is investment in these industries. There do, however, appear to be significant regional disparities in labour availability, often dependent on the perceived quality of lifestyle in a region, as well as the availability of alternative employment opportunities.
The availability of skilled labour is a separate, though strongly related issue. A significant number of interviewees noted that while there tends to be little opportunity to employ experienced labour, their preference, in any case, is to train new staff from scratch to avoid inheriting "bad habits". Conversely, several interviewees noted that experienced machinists had been lost to the industry through the availability of better remuneration and working conditions in other industries, as well as disillusionment with the wood processing industry (in particular, being made redundant through mill closure). Both cases imply gaps in the transferability of skills, which create inefficiency and could be addressed by better training or better human resource management.
The quality of labour attracted into the industry was perceived to be a significant issue by several interviewees. Several noted that the forestry industry has a poor image as a prospective employer and is consequently forced to recruit from the lower echelons of the labour pool. It was noted that, in many instances, forest industries tend not to be run to the same standards as other industries. Working environments, safety records and wage rates were cited as being often poor relative to similar industries. At the same time, an anecdotal discussion with a small group of prospective employees revealed perceptions of forestry processing as being heavy labour, in generally dirty, noisy and dangerous conditions. Hearsay about remuneration and quality of management were, however, important considerations in assessing prospective employment.
Employee perceptions of specific mills are clearly important in labour accessibility. Several interviewees noted that obtaining labour was not an issue, and one noted that their mill has a substantial waiting list of applicants. The same respondent noted, however, that obtaining silvicultural and harvesting workers is a significant challenge. Competition for labour from other industries is also a significant factor in labour availability. Wage rates tend to be higher in areas where there is strong competition for labour.
In general, the view is that the forestry industry needs to improve its image to ensure it attracts higher calibre people in the future and that the best people are retained. A number of interviewees noted that they have significant problems with absenteeism and turnover, and this affects productivity. At least one mill is paying attendance bonuses to try and remedy problems with absenteeism. Problems also arise at the mill management level, because many mills are located in rural areas, which may be less attractive to many high calibre managers.
Three other significant labour issues were raised:
- training environments;
- health and safety regulations; and
- industrial relations.
Most interviewees were making use of forestry training providers and were complimentary of the roles played by FITEC (Forest Industries Training). Several noted that there was a need for training institutions to provide a more flexible service – for example, offering programmes outside working hours or at weekends. Several interviewees also noted that training environments should ensure that they reflect "real world" working conditions in terms of the hours worked, the expectations of course workloads and the professionalism of trainers.
There was almost unanimous support for the quality of health and safety regulations, with most interviewees recognising the industry’s relatively poor record in this regard (as evidenced by ACC levy rates). Several interviewees were, however, critical of the implementation of the legislation. There was a belief that the Department of Labour is under-resourced to properly implement the Act, and this detrimentally affects its capacity in respect to skills, experience, and organization. Case law and due process are also still to be bedded in.
Industrial relations issues, which have impacted directly on wood processing investment, are discussed below in the context of the Employment Relations Act 2000.
Market development and access issues
The discussion on competitive advantage (above) notes that, in general, domestic markets for many processed wood products are saturated and, consequently, one of the greatest challenges for the forestry sector is to develop markets for the additional volumes of wood and processed wood products coming on-stream.
At present, there are essentially three fibre-deficit markets – the US Pacific North West, Southeast Asia, and North Asia. These are the regions where New Zealand needs additional market penetration to ensure the potential value of wood coming on-stream is realised. Primary target markets will probably include China, China-Taipei, Malaysia, Indonesia, India, Philippines and Thailand. For commodity products such as sawn timber price will be a major competitive factor, which means New Zealand will need to use technology to overcome the relative labour cost disadvantage (competing in Asia) as well as ensuring transportation costs are minimised. Presently, New Zealand has a comparative advantage in treatment and drying of radiata pine sawn timber. However, these advantages are unlikely to remain in the long run.
There are, however, several other major challenges for the forestry industry. Presently, a high proportion of New Zealand’s structural sawn timber production is exported to Australia. Australian production of sawn timber is expected to increase as Australia assumes a net exporter position for forestry products. Australian forecasts suggest this position will be reached between 2005 and 2010. In the meantime the Australian market for New Zealand sawn timber is likely to dwindle. There will, consequently, need to be new markets found for significant volumes of structural sawn timber, and these will probably need to be found in Asia.
In many instances, the development of Asian markets will require significant promotion of radiata pine for targeted uses. There remains, however, a range of significant barriers to access potential markets for radiata pine products. Interviewees noted that tariff escalation and prescriptive building code regulations currently constitute the greatest impediments to market access. A range of other market access issues including export phytosanitary access and certification requirements, biosecurity functions (particularly forest health and import quarantine regulations), and technical standards also warrant on-going attention. Pressure towards a free-trade environment needs to be maintained in all target markets, while efforts to ensure radiata pine is not discriminated against in building codes – or better still, mutual recognition of building codes – is also a priority.
Access to finance
During the early-1990s it was suggested that access to finance was a significant constraint on the wood processing sector. In particular, there was a suggestion that the forestry industry and its peculiarities were poorly understood in the finance industry. At that time the issue was addressed by holding several bankers seminars conducted by the Ministry of Forestry.
Most interviewees suggested that financing is generally accessible provided an adequate business case can be presented. There is, however, a strong awareness that banks hold balanced lending portfolios (across sectors) and to this extent finance is rationed. Financial markets have become more sophisticated, and wood processors need to become more sophisticated in their approaches to the banking sector. One respondent suggested that the banking industry is becoming more centralised and financial markets are now effectively Australasian. In future this centralisation could raise the cost of capital, particularly for independent processors located away from major urban centres. It was speculated that large-scale venture financing may need to be sourced through Australian-based institutions.
