The Diaper War: Kimberly-Clark versus Procter & Gamble

Kerry Mclellan University of Western Ontario Allen J. Wlorrison I Thunderbird (Graduate School of International Management On Novembetl 1, 1989, the management of Kimberly-Clark (K-C) watched with great interest and concern as Procter & Gamble (P&G) announced the appointment of a new CEO* Edwin Artzt. Mr. Artzt had considerable international experience in the disposable diapers industry, and management at K-C wondered if his appointment would signal a new phase of competition within the industry. Six months earlier, prior to Artzt's appointment, P&G had introduced gender- specific disposables with designer colours. While a significant product improvement, gender-specific disposables were not in the tradition of the technological competitive breakthroughs of the past. K-C had responded with test marketing of a similar product, but a national roll-out would still be several months away. The decision to proceed with a national roll-out was tempered by concern that such a move would acknowledge P&G's leadership in the marketplace. Further, K-C managers questioned whether a move into gender-specific disposables would distract the company from important research and development efforts aimed at the environmental concerns now confronting the industry. In considering options, K-C managers were faced with significant financial constraints and wondered whether greater opportunities would be available outside the increasingly competitive North American industry. International opportunities in Europe and Japan merited greater attention, particularly given recent moves by overseas competitors to enter the North American diaper industry. Also of interest to K-C management was the company's ongoing efforts to build a market position for its adult incontinence products. As K-C faced the 1990s, managers braced for heightened competition and wondered how and when to respond.

The disposable diaper, invented in postwar Sweden, was introduced to America by Johnson & Johnson in the late 1940s. Kendall and Parke Davis entered the marketa decade later. At that time, marketing efforts were focused on travelling parents with infants. Research & development efforts tried to increase product effectiveness by improving the methods of matting the absorbent tissue. These early diapers were used with fastening pins and plastic pants and were generally perceived as ineffective in keeping both babies and parents dry. With slow sales, prices for the product remained high ($.10 ea. for disposables versus $.03-$.05for cloth diaper services and $.01-$.02 for home laundered diapers). As a result,most firms remained uninterested in making significant investments in this market segment.

Procter & Gamble's Market Entry In 1961, P&G announced its entry into the disposable diapers industry with the introduction of Pampers; test marketing began a year later. The move to disposable diapers followed progress the company had made in cellulose fibre research through its 1957 purchase of the Charmin Paper Company. Pampers provided a clear technological breakthrough from previous products as it was the first disposable diaper to use a plastic back-sheet coupled with absorbent wadding and a porous rayon sheet facing the baby's skin. Despite these advantages, however, national roll-out was hindered by the product's high price of $.10 per diaper. This price was similar to that charged by other firms and reflected P&G's production approach of purchasing partially completed components to be assembled later. This manufacturing process, while the norm in the industry, was both expensive and time consuming. In 1964, P&G engineers developed a continuous process technology that allowed the manufacture of diapers at speeds of 400 per minute. This process proved many times faster than the previous manufacturing method and allowed the use of minimally processed raw materials. This advance, as well as changes in purchasing, allowed P&G to significantly cut costs. As a result, Pampers was reintroduced into a second test market site at a price of $.055 per diaper. The test was very successful and a national introduction followed in 1966. Full national distribution was achieved by 1969.

Kimberly-Clark's Entry _______________________________________________________________________________ Diaper research at K-C also began in earnest in the mid- 1960s, focusing primarily on new product technology. K-C used its experience with feminine napkins to develop a product that used fluff pulp in place of tissue. The pulp provided cheaper ( and better absorbency. These advantages, coupled with the introduction of adhesive tabs and an improved shape, were incorporated into a new product, called Kimbies, introduced by K-C in 1968. Kimberly-Clark's use of fluff pulp as the primary absorbent material provided competitive cost savings. Kimbies was parity priced with Pampers and competitive cost savings were not passed through to consumers. Rather, K-C re-invested the excess profits into further product improvements. This strategy fit with industry market research that showed a strong

