DARDEN fi UV3533 BUSINESS PUBLISHING UNIERSTYy VIRGINIA NORTHERN FOREST (A) The forest that has covered this region since the ice retreated is the setting for our lives, our economies, our culture, our sense of what is beautiful—all are shaped by this amazing spread of birch and beech and maple, of spruce and pine and hemlock. —Bill McKibben, Vermont For centuries the forest of the northeastern United States provided clear sky, clean water, and abundant wildlife for rural communities while supporting the local forestry industry. 's cut ees for sawmills and the pulp and paper industry, which created lumber, vencers, and paper products for consumers. More recently, recreational activities such as hiking and hunting have become an increasingly important part of the regional economy. The combination of tourism and a growing conservation ethic has led to the creation of parks and conservation reserves. By the end of the 20th century, a convergence of factors increased the value of the Northern Forest. Seventy of eighty years alter the region was almost completely deforested Lom overharvesting and the clearing of land for farms, ihe region’s trees were maturing and becoming. commercially attractive. Growing demand for forest products raised the value of the forested land that supplied sawmills. Because of population growth and the onward creep of Boston and Portland, Maine, landowners saw land values inezease in many areas slotted for residential and commercial development. During this period, the capacity of regional sawmills grew steadily. This capacity, measured in millions of board feet of lumber produced per year, increased on an average of 3.5% per year, doubling roughly every 20 years, AS a result, harvesting of saw logs grew steadily and with it concern for resource sustainability in the Northern Forest. That is, stakeholders from landowners to sawmill owners to government officials to environmentalists all wanted to make sure that the overall demand for saw logs, as driven by sawmill capacity, did not exceed the rate at which the trees were growing. They did not want sawmill demand to “overshoot” the productive capacity of the forest resource, a classic problem in renewable resource economies ‘This case was prepared by prepared by Cheng Cui, Chris Lotspeich, Andrew Jones, and Robert D. Landel. It was written as a basis for class discussion rather than to illustrate effective or ineffective handling of an administrative situation, Copyright © 2004 by the University of Virginia Darden School Foundation, Charlottesville, VA. All Tights reserved. To order copies, send an e-mail to sales(@dardenbusinesspublishing.com. No par: of this publication may be reproduced, stored in a rewrieval system, used in a spreadsheet, or transmitted in any form or by any ‘means—electronic, mechanical, photocopying, recording, or otherwise—without the permission of the Darden Schoo! Foundation.UV3533 that the region had experienced approximately a century earlier, when the number of sawmills in the region boomed and then busted, dropping by about 90% over 20 years (Exhibit 3) and devastating local economies, ecosystems, and culture. Business leaders, public officials, environmental and local residents argued over whether the region could maintain the momentum of economic development as well as its relative isolation and peaceful lifestyle, and, if so, how best to proceed, Most believed that the forest could support diverse uses and maintain both ecological and economic vitality. Each stakeholder was willing to work collaboratively to integrate social and environmental goals into the natural resource economy. All parties wished to avoid the common hazards facing commodity-based systems: resource depletion, environmental degradation, and economic and community decline, The Sustainability Institute, a consultancy specializing in systems thinking and organizational learning for economic, environmental, and social challenges, was approached to analyze the current situation, identify key driving forces, and describe potential future developments. More specifically, they were asked to focus on the broadly shared concern about a possible boom and bust of the sawmill industry. Public officials convened a multistakeholder forum to allow the parties to develop strategies for the future. Key questions were put before the group: Does the Northern Forest as a system have the structural potential for lumber mill demand io overshoot the sustainable yield of the forest ecosystem? If so, should the stakeholders take actions to avoid this imbalance? What strategies would best serve collective interests? It was hoped that the Sustainability Institute’s analysis could help this dialogue process. ‘The Northern Forest System From western New York to the tip of Maine, 26 million acres of timberland made up the Northern Forest, the largest remaining intact wild forest in the Kast. It stretched from Maine’s St. Croix River westward through New Hampshire and Vermont, and clear across New York's Adirondacks to ‘Tug Hill, The region encompassed remote, pristine lakes and rivers and vast tracts of forestland that sheltered more than 250 species of wild creatures and migratory birds ‘The Northem Forest was home to 1 million people who depended on the forest in various ways to sustain their communities, Another 70 million people—roughly a third of the nation’s poptlation—lived within a day's drive of the area The Northem Forest system encompassed both ecological and socioeconomic aspects that were interdependent. The ecosystem had its own dynamics, which