SCOTT ISN'T LUMBERING ANYMORE Once a textbook example of how to lose market share, the paper company is writing a new chapter based on sharply reduced costs and a transformed corporate culture.
By Bill Saporito RESEARCH ASSOCIATE Ann Goodman

(FORTUNE Magazine) – SCOTT PAPER CO. is on a tear. The corporation that sopped up punishment in the Seventies is now rolling up profits despite a continuing slugfest on supermarket shelves and a pulp market that has left most participants just that. In an industry not known for nimbleness, Scott Chief Executive Philip E. Lippincott, 49, is working a dramatic turnaround. Initiated in 1981, Lippincott's plan was straightforward: cut costs, kill the bleeders, and put the money where profits could be made. Scott spent about $1.6 billion, much of it to achieve greater manufacturing efficiency. So far, the plan has succeeded beautifully. Profits improved 51% in 1984 to $187 million, sales 5% to $2.8 billion, and the record-setting pace continues this year. Scott's operating margin -- operating profit as a percent of sales -- improved to 8.4% last year from 5.3% the year before, a difference worth $90 million. Scott's performance has been duly logged on Wall Street. Although the paper industry is suffering a bad year, Scott's stock hasn't fallen much below its 52-week high of $44.50. The market even took in stride the news in early September that Scott had bought out its biggest stockholder, Brascan Ltd., a Canadian investment company that owned 25% of the stock. With a standstill agreement with Brascan set to expire at the end of the year, Scott's management decided it was worth paying $45 a share -- a total of $240 million in cash and $300 million in a floating-rate debenture -- to get the Canadians out of the picture. To turn Scott around, its chief executive had to transform a corporate culture that mired the company in mediocrity. Inside the Big Blue Box, as Scott's azure-hued headquarters south of Philadelphia is known, an aging bureaucracy had perpetuated a hold-the-fort mentality. But Scott didn't even achieve that -- earnings per share advanced an average 6.7% a year from 1974 through last year, or minus 8.6% adjusted for inflation. Observes Lippincott, ''We used to look at our competition and say, 'Here's how we stand up against the best. Oh well. But here's also how we stand up against the worst, and there are people in the business who are worse than we are, and they're gonna have to disappear.' One of the things we neglected to consider was that capacity doesn't disappear easily in this industry.'' A Scott company man all his career, Lippincott was named C.E.O. three years ago, following the resignation of Morgan V. Hunter after only one year in office. Hunter, former president of R.J. Reynolds' tobacco operation, was picked over Lippincott by then chairman Charles D. Dickey Jr., who wanted an outsider to shake Scott up. What Hunter apparently shook up the most was Dickey, and after several reported clashes with the chairman, he departed. Dickey retired in early 1983, and Lippincott became chairman. Lippincott speaks passionately about people and the possibilities latent within them. ''The greatest opportunity most companies have is to get everyone working at levels approximating their potential,'' he says. In the old Scott culture, he argues, many employees scuttled along somewhere below that, waiting for orders from above. J. Richard Leaman Jr., president of the packaged products division -- essentially Scott's tissue-products operation -- agrees: ''We used to make all the decisions from Philadelphia: here's the strategy, you guys look at the sucker and figure it out.'' The company now wants the strategy to come from the lower echelons, who thereby have a stake in it and will push it up the ladder. To this end, Scott has shepherded staffers by the hundreds to suburban retreats to teach them how to think strategically. Using the mantra ''Thinking drives behavior drives results,'' the company focused on what its executives term achievement-oriented thinking. Scott has altered its incentive system to match. Pay for the top 600 people is now based partly on their contribution to profits. Recalls Leaman: ''We used to reward people based on what they owned -- budget, people, assets.'' A little terror hasn't hurt either: insiders say managers who don't produce either get religion or get shown the door, something that never happened before. Lippincott pared 11 layers of management in packaged products down to seven, partly by eliminating ''coordinators'' who served to link different functions -- marketing and manufacturing, for instance. So far, the company head count has decreased nearly 20% in four years, despite two acquisitions. The transformation is far from over. ''Every day we run into our old culture; it hits you in the face,'' reports Leaman. Says Lippincott of the tendency to resist change: ''People tend to go on automatic pilot.'' Scott seemed to be on automatic pilot through much of the 1960s and 1970s as Procter & Gamble executed typically aggressive marketing campaigns for Charmin toilet tissue and then Bounty paper towels. P&G's entry into the paper goods market precipitated a 20-year nosebleed for Scott, its market share falling from over 50% to the mid-20s by 1980. Then as now, paper towels and facial