relationship between improved product features and market and sales growth. The cost of product improvements could be passed on as many consumers seemed to show a high degree of price indifference. Competitive Battleground for Many Competitors ______________ __________ Other companies active during the late 1960s included Scott Paper, Borden, and International Paper. All three were experimenting with a two piece disposable diaper system in the mid-1960s. The system relied on technology developed in Europe and involved a disposable inner liner and a reusable plastic outer shell. The products also had a distinct advantage over Pampers in that the diapers used snaps instead of pins. By 1970, a competitive pattern had begun to emerge in the industry. Rivalry was increasingly focused on product innovation. However, these improvements were not always translated into market share gains for reasons that appeared to be two-fold: poor marketing communication of product benefits and the inability of some firms to reduce manufacturing costs to P&G's level. In spite of what some regarded as an inferior product, Pampers appeared unstoppable. By 1970, P&G peaked with an estimated market share of 92%. Observers began recognizing that technology alone was not enough and that many of the large industrial-focused paper companies might be in an untenable position in the industry. Industry Shake-out There was a rapid shake-out of the disposable diaper industry in the early 1970s. The restructuring was hastened by a constant series of modifications undertaken by P&G to further strengthen its Pampers line. For example, the company converted from tissue to pulp fluff in 1972 and to adhesive tabs in 1973. As a result of the heightened competition, Borden exited the industry in 1970, Scott left the U.S. market in 1971, International Paper stopped U.S. production in 1972 and Johnson & Johnsons Chicopee also discontinued its brand in 1972. Other competitors retreated slowly as continuous cosdy improvements upped the ante. This dominant position was maintained until K-Cs Kimbies began to gather steam in the 1972-1974 period. In 1971, Darwin Smith was appointed as the new president of K-C. Smiths objective was to reduce K-C's reliance on core newsprint and paper operations and to strengthen its position in consumer products. This transformation involved the selling off of various mills and woodlands, and the strengthening of the company's market leading Kleenex and Kotex brands. K-C's Kimbies was an early benefactor of this shift in strategy. Buoyed by increased marketing expenditures, Kimbies' market share peaked in 1974 at 20%. However, as the decade progressed, company management became preoccupied with other activities and sales soon began to decline. In spite of the transformation in the industry, disposable diapers were only used regularly on about 35% of babies in 1976. Total market growth remained flat. To most parents, the benefits of disposables were still not large enough to support their added cost. P&G and K-C Introduce Premium Products In 1976,P&G annunced the test marketing and selected regional introduction of a premium diaper product,Luvs.This diaper offered several improvements over Pampers,including a fitted shape and flexible snap closing system,Luvs were priced above Pampers. This introduction was intended to create a new premium market segment, moving Pampers into a middle segment. P&G continued regional market testing for more than 2 years but seemed indecisive on a national roll-out decision. Many observers believed that this hesitation was related to test market results indicating a large negative impact on Pampers. By 1978, K-C's corporate transformation was nearly complete and attention began to be refocused on the diaper sector. Kimberly-Clark introduced Huggies to replace Kimbies. Compared to both Pampers and Luvs, Huggies was better fitting, more absorbent and offered an improved tape fastening system. In support of the new product, K-C hired top marketing talent and backed tlj(e introduction with large promotional and advertising investments. At the time of Huggies introduction, Luvs was still available only on a limited regional basis. With the introduction of Huggies, P&G was forced to complete the national roll-out of Luvs. Luvs suffered from inferior performance relative to that of Huggies and was unable to gain control of the premium segment. Kimberly-Clark continued to produce Kimbies for the market's middle segment, but concentrated resources on Huggies, allowing Kimbies to die a slow death. The production of Kimbies was discontinued in 1986. Huggies' sales grew rapidly as consumers discovered the diaper's superior characteristics. Sales growth came not only through market share growth, but also as a result of the increased usage of disposable diapers. With Huggies, consumers could now more clearly see the benefit of switching from traditional cloth diapers to disposable products. Market penetration of disposables increased rapidly. Procter & Gamble Responds _______________________________________ ___________________ P&G initially did little to respond to K-C's new market entry, jfart of the reason for the slow response was that K-C had introduced Huggies after upgrading its manufacturing processes and P&G had large investments in older diaper machines. P&G was clearly hesitant to make the huge investments necessary to match K-C production processes. This older technology limited P&G's ability to match K-Cs product modifications and put the company at somewhat of a cost disadvantage. To avoid this expense, P&G aggressively promoted Pampers; however, sales continued to slump. Brand market share fluctuated widely dpring the 1981-1989 period; the early 1980s being the most difficult period for P8fG (Exhibit

1).