interacted with human, economic, and policy systems. These human systems maintained processes of their own. Three basic parts of this interdependent system were trees, people, and businesses. The fundamental components of the forest system were the trees. A forest comprised a mix of trees of different ages, species, and qualities. The Northern Forest had leafy, deciduous trees such as oak and maple and coniferous trees such as pines. Trees had similar life cycles,UV3533 although different species had varied life spans, growth rates, and other characteristics. Seeds used sunlight, water, and nutrients to grow into saplings and mature trees. Dead trees and leaves decayed into the soil and litter layer, releasing their nutrients for new seeds and other species to use. Trees provided food and habitat for other flora and fauna of the forest, some of which, in turn, helped the trees by spreading seeds while others acted as pests. Forests helped regulate the water cycle, nutrient flows, and soil stability. The diversity of the species mix in a forest system was usually a primary factor of health and resilience. Primary threats to forest health included pests, disease, fire, severe weather events, and excessive harvesting, The economic system valued certain trees more highly than others, depending on their age, quality, or species. ‘Trees of sufficient size and quality were considered harvestable saw-log trees, good for making lumber, which was then used to build houses, ships, and furniture. The inventory of saw-log trees was influenced by the forest's growth rate and the relative ages of the trees, as well as by the harvest rate, Trees matured over several decades. Younger, smaller trees had lower commercial value and were used for pulp and papermaking, composite panels and beams, and firewood. Sawdust, bark, and scrap byproducts of cutting and papermaking were used for fuel, animal bedding, and mulch. Harvesting could alfect the forest by changing the mix of species, and converting forest land to other uses or conditions. Clear-culling trees yielded the greatest supply of wood in the short run but damaged forest and stream health if done on too large a scale. More environmentally sustainable harvesting methods included selective harvesting. This technique tended (o yield fewer trees per acre but tried to maintain forest health by preserving sufficient iree cover and diversity for regeneration. Unfortunately, sclectively harvesting trces of a specific species or age class reduced a forest’s biodiversity and undermined its health. Harvesting the biggest, healthiest trees that often had the highest economic value degraded the gene pool by preventing more successful strains from reproducing. Some Jorms of tree removal were natural in origin. Such natural insults as disease or fire tended to Kill weaker trees, strengthening the forest's gene pool aver time. The very meaning of forest was debated and complicated by human intervention Landowners and sawmills cared most about how much harvestable wood was available, while environmentalists also cared about biodiversity and forest health. All stakeholders were interested in the size of the forest, and how it changed over time. The size of the forest was measured by surface area (e.g., acres or hectares) or in terms of total cubic feet of wood (billions of cubic feet for the whole forest). The inventory of harvestable saw logs and the amount of cut wood were both measured in terms of cubic feet. The annual growth rate of trees was measured in terms of cubic feet per year or billions of cubic feet per year for large areas. The harvest rate was also assessed by this metric. If the harvest rate exceeded the growth rate, the size of a forest decreased. Much like the farmer who rotated crops, landowners and sawmills replanted trees to build an inventory for future harvest, in effect increasing the forests growth rate.UV3533 There was a strong economic incentive to replant only the tree varieties of highest commercial value in an easily harvested layout. The result was often land covered with trees of the same age and species, sometimes called a plantation. These crops of trees provided some of the ecological services that forests provided but lacked the diversity and resilience of more diverse ecosystems. According to this view, it was possible to have more trees but less forest. Because forest health was hard to measure and subject to debate, stakeholder discussions usually focused on the size of the forest. Harvesting was not the only factor that reduced forest size. Apart from changes in forest composition, trees disappeared from the system at every stage because of land development, disease, erosion, and other factors. Industry experts estimated that land conversion would erode the forest ata rate of 0.25% per year from 2000 onward. The Economic System There were two primary human stakeholders in the Northern Forest economic system landowners and forest-based businesses. Landowners chose the ways in which they used the forest. Alternatives included logging, real-estate development, recreation, and conservation. Forest-based businesses were divided into two groups: forest products and tourism. Forest- products industries made up the more dominant group, although tourism was growing quickly in size and importance. The forest-products sector had two main categories: sawmills and industries supplied by sawmills. Sawmills created lumber and veneer out of larger, higher-quality timber called saw logs. Sawdust and other scrap were secondary products of these manulacturing