and toilet tissue accounted for about half of Scott's sales and earnings. In the late 1970s, low-cost producers such as Georgia-Pacific and James River Corp. put added pressure on Scott's tissue business. As inflation soared, a price war at the low end of the market so widened the gap between quality brands and bargain brands that the middle fell out. Scott's products were perceived as too expensive to be bargains but not good enough to appeal to the carriage trade. In response to P&G's incursions, the company took its franchise, ScotTissue and ScotTowels, and headed north, seeking a piece of the high ground. Most of Scott's buyers headed south to the low-priced offerings, and so did Scott's market share. ''Everyone said Procter was eating our lunch, but it was really the cheap brands,'' says Leaman. Under Lippincott the company finally figured out what it wanted to be in the consumer tissue business. Scott now claims that it has the leading ''value'' brand: not as good as the top quality but better than bargain brands, with more product per package than either. The company recently increased the sheet counts in ScotTowels to 124 from 119 -- the industry average is 90. Scott tries to keep the price 10 cents below the high-priced brands. The goal now is what Scott management calls brand dominance as opposed to market dominance -- the company claims it's more profitable to own a big piece of one segment of the market than to own small pieces of several market segments. The company still competes in the high-quality arena with Cottonelle toilet tissue and its Viva brand paper towel, which was recently improved to make its quality competitive with P&G's Bounty. If Procter tries to move Bounty toward the middle, it risks losing share to Viva at the top. For now at least, Bounty is staying put, but P&G is making noises about expanding into Scott's middle segment of the market with other brands. Scott says its strategy has worked on all counts. Although its overall market share has stabilized at about 25%, ScotTissue's share is up dramatically, and other brands the company has pushed continue to make gains. It remains a tough business. Surplus capacity has kept the list price of consumer tissue products at a standstill for virtually four years, and the consumer market stumbles along at about 1.5% annual growth in unit volume. While there is little innovation in this paper chase, Scott recently did manage to introduce a narrow-width version of ScotTowels; junior, all of 8 1/4 inches wide, is doing just fine, says the company. And because it has lowered manufacturing costs dramatically, Scott will not be nearly as vulnerable if another yawning price gap opens up and causes consumers to trade down to generic and private labels. If the low pricers want to drop the floor, Scott can go down and dirty without too much pain, the result of both a big investment push and a reshuffling of the company's assets. Scott has already started reaping the benefits of its most extensive cost- busting undertaking to date, a $330-million reconfiguration of the Mobile, Alabama, mill, which makes both tissue products and printing papers. (For more on investments in Mobile, see the following story.) The reconfiguration includes new equipment to make the company self-sufficient in energy, and a wood-handling system that should give Scott the lowest raw material costs in the industry. Although the plant is at the mouth of the Mobile River, Scott had been using railcars and trucks to haul three-foot lengths of timber downstate to the mill. Under the new system, tree-length timber is loaded onto barges a truckload at a time by 30-ton cranes. The barges are towed downriver and unloaded by similar cranes. The system saves the company about $25 million a year in freight and inventory costs. Scott also stands to make better use of its forest lands. In lumbering, 20 tons of scrub timber per acre must be cleared so that mature trees can be harvested. In the past this scrub was burned at the harvest site because it was too expensive to move it. ''We used to spend about $2 million in site prep costs to destroy the equivalent of 300,000 barrels of oil,'' notes Thomas H. . Kelly, Scott's southern woodlands manager. Now the scrap is barged to the Mobile mill to be used as fuel. SCRAP WOOD, along with bark, black liquor -- organic wastes reclaimed from the pulping process -- and coal will be fed into one of two new ten-story boilers at the plant. The steam will provide the energy to run the plant and at times will generate surplus electricity the company can sell. Similar projects at Scott mills in Maine and Pennsylvania are so energy efficient they could compete with $15-a-barrel oil, the company claims. The effect on Scott's costs is positively electrifying. The project in Maine lowered the company's energy costs per ton of paper there from $140 to about $40. The Mobile mill, which produces about 30% of the company's domestic output, ''should be as low cost as any in the U.S.,'' says Lippincott. Scott holds some other aces as well. The company's Warren division, which makes paper for magazine and textbook publishers, has unleashed a monster into the market for lightweight paper. This beast is a 300-yard-long, $200-million papermaking machine in Skowhegan, Maine, that is approaching its 215,000-tons- per-year