Business
The Poop on Drypers
For nearly a decade, the upstart Houston diapermaker cleaned up. Then things got messy.
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So how did the upstart do it? First, to win over customers, Drypers slashed its retail price, selling its diapers and training pants for an average of $1 less per package than the premium brands. Second, to win over retailers, Drypers cut its profit margin, offering grocery stores as much as 12 cents for every dollar of sales, compared with 5 cents or less for Pampers and Huggies. This was critical, because retailers are particular about diapers. The right ones are “traffic builders”: They take up shelf space, but they make up for it by luring parents, who typically spend heavily on food and other items, into the store.
A third Drypers innovation was to cut costs by “piggybacking.” The company let its better-heeled competitors spend millions on research and development and then rushed in with knockoffs of new products and advances—such as super-absorbent cores and elastic waistbands—which could be offered to value-conscious parents at a low price. “We were better followers than anybody else in the industry,” Tognietti boasts. Sometimes, however, piggybacking has gotten the company into trouble: In 1994 Drypers settled a suit in which Kimberly-Clark alleged a patent infringement on its inner leg gather.
Beyond the success of this approach, Drypers benefited from a sea change in the way Americans shop. Its diapers hit the stores at a time when consumers were becoming more thrifty and less loyal to the big-name brands. From 1989 to 1993, Pampers’ share of the market in U.S. grocery stores declined from 27 percent to 23 percent, and Luvs’ share fell from 24 percent to 12 percent. By contrast, Drypers’ share grew from 2 percent to 5 percent. The most recent figures available show Drypers with a 6.8 percent share of the market in U.S. groceries, compared with 27 percent for Huggies, 21.5 percent for Pampers, and 13.1 percent for Luvs.
Still, when you factor in mass merchandisers and drugstore chains, through which $1.7 billion in disposable diapers were sold in the U.S. last year, Drypers’ slice of the total pie is a mere sliver—2.7 percent in 1995 versus more than 38 percent each for Kimberly-Clark and P&G brands. Particularly tough to crack are Wal-Mart, Kmart, Target, and Toys R Us, which prefer to stock mammoth national brands rather than smaller ones—and Drypers still is, relatively speaking, small. The only good news on this front is that its diapers are now being test marketed at seventy Super Kmarts around the U.S.
The mass-market issue has long plagued Drypers; in fact, the company planned to have it resolved by now. In late 1994, to improve its national visibility, Drypers hatched plans to repackage three regional brands acquired in 1992—Baby’s Choice, Wee-Fits, and Cozies—under the Drypers brand name and launched its first national advertising campaign in the big parenting magazines. Unfortunately, the consolidation took place just as a barrage of bad luck was about to hit.
It began on December 20, 1994, the day the Mexican peso began to plummet: Drypers saw some $10 million in annual sales vanish nearly overnight. “We suddenly became unaffordable to Mexican consumers,” says Chambers, the CEO of Drypers’ international division. Even though the peso rebounded, Drypers’ sales didn’t. The following June, the company had to close its plant in northwest Houston, which supplied the Mexican market, and lay off 26 people. Today the 81,000-square-foot factory on Loop 610 still sits idle.
On the heels of the peso crisis came another hit: In February 1995, to catch up in market share, P&G slashed prices on Luvs, prompting Kimberly-Clark to cut prices on Huggies. The repositioning of Luvs as a mid-tier brand put it in direct competition with Drypers, whose own cut in prices wasn’t enough to satisfy analysts. “Luvs still carries a lower average price per diaper than Drypers,” says Tristan Gerra, an associate analyst with Dean Witter Reynolds, who points out that sales of Luvs increased 20 percent between the first quarters of 1995 and 1996, while Drypers posted only a 10 percent gain.
While the price war raged, the cost of wood pulp began to soar. Pulp prices peaked last October at an unprecedented $975 per metric ton, up nearly 75 percent in nine months. Unable to pass the increase on to consumers, smaller diapermakers like Drypers scrambled to cut costs. “We looked at every single item on the income statement,” says Klemp. “When a giant like Procter decides not to make any money, there is only so much you can do.” In the past, Drypers had been nimble enough to survive cost cutting and pulp price fluctuations. But this time, because it was in the middle of launching a national brand, it was caught off guard. “Within about a four-month period,” Klemp maintains, “we lost twenty percent of our market share.” To make matters worse, in June 1995 Drypers defaulted on a $15 million line of credit from First Interstate Bank of Texas. Without $20 million in new financing it would default on a $2.8 million interest payment due to bondholders in November.
The reversal of fortune was swift—“It was one of the most remarkable shifts in business I’ve ever seen,” says Lehmann—but the worst of it was over by mid-summer. Drypers’ share of the grocery market began to rebound after bottoming out at 4.1 percent in June 1995, and pulp prices started falling last fall. Bondholders granted the company an extension of its November deadline. And two of Drypers’ largest shareholders—Equus II and Davis Venture Partners of Tulsa—agreed to invest another $3.6 million to help it stay out of bankruptcy court. What persuaded them to up the ante? “These guys make a good product at a good price, and I think they’ll be successful,” says Lehmann, who has a lot to lose if he’s wrong: Equus II’s shareholders own 3.6 million of the total 6.6 million shares of Drypers’ common stock.
This March, Congress Financial Corporation of Dallas agreed to provide a $21 million line of credit. For now, at least, the company is enjoying some breathing room from its creditors and its competition. While Drypers remains “at the mercy of pulp price increases and retail price reductions by Kimberly and Procter,” according to Gerra of Dean Witter, the good news is that pulp prices are expected to remain flat through year’s end, and P&G—having sacrificed profits to wage last year’s price war—is making noise about making money again. In February it announced a price increase, though it backed off when Kimberly-Clark didn’t follow its lead.
There are still potential pitfalls ahead, of course: Financial data made public in May show Drypers operating at a loss despite an aggressive cost-cutting program instituted last July to save about $3 million a quarter. And restrictions on its new credit lines and a steep hike in interest costs will reduce its flexibility. International operations, for one, will have to make due with less cash. But one traumatic year hasn’t humbled Drypers’ CEOs or their investors. While they have no delusions about striking a fatal blow to either P&G or Kimberly-Clark, they’re confident they can thrive again in the giants’ shadow. “I just like the Davids of the world against the Goliaths,” says Lehmann. “We don’t have to beat them. We just have to make a good showing.”
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