The Costamentals of Human Resource Management in Finland and Sweden

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1 Forest, Wildlife and Wood Sciences for Society Development Prague, April 2009 Challenges to the forest machine business as a result of global economic change Arto RUMMUKAINEN*, Bo DAHLIN**, Markku PENTTINEN*, Ashley SELBY* & Jarmo MIKKOLA* * Finnish Forest Research Institute, Pl 18, FI Vantaa, Finland firstname.lastname@metla.fi ** University of Helsinki, Pl 27, FI Helsingin yliopisto, Finland firstname.lastname@helsinki.fi ABSTRACT The closing of forest industry mills will affect the forest machine enterprise business that was in a state of change even prior to the current economic crisis. No essential technical advancements can be anticipated. Improvements in profitability must therefore be based on business acumen and the re-engineering of service processes. Insecurity and seasonal fluctuations require an entrepreneur to possess economic and management skills. The paper outlines the harvesting business in Finland and Sweden. The key economic figures of the harvesting enterprises reveal long-term low profitability, and few enterprises have financial reserves to expand their operations. In future, customers may offer less work for all enterprises or they may make contracts with only a few larger enterprises. Problems also arise from the strong seasonal and economic variation in work volumes; today many forest machine entrepreneurs operate as a part-time business. The paper considers how harvesting enterprises can respond to these threats, how long can enterprises bear such disturbances, and what possibilities are there to adapt. Problems generate also new solutions, but for which enterprises? Keywords: Entrepreneur, harvesting, economy, business challenges, re-engineering. 1. Introduction The history of mechanical wood harvesting business started in Finland in the 1960s, when forwarders were introduced in terrain transport (Salminen 1996). The first Finnish processor prototype was introduced in 1969 at the same time as seven forest industry companies bought a big processor from Sweden. In the same year, the Forest Machine Contractors Association was founded (Piironen 1996). Often horse owner bought a tractor, thus the enterprises started as one-man and one-machine enterprises. The forest machine contracting business has grown in volume, while machine development and streamlining of operations have kept the harvesting costs very reasonable for customers (Penttinen et.al. 2006). During the recent decade, technical development has stagnated, so that rising machine and operating costs have threatened to raise harvesting costs for the customers. At the same time, forest industry companies have outsourced more tasks to entrepreneurs. The industry has promoted growth of harvesting enterprises in order to have fewer partners with which to negotiate (Ala- Fossi et. al. 2004, Rekilä & Räsänen 2008). The first generation of entrepreneurs is now 461

2 retiring, while hiring new operators is difficult because of low payment compared to diversified requirements. The harvesting business has seldom been a very profitable business (latest results Saviaho 2009, Penttinen et. al. 2008). The business has been dominated by micro enterprises that have weak negotiating power with the large customers. One quarter or fifth of enterprises has negative results. The median enterprise profit is a few percents, while the degree of self-sufficiency is clearly less than 50 percent. An 32 enterprise example with only larger, growth-oriented, harvesting enterprises showed positive results during the period (Soirinsuo & Mäkinen 2009), thus demonstrating possibilities for business. However, the volume growth has decreased their profitability. Larger volumes do not even satisfy significant share of entrepreneurs (Rekilä & Räsänen 2008). Customers aim to increase the size of harvesting enterprises while more tasks are outsourced to entrepreneurs (Ala-Fossi et.al. 2004, Rekilä & Räsänen 2008). The first generation of entrepreneurs are retiring and there is lack of proper operators. Entrepreneurs are encouraged to invest in machinery in order to cover the increasing domestic harvesting that may result from a decrease in imports from Russia. Two warm winters have also left a supply deficit because of the poor bearing capacity of unfrozen soils. Thus, even before the current economic depression, there were many signs that enterprises were in a difficult economic situation. With the virtual termination of round wood purchases at the time of writing, the forest machine operators' situation can only be expected to worsen. The global recession and its local consequences are summarised in Figure 1. Gibb (2000) describes demonstrates that an entrepreneur lives in a state of uncertainty and complexity. He/she is affected by global pressures that create a need for each level of actors to reposition their strategies and activities. The enterprise and the individual ultimately have to do the same in order to adjust to exogenous forces. E.g. global pressures on the forest industries has led to amalgamations, specialisations, and geographical relocations closer to specific markets, as well as creating new sources of raw materials, such a fast growing plantations in favourable climatic zones. It is such reposition process that filters down to crate the changing business environment for the forest machine operators in Finland. Global Pressures State repositioning Greater uncertainty and complexity - the need for an entrepreneurial response Organisational repositioning Individual repositioning Figure 1. The need for an entrepreneurial response to the changing world (after GIBB 2000). 462

