Sticky situation: label maker Avery Dennison finds itself mired in antitrust investigation.

ADHESIVE label making doesn't quite conjure up images of smoky back-room dealings. Yet those who work in the tight-knit world of pressure-sensitive label stock -- the massive rolls of paper, sticky on one side, that are used to make labels -- describe competition in the industry as "aggressive," "cutthroat" and even "ungodly."

Over the past 10 years, pressure from huge customers, along with rising commodity prices, new technologies and a slew of acquisitions, have transformed this little-known segment of the paper and adhesives industry into a $5 billion battlefield now under investigation by the Justice Department.

In the middle of the probe is Avery Dennison Corp., the not-so-sleepy Pasadena company whose founder, R. Stanton Avery, invented the first self-adhesive label in 1935.

Avery, the No. 1 producer of pressure-sensitive label stock, controls 50 percent of the market and has been cited for its attempts to "limit competition" in the Justice Department's related antitrust lawsuit to block a merger between the industry's No. 2 and No. 3 U.S. players.

Though Avery is never mentioned by name in the lawsuit, the company is cited throughout the complaint as "the leading producer" of pressure sensitive label stock.

Daniel O'Bryant, Avery's chief financial officer, said in a conference call that the company was cooperating with the Justice Department.

"We will continue to cooperate with this inquiry," he said. "There's really nothing more we can tell you until we hear more from the DOJ."

Some analysts believe the investigation is just another example of the Justice Department's new aggressiveness. But several label stock suppliers and customers said they were not surprised by the allegations.

If anything, they believe that acquisitions have concentrated the market in so few hands that the major players are now in a position to promote each other's interests -- and counteract some of the forces that have been causing prices to fall.

"The material manufacturers have really been in a pinch," said Nick Valestrino, president of Los Angeles Label Co., a label producer. "Some of Avery's competitors in certain areas have been giving them a run for their money."

Low profile

Though consumers have probably never heard 'of label stock, it is one of the most ubiquitous products in the world, used in every type of labeling from wine to shampoo, deli meats to frozen foods.

Avery was started in middle of the Great Depression, when young entrepreneur R. Stanton Avery created the first adhesive label from a small Los Angeles loft and sold them under the name Kum Kleen Products. Within a decade, the company had sales of $500,000 and had changed its name to Avery Products. It expanded rapidly overseas and issued stock to the public in 1964.

Corey Reardon, a director at market research firm Alexander Watson Associates, cited a number of factors that have led to intense competition and lower margins for label stock suppliers like Avery.

One problem is that customers, mostly giant multinational corporations, from Procter & Gamble to Gillette Co. to Unilever PLC, exert massive purchasing power on the industry, pushing prices downward.

The other is factor is industry consolidation, which has reduced the industry to just three major players.

In 2001, Avery Dennison bought Jackstadt GmbH, which had been the world's largest privately held manufacturer of self-adhesive materials, for $295 million. And the proposed merger of No. 2 Raflatac Inc., a unit of UPM-Kymmene Group of Helsinki, with Bemis Inc.'s Morgan Adhesives Co. (Mactac), the No. 3 player, would give the new company 15 percent of the U.S. market share.

Up until this point. the three-way competition has only led to falling prices.

The price mix, a term used by the industry to describe a mix of price and paper grades, has fallen between 1.5 percent and 2 percent in the past year, said Gansham Panjabi, an Lehman Bros. analyst.

"Not only are prices decreasing, but customers are shifting to lower margin products," he said. "I think the DOJ just wants to ensure that competition stays intact. The bottom line is, we'd be paying. more for labels if two guys control the market."

Shrinking Industry

What surprised analysts and those close to the industry was the way in which Avery Dennison's role has been characterized.

For example, the complaint states that, "UPM and the leading producer have already attempted to limit competition between themselves, as reflected in written and oral communications to each other through high level executives regarding explicit anticompetitive understandings."

The Justice Department goes on to state that, "the extent to which these efforts have succeeded to date is not entirely clear."

Central to any allegations that could be levied against Avery Dennison is its close supply relationship with UPM.

Besides producing label stock, UPM-Kymmene is one of the largest paper producers in the world. Over the past several years, Avery has become UPM's largest customer of label papers. Conversely, UPM has become one of Avery's largest suppliers.

This supply relationship, according to the lawsuit, provides UPM and Avery "with the motivations, opportunities, and means to coordinate on price, monitor adherence, punish cheating, and engage in side payments that can be hidden in label paper transactions."

Ironically, UPM has been a major contributor to falling prices. It entered the U.S. market for label stock in 2001, and has engaged in rabid price competition with Avery.

The Justice Department even cites UPM's contribution to the "market-wide erosion of prices," an issue that has been reinforced by buyers in the industry.

Barbara Chavez, president of Stixon Labels in Albuquerque, N.M., a family-owned business that makes labels for water bottles, salsa and wine, said label producers have become more aggressive as the industry has consolidated. "They will do anything they have to, to get the leading market share," she said.

Competition vs. cooperation

But Douglas Christopher, an analyst at Crowell Weedon & Co. in Los Angeles, said he was surprised by the complaint because it acknowledges that customers have benefited from falling prices. Rather than colluding, the complaint shows how the three leading suppliers have all made major investments to add new production capacity to the industry.

"What they're essentially saying is that it's illegal to do something really well and at a low cost," he said. "This is a low-margin business and it seems to me that what we have here is a few single managers talking out of turn about the industry."

One certain result 'of 'the Justice Department's actions is that Avery Dennison and other suppliers won't be able to raise prices any time soon, he said.

Uncertainty about the investigation, which was announced on April 14, has caused Avery Dennison's stock to fall 15 percent, to $52.76 as of April 24.

UPM, which has said it plans to "vigorously defend" the Justice Department's action, raised its paper prices in February. The company, with $10 billion in revenues last year, produces and supplies paper to glossy magazines and catalogs.

What is clear, however, is that many players are now operating in fear.

The industry is "a very competitive business," Scott Wochos, a senior vice president at one of Avery Dennison's smaller rivals, Green Bay Packaging Inc. in Wisconsin.

He would not comment further because he was in the' process of retaining an antitrust attorney.

[GRAPH OMITTED]

[GRAPH OMITTED]