W EXHIBIT Market Share Data (% of U.S. Retail Shipments^ Brand 1980 K-C Huggies P&G Pampers P&G Luvs Other

1987
7.1 55.7 9.8 27.4 23.1 25.0 24.2 23.5 19.2 12.0 11.3 11.7 48.0 12.3 44.7 18.1 40.0 24.0 35.0 31.3 30.5 35.0 32.0 21.0 31.3 42.2 15.2

1988
31.7 35.6 16.1 17.6

1989
32.0 31.6 17.4 19.0

1981
17.2

1982
18.0

1983
17.7

1984
17.5

1985
19.0

! publicly available

documents on product shipments.

By 1983, mirket research began to convince P&G management that the middle sector was disappearing. Consumers either wanted the best products for which they seemed willing to pay or they wanted low pricedtypically private labelproducts, regardless of performance. Pampers appeared to be stuck in the middle. It was not until 1985, when Huggies had captured 30% of the market, that P&G upgraded its products with comparable features and fought to regain market share. There wflre two elements in the strategy. First, P&G decided to reposition Pampers as a Premium product, comparable to Luvs. The re-positioning was accomplished through improvements in Pampers' shape and fastening system. Second, to improve cost structure and offer the improved features, P&G made major investmehts in its production system. The competitive upgrade of P&G's diaper lines wall very expensive, costing an estimated $500 million for new plant and equipment* A further $225 million in additional advertising and promotion support was usfed to re-launch their slumping brands. Super-Thin Drapers ____________________________________________________ _ During 1986, cbmpetition between P&G and K-C entered a new stage of intense technological rivalry with both companies introducing super-thin, super-absorbent disposables. The new diapers contained polyacrylate, a powder crystal that absorbed 50 times its weight in liquid. By using polyacrylate, diapers could be manufactured Hhat were 30% thinner. The two firms had to reeducate consumers into not associating absorbency with thickness. The campaign was a success and parents seemed to like the new diaper's sleek profile and improved performance. P&G and KC were able to achieve transportation cost savings and retailers were pleased with improved shelf utilization. Procter & Gamble introduced the new technology early in 1986. Kimberly- Clark's introduction followed nine months later. Procter & Gamble's competitive leadership in North America, however, did not come from development work in the U.S., but rather from access to technology developed in Japan, where the company had considerable operations. Kimberly-Clark lacked a significant presence in the Japanese market and had been forced to follow P&G's introduction in North America. Initially, P&G and K-C were dependent on Japanese suppliers for this key material (polyacrylate) and neither was able to obtain the North American license. After two years, however, Cellanese, a U.S. chemical firm, was given a license to manufacture it in North America. Market Segments The introduction of super-thin technology clearly hastened the demise of the mid-market segment. Super-thin technology was regarded as so unique that its utilization Would automatically position a product at the high end of the market. The re-positioning of Pampers in 1984 and the withdrawal of Kimbies in 1986 represented 4n effective abandonment of the midprice segment of the market by the major industry players. During the later half of the 1980s, neither P&G nor K-C attempted tci introduce products to fill the now largely unserved mid-price market segment. The more traditional , lower technology diapers were positioned in the low-price segment. During the early 1980s, P&G and K-C had tested products aimed at the low-priced segment. Kimberly-Clark tested Snuggems. and Procter & Gamble

Head-To-Head Competition

experimented with Simply Pampers. Neither product received national distribution although regional testing continued until the later part of the 80s. The inability of p&G and K-C to place products in the low-priced segment was primarily the result of the reluctance of mass merchandisers to give Snuggems or Simply Pampers adequate shelf space. The retailers were able to earn much higher margins from their private label brands, targeted at the same segment.