3 2. Wood harvesting enterprises Situation in Finland There is no single description of a forest machine enterprise. The Finnish Vehicle Administration (AKE 2008) maintains a register of over forest machines. All machines have had to be registered since the beginning of The register includes old and even scrapped machines because there is no up-dating process. Excluding such old and inadequate machines leaves about machines and owners (Penttinen et.al. 2009). A monthly inquiry on forest industry, forest management associations and state Forest Service indicated that some machines were working in January 2008 ( 2008). Forest harvesting is the most common supplementary business in agriculture. In 2005, farms had incomes from forest harvesting (Tike 2008). Many of these businesses operate with farm tractor-based machinery and only on a part time basis. The bulk of the harvesting work is made by full-time enterprises with special machinery. However, the strong seasonal yearly variation of working volumes requires a multi-business approach to cope with the periods of the year when harvesting activities are at a minimum. The following economic analysis utilises material concerning about enterprises derived from the Vehicle Administration data (Statistics Finland 2008). Because of missing data, each key figure has different number of observations, generally about The harvesting business is still dominated very small entrepreneurs. Half of enterprises have only one or two machines, but their turnover is only one third of total turnover (tab. 1). The largest companies own about 30 machines and employ 50 operators. Table 1. Number of enterprises and their turnover, number of machines and personnel in machine number classes in 2007 (Statistics Finland-material 2007). Number of Number of Total turnover Number of machines Number of personnel machines enterprises % % % % 1 36,7 12,9 13,1 11,2 2 25,3 16,1 18,0 14, ,3 25,2 25,9 25, ,0 10,3 10,8 11, ,7 14,5 13,3 15,2 Over 10 1,9 10,9 10,3 1,1 Total, % 100,0 100,0 100, Total, value Mill Table 2. Turnover, number of machines and personnel per enterprise by enterprise form in 2007 in Finland. Turnover per enterprise Machines per Personnel per Enterprise form enterprise enterprise Lower quartile Median Upper quartile Median number of Median number of employees machines. Person enterprise 70,5 125,9 220,7 1,6 1,3 Partnership 148,4 242,0 391,3 2,4 2,2 463

4 Limited partnership 146,9 227,9 414,5 2,4 2,9 Limited company 244,3 442,3 836,8 3,6 5,8 All 140,9 291,9 566,8 2,8 3,8 Small enterprises are most often single-person enterprises (tab. 2). Almost half of enterprises are limited companies; their median turnover is four times larger than that of single-person enterprises. The number of employees in limited companies is also larger than that in the single-person enterprises. Limited companies utilise new machines in two working shifts, whereas single-person enterprise owners may operate a second-hand machine alone in one long shift. The capacity of a single-person enterprise is often more flexible than that of a limited company. First, because the owner can freely decide about working times with less regard for working time legislation and overtime pay rates. The economy of Finnish wood harvesting enterprises varies, but many make a loss (fig. 2). The median net result percent of single-person enterprises was negative during the whole study period. The net result was positive and its variation was smaller in limited companies, which represent almost 79 % of total turnover in harvesting business. The net results of single-person enterprises, limited partnerships and partnerships in figure 2 represent situation, where wage correction in amount of one or one and half (for partnerships) operators typical salary, has been deducted from original net result % Person enterprise Partners hip Limited partnership Limited c ompany Figure 2. The medians of the net result percent in enterprise form classes in in Finland. Debts burden especially smaller enterprises (figure 3). The variation of net debt percent is widest in smallest enterprises; the larger enterprises the smaller variation. The median net debt percent is less than 40 % in biggest enterprises but almost 80 % in smallest. One could suppose that large enterprises are run with better economic knowledge. 464

5 % Over Figure 3. The median and lower and upper quartiles of debts minus financial assets divided by turnover by turnover class in Maybe the most concrete and well-known information depicting the financing situation is the repayment period of debts also called payback period in years, which the invested external capital divided financing result (CCA 2005). Median of all enterprises achieved roughly the level of 2.5 years. Even the upper quartile was less than 4.5 years. The medians in different turnover classes unveil only modest distinctions between the turnover classes (figure 4). Typical keeping period of a new forest machine is 3-5 years, which is good in line with these payback periods Years Over Figure 4. The median and lower and upper quartiles of repayment period of debts by turnover class in