processes Builders used lumber and veneer panels for construction. Pulp and paper mills created paper products out of sawmill residues and smaller, lower-quality timber called pulpwood. Low-quality wood, chips, and residues were also bumed by individuals and businesses for heating and generation of electricity. Sawmills bought cut trees or owned forested land. They processed saw logs for sale locally and served as the link between the forest and commercial wood users, The sawmill industry provided the fastest-growing demand for trees and effectively represented other forest-product sectors Technology innovation and industry consolidation had changed the employment pattern in the sawmill industry. Mills had become more automated and efficient, improving. yield and production while cutting costs and labor requirements. Logging operations had experienced similar trends, In the last decade, total employment in the forest-products industry shrank while lumber production increased. Many communities faced high unemployment, and families were moving away from these areas as a result. Despite the demographic changes in these arcas, @ booming sawmill industry had long been seen as the only immediate and reliable source for jobs. Increasingly, tourism was providing employment opportunities. Hiking, camping, hunting and fishing, river rafting, and colorful fall foliage brought visitors to the region. Visitors paid for5 UV3533 services such as lodging, restaurants, and guides. Some bought second homes in the area. These recreational activities benefited fiom intact forest cover and healthy woods and watersheds. Many tourism advocates agreed with environmentalists on the value of maintaining at least some land free of logging to appeal to visitors. Apart from the unsighiliness of clear cuts, it was not understood whether or not lagged and reforested areas were also useful for recreation, Landowners, Sawmills, and Market Forces Landowners decided when and where to harvest, how much to harvest, and at what price to sell logs to sawmills. Industry experts divided the landowners into five categories based on how the land was managed. Land could be converted from one category to another, with some delays and other exceptions. The typical local landowner had a relatively small plot of nonindustrial private forestland, Landowners made up the largest group, which owned just more than half of all land. Generally they did not have complex, long-term plans and would not log their land in a given year Harvesting decisions were based on the current market price and the tolal number of available trees rather than on how many trees had been grown in any given year. Most harvested an average of 10% of their (otal saw-log inventory annually but would cut more lumber if prices were good or if they needed the money for other reasons. Investment-oriented landowners were the second-largest category and owned roughly 20% of the forest. The group included sawmill owners, financiers, and others who wanted to maintain a competitive return on investment. They harvested on a rotational basis, logging and replanting so that a ceriain percentage of their trees were harvestable each year. Saw-log output, however, could be increased if the market price was high enough or if the mills faced 2 serious shortage. Many investment landowners changed their rotational goals based on demand from the mills A smaller, mill-integrated group aimed to ensure that the mills were fully supplied. This group was just under half the size of the investment category and included other sawmill owners, and others who wanted to serve that market. Harvest plans were adjusted to stabilize the saw-log supply and even drive down the price if possible, Some created plantations of select trees with growth rates as much as 40% faster than those of the average forest in the service of these goals, Reserve land was not harvested for saw-log sale at all and equaled about 10% of the forest. Reserve landowners increasingly created conservation easements on their land, irrevocable covenants that restricted logging forever, regardless of future ownership. About 5% of the forest was working conservation land. Rotational harvesting was designed to prioritize forest health, and logging ceased when it lost money. Saw timber on conservation land could be harvested later when the land was sold to a new owner.UV3533 Over time, the mill-integrated group had become smaller while the investment and conservation groups had grown. As a result, fewer landowners were willing to cut down the trees on their land in the future. One key measure of the sawmill industry was the overall capacity of sawmills in the region, measured in millions of board feet produced per year. Sawmill capacity was increased by new investments and depleted by the retirement of capacity. Capacity, in turn, drove sawmill production, which created demand for saw logs and pushed up the harvest rate, Higher saw-log demand and decreasing supplies of saw logs both increased saw-log prices, which, in tum, drove the harvest decisions of some landowners, Saw-log price was the most important influence on sawmill profitability, Mills invested their profits in additional production capacity because they anticipated future profitability. The new capacity increased future production and led to higher revenues. Without consideration for constraints from demand or resource availability, it was anticipated that the investment cycle would stimulate continued growth in the sawmill industry. It was a common trait of commodity systems