Head-To-Head Competition By the Fall of 1989, the industry had effectively evolved into a duopoly dominated by K-C, with a 32% market share and P&G with a 48% share. Both companies sold super-thin diapers exclusively. In 1989, total retail sales of disposable diapers exceeded $4.5 billion in the United States and $400 million in Canada. As a duopoly, competition between P&G and K-C was intense. Given the huge fixed costs involved in the production of disposable diapers, it was estimated that each percentage gained in market share resulted in 6-10 million dollars in additional annual profit. As the disposable diaper market appeared saturated with little growth in the total market expected, it was becoming increasingly apparent that competition for market share would intensify. Historically, market share positions had been extremely volatile, but market growth had helped reduce the risk of low capacity utilization for the firms. In a stable market, market share fluctuations could lead to reduced capacity utilization and profitability pressures for the losing firm. As the rivalry between P&G and K-C heated up, it was uncertain whether the principal focus of the competitive battle would remain fixed on technological innovation and strong promotional support. The stakes were clearly .high and both companies were very intent on winning the batde. It was estimated the K-C and P&G both enjoyed net profit margins of 15% on diapers, as compared to less than 10% on most of their other consumer paper products. In determining the future basis of competition, both P&G and K-C had different resource bases and corporate interests. These are described in the following two sections.

Procter & Gamble Company In 1989, P&G was a leading competitor in the U.S. household and personal care products industries with $13.3 billion in U.S. sales. For detailed financials, see Exhibit 2. P&G's products held dominant positions in North America in a variety of sectors including detergents (Tide, Cheer), bar soap (Ivory), toothpaste (Crest), shampoos (Head and Shoulders), coffee (Folgers), bakery mixes (Duncan Hines), shortening (Crisco) and peanut butter (Jif). Disposable diapers were an important product group that comprised approximately 17% of the firm's total sales in North America. Historically, most of P&G's annual growth had come from the expansion of existing brands where the company's marketing expertise was well known. In building these brands, P&G typically followed a strategy based on developing a superior consumer product, branding it, positioning it as a premium product, and then developing the brand through advertising and promotion. The strategy was consistent with the company's objectives of having top brands and highest market shares in its class.

536
EXHIBIT 2 Procter & Gamble ________________________Consolidated Statement of Earnings Years Ended June 30 (Millions of Dollars Except Per Share Amounts) | income Costs and expenses Net sates Interest and other income

Case 11 The Diaper War: Kimberly-^i<n-

1989 $21,398 291 21,689 13,371 5,988 391 19,750

1988 $19,336 155 19,491 11,880 5,660 321 17,861 1,630 610 1,020

1987 $17,000 163 17,163 10,411 4,977 353 805 16,546 617 290 327

Cost of products sold Marketing, administrative, and other expenses Interest expense Provision for restructuring Earnings Before Income Taxes Income Taxes Net Earnings Consolidated Balance Sheet

1,939 733 1,206

June 30 (Millions of Dollars) Assets Current assets Property, Plant, and Equipment Goodwill and Other Intangible Assets Other Assets Total 6,578 6,793 2,305 675

1989

1988 5.593 6,778 1,944 505

$16,351

$14,820

Liabilities and Shareholders' Equity

Current liabilities Long-Term Debt Other Liabilities Deferred Income Taxes Shareholders' Equity Total

4,656 3,698 447 1,335 6,215 $16,351

4,224 2,462 475 1,322 6,337 $14,820

Segment Information 1 Geographic Areas I Millions of Dollars 1 Net Sales 1987 1988 1989 United States International $11,805 $5,524 12.423 13,312 7,294 8,529 Interdivisional $(329) (381) (443) Total $17,000 19,336 21,398

1987 329 120 (122) 327 1988 864 305 (149) 1,020 1989 927 417 (138) 1,206 Net earnings have been reduced by $357 million in the United States, and $102 million internationally by the provision for: restructuring.

