The Poop on Drypers

For nearly a decade, the upstart Houston diapermaker cleaned up. Then things got messy.

ONCE UPON A TIME, babies’ bottoms were swathed in reusable squares of absorbent white cotton secured by safety pins—not because it was politically fashionable, but because they were the only diapers around. Then, in 1961, Procter and Gamble introduced Pampers brand disposable diapers, and parenting changed forever: Soon babies everywhere were being reared in layers of pulp and plastic fastened by strips of tape. As the only major player in the game, P&G reigned until 1973, when Kimberly-Clark introduced a formidable brand of its own, Kimbies. Five years later, P&G brought out Luvs, and Kimberly-Clark countered with Huggies, which toppled Pampers in mid-1985 to become the top U.S. brand. Who was ahead hardly mattered, though, for over time, as disposables grew to absorb more than 90 percent of the nearly $4 billion in annual domestic diaper sales, the premium brands generated huge profits and made their parents richer.

But in 1987 an unlikely new player, Houston-based Drypers, joined the fray. With just $2.25 million in start-up money, the company’s founders—two ex— P&G employees and an ex-accountant—embarked on what seemed like a suicide mission: to challenge the diaper duopoly head on, just as Wendy’s had done with Burger King and McDonald’s. Its strategy was to carve out a niche between the pricey premium brands and cut-rate brands such as DSG and Fitti. “Our goal was to turn one in ten customers,” says Terry A. Tognietti, the CEO of Drypers’ North America division.

At first, the strategy succeeded. Although Fortune 500 firms including Johnson and Johnson and Colgate-Palmolive had tried and failed to crack the market, Drypers amassed $156 million in annual sales by 1993 and rose to be a distant third. That year, Inc. magazine named it the fastest-growing private company in the U.S. Yet Drypers’ fortunes fell just as quickly as they rose. Last year, as the company planned to roll out a new nationwide brand, the peso collapsed in Mexico, where more than 5 percent of its business was based, the cost of wood pulp—a key ingredient in disposables—skyrocketed, and P&G initiated a price war. Consequently, Drypers had to shutter its Houston plant, lay off workers, and contemplate filing for bankruptcy protection. Its stock, which hit a high of $16 a share following a public offering in March 1994, plummeted to $1.38. “Everything that could go wrong did,” Tognietti says with the look of a man who has taken a bullet.

Were Drypers officials to blame? Absolutely not, they say, and analysts agree; the company simply fell victim to bad luck, bad timing, and external factors that could not be controlled. “It’s just unbelievable that all those things could have occurred at the same time,” says Nolan Lehmann, the president of the Houston investment fund Equus II, which has pumped nearly $9 million into Drypers since 1991. In the annals of business, of course, this sort of outcome to an underdog story is not that unusual: Often, despite David’s valiant efforts, Goliath wins the battle. What is unusual is that this time, David is getting another shot. Refinanced and reenergized, Drypers is making a bid to take on the heavyweights again. The company has just introduced a new product line—Drypers With Baking Soda—and signed a deal to produce diapers in Mexico. “Full speed ahead,” says chairman of the board Walter V. Klemp.

Although Drypers has always been based in Houston, its roots are in Portland, Oregon, where three 25-year-old bachelors were searching for a business opportunity. “We had no experience producing diapers,” admits Klemp, who had been an accountant with Coopers and Lybrand. But he and his partners understood economics. A baby, on average, uses six diapers a day for thirty months, for a total of 5,475 diapers. At an average retail price of 17 to 25 cents for each disposable diaper, that’s as much as $1,368.75 per baby—and there are an estimated 10 million babies in the U.S. The European diaper market serves another 10 million babies. And developing areas with high birth rates, such as Mexico, South America, and Asia, are largely untapped. Overall, the worldwide market is worth $12 billion—and could eventually hit $100 billion. “It was too big of an opportunity to pass up,” Klemp says.

In 1984 Klemp, P&G sales representative David M. Pitassi, and glue salesman Tim G. Wagner founded a small diaper manufacturer called VMG (a combination of their middle initials). Soon they were joined by Raymond Chambers, who had been a manufacturing engineer for Pampers. Perhaps because it was one of the first high-quality, value-oriented diaper brands, VMG sold out its first production line in just three months. Still, that surprised everyone, including the company’s outside investors, who decided they needed a more professional management team.

Klemp and Pitassi cashed in their small stakes in VMG and two years later headed to Houston, where they were joined by Tognietti, who had managed the Luvs production team at P&G. Using the same business plan that had worked so well before, they started Drypers, and it too thrived. In 1991 the company attracted its first big infusion of Texas capital: $3.3 million from Equus II. “We invested in the individuals,” says Nolan Lehmann. “They’re among the most dedicated managers we’ve dealt with.” The following year, Equus II kicked in $3.1 million more, and Drypers could afford to pay $40 million to acquire VMG, hiring Chambers in the process.

Lehmann hadn’t been the only one paying attention. Although P&G barely noticed VMG, Drypers’ start-up raised eyebrows at the conglomerate’s Cincinnati headquarters. “We consider all comers a competitor,” insists P&G spokesman Scott Stewart, but when Drypers stole away Tognietti, there was suddenly talk of legal action. “Three hours after I gave notice, my son Dominick was born,” Tognietti says. “When I got home from the hospital at five a.m., I got a phone call saying, ‘Come to Cincinnati. You’ve got a big problem.’” P&G threatened to sue to prevent Tognietti’s hiring, but after five months a settlement was reached in which he promised not to steal any

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