that reinvestment, higher efficiency, and increased demand, drove production growth, If saw-log prices rose or lumber prices fell and sawmills lost money, some closed. Some mills passed on the additional cost to their customers by raising the price of lumber. Because the short-term market demand for lumber was highly inclastic, these mills stayed profitable by increasing revenues rather than cutiing costs. Mills with sufficient capital upgraded technology and equipment to cut costs relatively quickly. For example, computer-aided saws with laser guides determined the optimal cutting pattern for each log. This increased usable lumber yield, decreased wood scrap. and allowed the mill to process smaller and lower-quality logs. Mills with increased eflicieney and capacity ‘maintained profitability despite higher raw-material costs. Greater effective mill capacity, however, spurred higher saw-log demand, causing prices to rise and further erode the industry’s profitability. This effect was recognized widely asa trap of commodity systems. ing Signals The complexity of the system was reflecied in the information content of the saw-log pricing signal in the market. In theory, the price of saw logs was determined by the interplay oF supply and demand, Saw-log sellers (landowners) adjusted their output based on price. Buyers (sawmills) responded to price increases by attempting to increase efficiency. The supply of trees was fixed in the short run, although overall saw-log availability had been higher than expected in recent years, Landowners’ projected harvest levels were typically fixed every year but differed for each landowner category. For example, in any given year, 45% of the landowners harvested. This group also tended to cash out current inventory within 10 to 15 years. The projected harvest level, however, did not define the actual harvest. Instead, the actual harvest was determined byUV3533 the physical inventory of harvestable trees, the market price of saw logs and lumber, and the willingness of the landowners to adjust production based on market response. It was estimated that if the price of saw logs increased by 50%, the percentage of landowners willing to harvest would grow by about 30%. Because more trees were harvested and the supply of saw logs increased, the price increase was moderated Sometimes the pricing signal was overstated. When the market entered a boom, industry analysts and trade publications began to project continued high-price growth, This led to overinvestment in excess capacity and worsened the next slump. Later, the same effect would depress market confidence and delay recovery. Some environmentalists and public officials were concerned that the market dynamic included delays or other dampening of signals of saw-log scarcity and that the price signal did not seem to prevent overharvesting. Harvests had increased in cases when prices rose and also in times when they fell, but the reasons for this were not clear. These groups suspected that buyers and sellers had complex motives and behavior in responses to price changes that did not seem to follow the conventional dynamics of supply and demand alone. Challenges to the Northern Forest System The market for forest products of all kinds had grown and with it the demand for saw logs. Many in the region’s forest-based indusiries viewed the lower-cost Canadian imports as a dire threat. Financial pressure ofien forced landowners and sawmills to boost production. The attempt to raise revenue by increasing output even when prices were falling led to overharvesting as well as saw-log-supply gluts. These trends risked overshooting both the forest’s capacity to sustain logging and saturating market demand and contributing to a downturn in the forest-based economy, ranging forestry practices and technology had affected the woods more visibly than ever throughout the past three centuries of logging. Some timber companies pursuing short-term profits shifted from selective logging to large-scale, clear-cut tracts. This approach yielded more trees per acre at lower cast but left behind stumps and increased erosion. Mill improvements and new products and processes allowed for the economic viability of ever-smaller trees, Private land owners, who contralled the majority of the forest, tended to manage their forestlands based on @ 10- to 15-year horizon, which was far shorter than the 40 to 50 years needed for a tree to grow into harvestable hardwood. Some landowners cut as much timber as could be sold quickly and then subdivided or sold the land io developers. Such behavior could result in excess sawmill capacity and saw-log price collapse in a boom-and-bust cycle. Instability in the form of the risk of overshoot existed in this system on many levels as @ result of these changing practices. The Northern Forest had experienced overshooting before. At the time of European settlement, the region’s large white pines were highly valued for their use as ship masts. National independence and subsequent changes in transportation technology created important new8 UV3533 markets for saw timber from the Northern Forest. The forest industry met the demand by heavily cutting the forest’s best timber. In the decades that followed, the Northern Forest lost its advantage in saw-timber production to the western frontier due to the regional shortage of larger old-growth trees. As lumber manufacturing moved west, it left behind excess sawmill capacity and a forest degraded by the practice of “taking the best and leaving the rest.” Land cleared by farming and