By Euan Rocha

NEW YORK (Reuters) - Growing demand from retailers and manufacturers for smaller, eco-friendly packages is pushing box makers and chemical companies to create compact packaging that is bio-based and recyclable.

Most initiatives, although still in their infancy, are being spurred by increasing environmental awareness and looming legislation. But companies exploring smaller and 'greener' packaging options are also doing so with a keen eye on profits.

"I would say that the balance is still probably weighted more toward cost control," but the significance of environmental benefits is growing, said Wachovia analyst Ghansham Panjabi.

At the forefront of one such initiative is the world's largest retailer, Wal-Mart Stores Inc. Last year, the company announced a plan to reduce packaging by 5 percent by 2013, a move that could save it $3.4 billion.

A reduction in the volume of packaging has interesting ramifications said Robert Anstine, vice president of marketing at International Paper Co's Shorewood packaging unit, which is working with Wal-Mart on its packaging reduction program.

"If you go to a smaller package, it means you can put more of them in a shipping container, which means you can get more product on a truck; it lowers the amount of energy and fuel used to transport the product," Anstine said.

However, the chain reaction does not stop there. It also means more products on shelves, a higher probability of customers finding the products they seek and fewer man hours spent restocking shelves.

Bio-based packaging products are also becoming increasingly popular and being used in surprising places.

International Paper for instance manufactures PaperFoam, a starch-based product that can be used in lieu of traditional plastic compact disc trays.

Target Corp, the No. 2 U.S. discount chain after Wal-Mart, recently partnered with bioscience company Metabolix Inc to create a new gift card using Mirel, a bio-based plastic.

Curiously, a rather nondescript packaging product -- brown paper bags -- has begun to gain traction again as cities and municipalities begin to restrict the use of plastic bags.

"We do see that (paper bags) coming back quite a bit and we can produce a paper bag with a pretty high recyclable content," said Don Atkinson, vice president of marketing at Weyerhaeuser Co.

Even, chemical makers that have traditionally manufactured hydrocarbon-based plastics have begun exploring some bio-based options.

Dow Chemical, the largest U.S. chemical maker, is exploring ways of making polyethylene -- a widely used plastic -- from sugar cane. While DuPont Co is producing propanediol, an ingredient used in cosmetics and anti-freeze, from corn sugar.

But the big question is -- will customers pay more for more eco-friendly packaging?

Brian Igoe, chief brand officer of Metabolix, says customers are willing to pay more for cleaner products, but some analysts and executives beg to differ.

"It has to be priced competitively, because, historically, what we've seen is consumers and retailers are not particularly interested in paying more for a 'green' product or package," said International Paper's Anstine.

Analysts and executives concur that customer behavior, more than legislation, remains the deciding factors in the debate.

"Consumers ultimately get to decide. You can introduce all sorts of legislation, but at the end of the day it depends on what the consumer does," said Wachovia's Panjabi.