1 Net Earnings*

Source: Procter & Gamble, 1989 Annual Report Procter and Gambles marketing strengths were supported by a core competence in research and development. With shorter product lifecycles for many non-food consumer products, R&D was becoming increasingly important to the company. Much, of the company'^ Jl&D efforts were focused on upgrading existing products. However, in the late 1980s, the firm was devoting large amounts ofK.8iD

Head-To-Head Competition Resources towards several new products, such as Olestra, a fat substitute. In 1989, diapers were estimated to have received approximately $100 million. Some industry observers suggested that the slowdown of innovations in the diaper wars total P&G research and development expenditures were $6'28 million of which may have been partially a result of P&G channelling R&D resources to new product areas.

While P&G had generally been successful with its internal development efforts, gross margins had not been as high as those of competitive firms. During the late 1980s, the company also showed signs of waverinz in its approach to market development. Attracted by opportunities in other markets, P&G had circumvented the development process and proceeded with |several highly publicized acquisitions, including Richardson-Vicks (Vicks cough/eold remedies, Oil of Olay, Clearasil, and Vidal Sassoon hair care products), G.D, Searle (Metamucil, Dramamine and Icy Hot), Bain de Soleil (sun care products), atj,d Sundor Group Inc. (fruit drinks). The results of these acquisitions were not yet clear in 1989.

In addition to being a dominant competitor in the U.S. household products and personal care products industries, P&G also had a strong ppsition in several key international markets. In 1989, international sales surpassed $8 ,5 billion and income from international operations soared to $417 million, up aljnost 37% from the previous year. Sales growth in Europe and Japan was particularly impressive, with European sales up almost 15% and Japanese sales up more |han 40% over 1988 figures. Performance in international markets was led by strong showings in diapers and detergents.

Kimberly-Clark In 1989, K-C was a leading manufacturer and marketer of personal, health care and industrial products made primarily from natural and synthetic fibres. In 1989, the firm had revenues of $5.7 billion with a net income of $4?4 million. Detailed financials are found in Exhibits 3 and 4. Well known products manufactured by K-C included Kleenex facial tissues, Kotex and New Freedom feminine care products, HiDri household towels and Depend incontinence products, (for product analysis, see Exhibit 5.) Huggies disposable diapers were K-Cs lajgest single product contributing $1.4 billion to 1989 sales and an estimated 37% ,of net income. Kimberly-Clark was organized into 3 divisions. By far th largest of these was the personal, health care and industrial products division. Personal products included disposable diapers, feminine care products, disposable hand towels and various incontinence products. Heath care products included primarily surgical gowns, packs and wraps. Industrial products included cleaning wipers made of unwoven materials. Together, the division's products contributed 77% of K-C's 1989 sales and 78% of its

net income. Kimberly-Clark also manufactured newsprint and groutydwood printing pa- Efy 536 pers, premium business and correspondence papers, cigarette papers, tobacco products and specialty papers. These operations were part pf the firm's second Bs|l division that represented 19% of corporate sales and net income. The importance Hh- of the woodlands-related products to K-C had diminished thrqughout much of the 1970s and 1980s as the company shifted resources into consumer products. The two divisions were, however, closely linked to the degree chat many of K-Cs consumer products relied on cellulose fibres supplied by the company's woodlands operations.It is estimated that 65% of the wood pulp needed for consumer products were supplied inhouse,a level considered high in the industry.It was thought that

Kimberly-Clark Corporation and Subsidiaries: Consolidated Income Statement

Case 11 (S millions of dollars except per share amounts) I Net sales I E X HICost BI T of products sold Distribution expenses Gross Profit Advertising, promotion and selling expense Research expense General expense Operating Profit Interest income Other income Interest expense (Millions of dollars) Other expense Total Current Assets Income Before Income Taxes Net Fixed Assets Provision for income taxes Investments in Equity Companies Income Charges before equity Interests Deferred and Other Assets Share of net income of equity corr/panies Total Assets Minority owners' share of subsidiaries' net income Total Current Liabilities Net income Long-term Debt Other Noncurrent Liabilities Deferred Income Taxes Minority Owners' Interests in Subsidiaries Total Stockholders' Equity
Source: Kimberly-Clark 1989 Annual Asset Total Liabilities and, Equity Report s Liabilities

-|

1989 1443.2 3,040.9 296.6 142.3 $4,923.0 $1263.2 745.1 79.9 643.5 105.5 2,085.8 $4,923.0