6 Studying financial adequacy perhaps the most common indicators are quick ratio and current ratio. The latter is not relevant in service business with no current assets. The former focuses the relation of the sum cash and marketable securities and short term receivables to short term liabilities. Moreover, cash ratio tells the extent to which readily available funds such as cash and equivalent can pay short term liabilities, but it hardly can give any additional information, either. The quick ratio had 0,8 median, some 1,5 upper quartile, but the lower quartile was only 0,3. Even here the variation of quick ratio was larger in smaller enterprises. In recession, profitability of business does not help. Financing and especially liquidity is hte issue. A kind of basic equation of financing can be considered the use of financing result, the exceeding part of which is reserve: "Reserve = financing result - installments of debts (their net decrease) - own financing part of investments - distribution of profit for own capital - addition of working capital". The median reserve grows with the enterprise turnover, as also the variation of it (fig. 5). The lower quartile of reserve is negative in all enterprise size classes. Even in the largest enterprise class the upper quartile of reserve is about one third of value of a new forest machine. So, most of harvesting enterprises are not prepared to endure long break in work EUR Over Figure 5. The median and lower and upper quartiles of reserve (see text) by turnover class in Situation in Sweden SMF-Skogsentreprenörerna is an organisation for forest entrepreneurs in Sweden (SMF Skogsentreprenörerna 2009). Its ca. 800 member enterprises correspond roughly to half of the companies active in the business. SMF publish annually key figures of their members which are limited companies; in 2007 this number was 498. These may be somewhat biased sample for the whole forest machine business in Sweden due to 466

7 that enterprises that are not limited companies or not associated to the organisation are probably more often smaller and may work only parts of the year. However, both groups encompass a large variation of companies. The situation for forest entepreneurs in Sweden is, and has been, similar to the Finnish one. In 1995 the forestry business was in full swing again after some very bad years. The economic crisis that faced the business in the early 90s withdrew harvesting capacity as entrepreneurs went bankrupt or left the business. Companies that were in operation in 1995 were given an opportunity as the demand increased significantly. However, during the proceeding years the situation was normalized and the return rate decreased drastically (fig. 6). Year 2005 broke the downward trend, but can be explained by the extraordinary harvesting conditions after the storm Gudrun in Southern Sweden. Some 75 million cubic metres were felled by the storm in January This corresponds to almost the same volume as the normal annual cut of Sweden. In 2006 the demand for harvesting capacity was strongly reduced, as there were a lot of wood in stock. A new storm in January 2007 felled another 15 million cubic meters in Southern Sweden, which probably affects the figure for ,0 14,0 Return on assets, ROA, % 12,0 10,0 8,0 6,0 4,0 2,0 0, Year Figure 6. Return on assets in per cent for Swedish SMF-member entrepreneurs (limited companies) in (SMF Skogsentreprenörerna 2009). The net result on turnover shows a somewhat different trend compared to the previous one (fig. 7). The years around the millenium shift, were exceptionally bad for the entrepreneurs; unclear due to what causes. Once again 2005 is an excemption beacause of the effects of the storm. 467

8 8,0 7,0 Net result of turnover, % 6,0 5,0 4,0 3,0 2,0 1,0 0, Year Figure 7. Net result of turnover for Swedish SMF-member entrepreneurs (limited companies) in (SMF Skogsentreprenörerna 2009). During the study period to 40 % of SMF members had negative result (SMF Skogsentreprenörerna 2009). The highest share of negative result was attained around the change of millenium, just as the lowest net results. First years after that showed lowering numbers of enterprises with negative result. At the lowest share was 20 % in Till 2007 the share of enterprises with negative result had grown to 33 %. The Swedish forest entrepreneurs seem to be struggling with the same type of problems as their Finnish colleagues: decreasing profitability and many companies in the red. The current economic crisis will have a strong influence in the prospects for the entrepreneurs. The Swedish Forestry Agency (2009) reports that the area reported for final felling decreased with 36% for the two first months of year 2009, compared to the same period the preceding year. 3. Changing business environment The current global recession has hit the Finnish export-based forest industries hard. The production of saw wood in Finland dropped 21 % in 2008 down to 9,8 mill. m 3 (Finnish forest 2009). Pulp and paper production dropped 8 % to 13 mill ton; veneer production 10 % to 2,3 Mill. m3. In Sweden, the depreciation in the value of crown against the Euro has offered better possibilities for its forest industries. In Finland, the year 2007 witnessed an all time record in removals. The average volume of commercial round wood removals was 54 mill. m 3, as in 2007 it was 58 mill. m 3, with the energy wood volume being 64 mill. m 3 (Metinfo 2009). The variation of commercial round wood removals during the most recent three years was large: 51 mill. m 3 in 2006, 58 Mill. m 3 in 2007 and 51 Mill. m 3 in The difference of high and low removals is 7 Mill. m 3, which represent an average capacity of 200 harvesters with typical production of m 3 /y. Weekly wood market statistics offer some prediction for 2009 removals. The wood transactions in January were 4,6 mill. m 3 468