capacity and doing wonders for Scott's bottom line. The division now accounts for 30% of company sales, and last year -- a good one for coated paper -- it nearly tripled its pretax profit, pumping in nearly 45% of the corporate total. Traditionally, Warren has been a market leader in high-quality coated papers -- No. 1 and No. 2 grades in the five-number continuum of the trade -- but its returns were mediocre, reflecting the division's high operating costs. Scott took an uncharacteristic risk in building the new machine, which makes No. 3 and No. 4 grade paper. ''The belief in the late Seventies was that cable TV, the visual elements, were going to subdue print,'' says Robert E. McAvoy, Warren's president. ''But we were beginning to believe that busy lifestyles were doing the reverse, raising the need for higher-quality information. As we put together points of view we thought we saw a trend line not seen by people in the industry.'' The view was correct: between 1979 and 1984 the demand for lightweight paper, used principally for magazines and mail-order catalogues, increased nearly 8% a year. ''The L.L. Beans were coming out of the woods,'' says McAvoy. The Maine machine came on line in time to meet that upsurge in the printing business that caught most of Scott's competitors by surprise. Publishers like Scott's particular type of No. 4 grade paper because it reproduces photos and color as crisply as the more expensive, heavier stock, while its lighter weight keeps mailing costs down. Part of the magic is in the coating process, which is so revolutionary that Scott keeps it under tight security. ''People have had little opportunity to meet the position we have carved out,'' says McAvoy. To keep the competitive situation going its way, the company is now erecting another monster alongside the original. While the added capacity may soften Scott's own market, the company wants to make sure nobody else does this for them. The new machine enabled Scott to reconfigure its other papermaking capacity. Before, each of its 11 printing-paper machines was in effect a jack- of-all-trades, making different grades of paper as needed. Now the division has a team of specialists, with the big guy in Maine as the center, making lightweight paper. Machines in Mobile make medium-weight grades while machines in Muskegon, Michigan, make only heavyweight grades. Specialization gives the machines longer, more efficient production runs. Now that most of the hardware is in place, Lippincott is looking to improve Scott's place in fast-growing markets abroad and in the U.S. market for paper products used away from home. ''Up until now,'' he says, ''we've been majoring in recovery and minoring in growth.'' Scott's international operations have suffered not only from the standard currency translation problems but also from a lack of managerial attention. ''When you go from plus $40 million to minus $39 million in a year in international there is some suggestion you have less control than you should,'' Lippincott observes. That's just what happened to Scott in 1982. The company is lopping off affiliates in six countries and is trying to improve its share of the Western European tissue market. Another main target is domestic: selling napkins, tissues, paper towels, dispensers, and soap products to restaurants, hotels, and commercial buildings, where the market for paper products continues to grow faster than in grocery stores. The company is changing its tactics in this arena. ''We've been in the middle of the stream,'' says Lippincott. ''And we've got to get to one side of the shore or the other.'' Scott isn't going to bang heads with the aggressive price competition of Fort Howard Paper, which owns 30% of the market. Scott hopes instead that by offering distributors one-stop service with everything from soap dispensers to paper napkins it can match competitive offerings. And just as in consumer products, it is pushing value, emphasizing cost per use rather than price alone. Last year Scott bought SaniFresh, a manufacturer of institutional soaps, detergents, and dispensers, and more recently it acquired Hoffmaster, a maker of high-quality paper products for restaurants. The paper industry isn't one to reward its players lavishly. Lippincott's goal is to bring the company's return on total capital up to 12%; it now stands at 8.5%. ''To say Scott's return on capital is atrocious is to pay a compliment,'' notes one security analyst who follows this unglamorous industry. Lippincott claims the $1.6-billion investment the company has made in lower-cost production is still working its way to the bottom line. Meanwhile, several rivals are expanding or modernizing their plants and piling into Scott's markets, which may impede that bottom-line improvement. The folks in the Big Blue Box seem inordinately calm in the face of these developments. In the past four years, they have come to believe that they can shape their own destiny. BOX: INVESTOR'S SNAPSHOT SCOTT PAPER SALES (LATEST FOUR QUARTERS) $2.9 BILLION CHANGE FROM YEAR EARLIER UP 8% NET PROFIT $195.1 MILLION CHANGE UP 23% RETURN ON COMMON STOCKHOLDERS' EQUITY 12% FIVE-YEAR AVERAGE 10% RECENT SHARE PRICE $40.25 PRICE/EARNINGS MULTIPLE 10 TOTAL RETURN TO INVESTORS (12 MONTHS TO 8/30) 42% PRINCIPAL MARKET NYSE Explanatory notes: page 126