Another respondent suggested that investment in forestry processing could be an attractive investment option for Maori investment. Wood processing investment could be complementary to Maori forest ownership, it offers a long-term and stable investment environment in a land-based industry and is suitable for passive investment, as well as being an industry employing a high proportion of Maori. The respondent noted, however, that despite significant efforts on his behalf to engage interest from local Maori groups, the difficulties in obtaining a mandate for investment had proven too difficult.
Certification
Almost all interviewees noted environmental certification is an important issue for forestry processors in helping to capture a marketing edge in environmentally sensitive markets. Several interviewees discussed the 1999 announcement by US company Home Depot that it will stop selling wood products from environmentally sensitive areas. By the end of 2002, Home Depot plans to eliminate from its stores wood from endangered areas and give preference to 'certified' wood. To carry the "certified" label, a supplier's wood must be tracked from the forest, through manufacturing and distribution, to the customer and must ensure a balance of social, economic and environmental factors. Home Depot is the world’s largest retailer of lumber, with sales approaching 10 percent of the world’s sawn lumber supplies.
There was widespread support for the concept of an FSC-endorsed programme dedicated to New Zealand planted forestry. There was also a suggestion that New Zealand should aim at nationwide certification covering all planted forests, noting that this would confer an enormous marketing advantage to New Zealand.
Other issues
As part of the interview process a range of issues were raised as being relevant to investment decision-making processes, without necessarily being a sufficiently large constraint to dissuade investment. These issues are briefly discussed below.
Biosecurity
Biosecurity is a major issue for the forest-growing sector and consequently, has flow-on effects in assessing risks to investment in wood processing. Several interviewees mentioned biosecurity as in issue in investment decision-making, but it does not appear to be a significant constraint on wood-processing investment. The general perception was that government was paying greater attention to biosecurity issues and that progress toward better biosecurity is being made.
Carbon taxes
Carbon taxes are not a reality at present and consequently do not impact on investment. The potential for the imposition of carbon tax or energy tax is, however, a significant concern for the New Zealand wood processing sector – and was noted by a number of interviewees. The message that emerged was that such a tax would not be a major concern – provided it did not disadvantage NZ processors. The clear consensus among interviewees was that New Zealand should continue to participate in the climate change debate, but certainly should not be leading any process that would impose additional costs on industry and reduce their international competitiveness. In this instance, carbon taxes could clearly impede future investment.
Immigration
An issue associated with labour availability relates to accessing management and labour expertise from abroad. Two respondents noted that they had experienced difficulties with immigration regulations, particularly with bringing a timber grading specialist into the country. A suggestion was made that immigration work skills criteria (and NZQA assessments) do not adequately recognise the value of some wood processing skills. Several other companies had brought in overseas expertise (mainly management or technical experts) without immigration difficulties.
Technical specifications of plant and machinery
Two respondents noted that some technical specifications on plant and machinery differ from overseas specifications and suggested there would be value in harmonisation of standards. Specifications of pressure vessels (boilers, etc) are different to, for example, US standards.
Industry leadership
A number of interviewees commented on the issue of industry leadership. Most believed that in general terms, centralised leadership in the forestry industry is weak. A view was expressed that the natural leaders of the industry are the chief executives of the large corporates, and a primary reason that strong leadership hasn’t emerged is the short tenure of recent appointees in these positions, and a consequent focus on short run goals. More generally, however, interviewees suggested that various companies have different objectives and strategies and, consequently, industry leadership was relevant in only a limited number of spheres (for example, establishing a national certification scheme). Several questioned whether the concept of industry leadership was given excessive prominence in New Zealand, and suggested that the concept was largely a hangover from the centralised leadership provided by the New Zealand Forest Service. A general conclusion was that New Zealand should look at how aspects of leadership are manifested in other successful forestry countries.
That having been said, several respondents noted that the forestry industry associations possibly don’t have the traction they should. One suggestion was that the association structure was fragmented, and because different associations tend to represent constituencies it is difficult for the forestry industry as a whole to speak with a common voice.
Equitable treatment of overseas firms
An issue raise by a couple of interviewees was differential treatment of domestic and overseas firms. This criticism was made mainly in terms of informal components of the business environment, rather than in terms of set processes. For example, it was noted that on occasion supposedly neutral arbiters had been quoted in less than neutral terms in the media. An example cited was where a neutral official was quoted as remarking that a foreign company had a less than perfect understanding of the New Zealand business culture. This comment was taken very seriously offshore as evidence that procedures were not being applied in an even-handed manner. The key point is that New Zealand needs to be scrupulous in all aspects of process to ensure the country’s image as an investment destination is maintained.
Research and Development
Traditionally, the bulk of research, science and technology investment in the forestry sector has been on the raw material. Researchers continue to obtain support more easily for production rather than processing and marketing research, from private sector funding. However, processors are having increasing difficulty in being able to economically manufacture a range of high value products from radiata pine. There is therefore a need for R&D to target more sophisticated processing technologies and developments, particularly:
- Smart segregation technologies to overcome the variability of radiata pine.
- Profitable end-uses for the whole log, including the lower value top logs.
- New products for new markets.
Unfortunately the private sector research investment in R&D on new product developments has been minimal. One of the policy initiatives which has the ability to stimulate research in these more targeted areas is the formation of centres of excellence, particularly into non-traditional uses of radiata pine, which could link the capabilities of a number of institutions, including CRIs and universities.
Contact for Enquiries
Rural Affairs Coordinator
Sector Performance Policy
MAF Policy
Ministry of Agriculture and Forestry
PO Box 2526
Wellington
NEW ZEALAND
Phone: +64 4 894 0675
Fax: +64 4 4 894 0745
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