9 in 2007, 2,0 mill. m 3 in 2008 and 1,3 mill. m 3 in In 2008, the raw wood imports remained at the record level 20 mill. m 3, mainly because forest industry imported the last inventories from Russia in advance of a threatened increased in Russia's round wood export taxes. At the time of writing, Spring 2009, it looks as if most harvesting enterprises will have to stop their operations for at least 4-5 months (Jaakkola 2009, Palokallio 2009), while the two largest wood purchasing companies are temporarily suspending their own harvesting organisation. All forest machine operators are therefore threatened by lay-offs. By the beginning of March 2009, a quarter of forest machine enterprises had already laid-off their personnel (Palokallio 2009). Some approximate scenarios demonstrate the scale for the problem. If the forest industry closes for 4 months, there will be some 18 Mill. m 3 less removals and thus 520 harvesters and 560 forwarders will be without work, calculations base on an average harvester productivity of m 3 /y. These numbers represent one third of typical harvesting capacity. The currently large inventory of domestic and imported wood does not improve the outlook for harvesting enterprises. 4. Effects on harvesting enterprises If all enterprises have equally long breaks, those with the weakest economies will have to leave the business in the long run. After the crises, solid enterprises will remain in all enterprise size classes. If customers utilise the crisis as an opportunity to develop their supplier policy, they may offer work predominantly to those enterprises they intend to continue to deal in the future. If customers seek to deal with fewer harvesting enterprises, this may lead to a decrease in the smallest enterprises regardless of their solidity before the crisis. On the other hand, the remaining (larger) enterprises will then have more negotiation power, which in turn should lead to better profitability. According to the news all harvesting enterprises have to take a break (Palokallio 2009). The harvesting enterprise structure may change even without customers decisions. Area or key enterprises may have one or more subcontractors or the area/key enterprise may be owned by a network of enterprises. There will be hard decisions on how to divide the work that is available. The reserves of Finnish harvesting enterprises were small (fig. 8). Burn rate describes the minimum monthly/yearly required cash of an enterprise. It shows the ultimate financial opportunities of an enterprise or how long an enterprise can continue by paying only absolute obligatory cost. So, it describes how long enterprises can survive in present recession circumstances. Two most common enterprise types were chosen for example: person enterprises with turnover less than and limited companies with turnover larger than They represent respectively 14 % and 13 % of the total number study enterprises. It is assumed that enterprises pay only interests for loans, so loans have been negotiated amortization-free for the recession period. Naturally, there a no new investments made. Owners are also getting no dividends or other incomes. Two cases of operator wage payment are considered. In first case wages are paid as usual, in other operators are laid off, so no wage cost come. If only interests have to be paid a typical median person enterprise can continue almost two and half years (tab. 3). In the same way a limited company can continue almost four years. Upper quartiles of both enterprise types can theoretically hold almost twenty years. But the lower quartiles have less than 3 months to live. Limited companies negative time is based on negative financing assets, which consists here also 469