logging before the mid-1800s was recolonized by light- loving pine trees, When these stands matured, they fueled pine-based industries, and sawmills once again came to life. After rapid growth around the turn of the century, lumber production shrunk by almost 75% from 1910-1930, due to a massive spruce-budworm infestation and then the Great Depression, The number of sawmills fell from a peak of 4,800 at the beginning of 20th century to about 450 in the early 1930s. World War II boosted demand, and after the war the spruce-dominated forest became more valuable for paper making as well as housing. Sawmill investment and production rose steadily, feeding an expanding economy but further degrading the forest Balancing Forces Many regional businesses believed logging levels would keep the forest and the industry sustainable. They argued that the timber-industry contraction in the 1930s was largely due to the Great Depression and a severe frost that destroyed many trees. After that, the local industries ook good care of the forest for generations. Sawmills and timber companies not only cut down irees but also planted young ones. They kept their land holdings open to hunters and hikers while locking out most development and providing the largest share of tax revenues for the region Timber company owners and managers declared that they were so passionate about this forest that they would do their best to prevent any boom-and-bust capacity overshoot. There was historical data to support this claim. Despite public concer for the depletion of forest resources, the Northem Forest had actually been growing rather than disappearing since the 1970s, The overall inventory of timber on saw-timber acres, which was one of the most important measurements for older harvestable timber in the Northern Forest states, had been growing for the past 30 years (Exhibit 1), The increase in timber inventory stemmed primarily from new growth. Regional lumber production had been increasing by about 3.5% annually. This figure appeared to double every 20 years (Exhibit 2). Additionally, 25% of saw logs were exported to Canada. This figure was growing as well. Despite increasing wood-use efficiency, higher lumber production had led to higher saw-log harvest rates, As a result, while the saw-timber-acres inventory was still growing, the harvest rate was gradually catching upUV3533 Public Policy Public policy could significantly influence the behavior of the stakeholders in the Northern Forest system. First, ihe public could be motivated to protect the forest resources if the reported total saw-log inventory fell. Government regulation could then force the industry to reduce saw-log production. If such controls were probable, a negotiated solution could be achieved that could avert new regulation and shape stakeholder behavior toward optimal sustainability of the system. For example, the industry could agree to such harvest-level reductions as capping the cut at 90% of the previous year’s harvest, New technologies could be employed. Other consensus strategies would be possible, The Sustainability Institute would play an important role by providing stakeholders with data and models to inform the dialogue about forest-system dynamics, The Meeting As a project manager at the Sustainability Institute in charge of the Northern Forest project over the past six months, you have been working with an advisory board representing various interest groups in the region, including sawmill owners, environmentalists, and policy groups, to leam about the challenges and perspectives of cach. Now you understand how different forces behave in the system to develop a basic model. Your model will be unveiled for the first time at the upcoming advisory-board workshop hosted by the state foresters and facilitated by the Sustainability Institute, where you must deliver your final analysis. The model is not a prediction for the exact timing of events. Your goal is to show the audience how the forest, landowners, sawmills, and market interact and point out the pattern of system behavior over time.-10- UV3533 Exhibit 1 NORTHERN FOREST (A) Inventory on Sawtimber Acres 50 — = 0 1970 1980 1990-2000 Nove: From op Total, ME, NY, NH VT Volume on Sawtimber Acres 50 40 3 30 é 20 . 10 0 1970 1980 1990-2000 Data Source: USFS studies and NEFA estimates:“le UV3533 Exhibit 2 NORTHERN FOREST (A) Lumber Production 2500 2000 1500 MMBF 1000 500 0 1970 1980 1990 2000 Data: U.S, Consus— Lumber Prod. and Mill Stocks NF State Lumber Production 1869 - 1945, 3200 2400 1600 800 Millon board feet per year ° 1860 1880 1900 1920 1940 Source: USDA, Steer, 1948-12- UV3533 Exhibit 3 NORTHERN FOREST (A) NF State Sawmills 1905 - 1945 5000 4810 4000 3000 2000 € & € 2 1000 0 5 1905 1915 1925 1935 1945 Source: USDA, Steer, 1948,-13- UV3533 Exhibit 4 NORTHERN FOREST (A) Reported Maine Logging Jobs 6000 5000 4000 3000 2000 + 1000 4 1980 1985 1990 1995 2000 Source: U.S. Dept. of Commerce (SIC 241) Note: an increasing number of logger jobs may be going unreported Maine Sawmill Jobs vs. Lumber Production 4000 1200 3000 900 3 8 g 8 2000 00 8 ° © 5 1000 lote: Jobs include planing mill jobs 0 0 1980 1985 = 1990-1995 2000 Source: US. Department of Commerce-14- UV3533 Exhibit 5 NORTHERN FOREST (A) Northern Forest Land in Landowner Behavior Classes oe sceneanaon reneged ring rs 2 tventret renaae won me 2 wats ate on rhe marae wing oe Northem Forest Land in Landowner Behavior Classes Estimates or 1997 s-Eovonl ‘enn om | innagad veg om oumernen manages og poet 2. ail tga wn Fs Source: Sustainability Institute,