10 accounts payable and assigned debts. Times shorten very fast if wages are paid. Limited companies have lots of personnel, so financing of a median company is ending in two months. Median person enterprise can continue more than year even if wages are paid. Actually this means that they have only few or no employees. Lowest quartile enterprises cannot continue if they pay wages. Table 3. The median and lower and upper quartiles of burn rate values of typical Finnish harvesting person enterprises and limited companies at the end of Enterprise size Wage payment Burn rate = endurance in years and type Lower quartile Median Upper quartile Small person Wages paid 0,09 1,23 4,12 enterprise Large limited Wages paid -0,08 0,21 0,54 company Small person No wages paid 0,36 2,44 17,75 enterprise Large limited No wages paid -1,42 3,64 17,59 company Enterprises face recession in surprisingly different positions in the light of the financial resources for the monthly burn rate. Nearly one fourth of them have real difficulties to survive in case the recession will continue, say, few months. The smallest ones hardly have any wages to be pay. The biggest ones are facing temporary dismissal of the workers; otherwise the financial resources last only for some months in median enterprises and only half a year even in the upper quartile enterprises. Whenever dismissals are used the financial assets are sufficient for more than a year in some cases of biggest enterprises. Surprisingly, lower quartile enterprises even among the group of the biggest have hardly any buffers with or without dismissals. Burn rate figures give some upper limits of enterprises endurance. In most cases there are some other payments like insurances, taxes, telephone bills etc. which increase the payments and shorten the time enterprise can continue. Most enterprises are the only source of income for the owners, so owners living cost shorten time considerably. Situation is severe. 5. What for the future Given the present situation, a key question is which enterprises will receive harvesting contracts once the demand for domestic round wood increases. In most cases, the agreement between customer and entrepreneur contains price per wood assortment volume and total volume, to which entrepreneur is bound. Unfortunately the customer is in most cases not bound to offer work of that agreed volume. The challenges that the forest machines operators were facing were considerable and they have been exacerbated by the down-turn in the global economy. The present situation of flux nevertheless may offer a number of entrepreneurial opportunities. Harvesting enterprises could try to evolve agreement with customers to help develop better profitability. Lessons learned from 2005, when oil prices rocketed, mean that most agreements today contain compensation clauses to allow for fuel or other prices changes. If the contract contains volume-related clauses, there should be compensation rules for both sides should the volumes be unattainable. Today, all risks are placed on 470

11 the harvesting entrepreneur. However, most extra tasks are now included in the basic compensation, so there is no separate compensation for i.e. transfer of machines between work sites and pre cleaning of thinning stands. If the entrepreneur cannot negotiate on these tasks, he/she may suffer unnecessary high costs. It is therefore important that an adequate level of compensation should be achieved in contract negotiations. The key challenges of the wood harvesting enterprises could be described by one word, adaptation. They are forced to cope with the recession. At the same time new opportunities emerge e.g. by the pressures to increase the bioenergy. Some country level plans have been presented, which require hundreds of new entrepreneurs, machines and operators. The entrepreneurs are primarily forced to dismissal their workers for a while. No investments can be considered. The amortizations of debts have to be renegotiated. At the same time, the enterprises should be kept up the readiness to work with full load whenever the upswing starts. Entrepreneurial opportunity is the creation of a new production function, where production is the choice of products or services, the source of supply, the method of production, the method of organisation, and the choice of markets. An opportunity is a "favourable chance" (Christensen et al. 1994) that emerges when an entrepreneur finds a new combination of one or more of the following: new products or services, new production or organisational methods, new markets, new sources of input and/or new market structures (Schumpeter 1934). Without opportunity recognition entrepreneurship cannot take place (Singh 2000, Christiansen et al. 1989, 1994). Entrepreneurial opportunities do not necessarily stem from achieving a balance between supply and demand - the entrepreneur can also be a radical innovator (Schumpeter 1934). 6. Discussion The current crisis in the forest machine operator sector can be seen as a de facto destruction of the previously prevailing situation. As shown in this paper, the sector will undergo considerable repositioning once the present crisis is over. Some businesses will fail to survive, and their resources will be transferred to other sectors, or their entrepreneurs will retire. Others may seek to diversify their business by seeking to produce new services to meet new demands. In this respect the entrepreneurs can be reactive, and simply wait for opportunities (favourable chances) to come their way, or the can be proactive, and be active in seeking and creating demands for new services. A key to this process resides in the business-related information that an entrepreneur possesses and his ability to use that information (e.g. PRED 1967, SELBY 1987 & 1989, COHEN & LEVINTHAL 1990, GARUD, R. & NAYYAR 1990, LANG ET AL. (1997). The process places great onus on the quality and quantity of relevant information. Thus, it is important that all interested parties in the forest machine operators' business environment (i.e. the web of economic and social relations that are connect to an enterprise, see. e.g. JENNINGS & BEAVER 1997, GIBB 1997, SINGH 2000) should be committed to maintaining such information, e.g. via professional associations, advisory bodies, extension organisations, public sector officials, the media etc.). To what extent entrepreneurs benefit from such a system also depends upon their ability to seek out and use business related information. How successful they have been can, regrettably, only be fully understood after the current crisis is over, but at least the information can be made fully supportive at the present time. 471

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