1988 1278.3 2,575.8 291.7 121.8 $4,267.6 $925.7 743.3 53.7 585.0 94.3 1,865.5 $4,267.6

vertical control provided the advantage of flexibility and security under rapidly changing competitive conditions. However, it also signiBcandy complicated strategic plannijlg and potentially magnified swings in performance that accompanied shifting competitive conditions. Observers noted that prices for newsprint and paper products had been highly cyclical during much of the 1980s. In 1989, there was an indication that prices w e f e softening and would likely remain depressed as large amounts of capacity were expected to be added to the industry in the early 1990s.

m
EX H IB IT 4

Head-To-Head

Kimberly-Clark Corporation and Cnk Analysis of 1989 I Consolidated n Ubs,d,ar,eS ($ Millions) * d Prating Results I

Competition

By Geography
Sales

1989

North America Outside North America Adjustments Consolidated

% Change vs. 1988

% of 1989 consolidated

$4,664.0 1,087.1 (17.5) $5,733.6 $316.7 107.1 $423.8

+6.4% +6.0

81.3 % 19.0 (3)

Alet Income

North America Outside North America Consolidated

+6.3%
+12.1% +11.3 +11.9%

100.0 %
74.8 % 25.2 100.0 %

Source: Kimberly-Clark, 1989 Annual Report

Segment Breakdown, 1981-1989

($ Millions) 1981
1982 1983 1984 1985 1986 1987 1988 1989

Net Sales

Consumer Products Division Forestry Division Aviation Division Subtotal (interclass) Total Consumer Products Division Forestry Division Aviation Division Subtotal Corporate Total Consumer Products Division Forestry Division - Aviation Division Subtotal Unallocated interclass Total

Operating Income

Return on Average Assets

$2,205 $2,464 742 795 61 75 $3,008 $3,334 (62) __ (60) $2,886 $2,946 $3,274 $171 $173 $221 120 3 109 7 118 _ 8 $294 $289 $347 (16) (19) (31) $278 $270 $316 10.5% 11.4% 12.0% 19.6 22.5 20.4 10.8 5.0 12.3

$2,103 781 44 $2,928 (42)

$2,734 845 97 $3,676 (60)

$3,172 856 118 $4,146 __ (73) $4,073 $3,616 361 162 _2 $263 139 $525 11 (39) $413 $486 (38) 15.3% $375 27.1 12.7% 2.8 23.9 15.0 15.1% N.M. 12.3% 17.4% N.M. 14.6%

3,370 876 99 $4,345 (42) $4,303 $363 145 9 $516 (32) $485 14.0% 22.8 12.3 15.7% N.M. 13.5%

$3,809 1,001 125 $4,935 (50) $4,885 $434 177 13 $624 (38) $586 15.9% 26.0 17.0 17.9% N.M. 15.5%

$4,165 1,121 166 $5,452 (59) $5,394 $435 204 23 $662 (21) $641 14.2% 27.7 17.4 12.0% N.M. 11.9%

$4,481 1,096 211 $5,788 (54) $5,734 $535 129 26 $690 (17) $673 15.091 15.7 16.5 11.99 N.M. 11.79

14.% N.M. 11.7%

12.7% N.M. 10.6%

13.9% N.M. 11.3%

Source: Duff & Phelps Research Report, November 1988, Kimberly-Clark 1989 Annual Report

in UJ to

540

Case 11 The Diaper War: Kimberly-Clark versus Procter 8c Gamble

yp E X H I B I T 5 Kimberly-Clark Consumer, Health Care, ($ in Millions) Domestic Categories / Disposable Diapers / Facial Tissue 1 Feminine Pads 1 Tampons / Paper Household Towels / Bathroom Tissue / Table Napkins I Consumer Incont Products 1 InstTInd. Tissue Products Inst. Healthcare Other Nonwovens Medical Total Domestic Canada Sub-Total North America Outside North America Total Consumer Division 60 170 180 176 30 2,821 250 3,071 738 3,809 1987 Est Sates 1,220 220 450 270 30 170 35 30 52 21 2 10 0 1987 Est Open Profit

Industrial Products 1988 Est Mkt. Est Rank of Share Brands 32% 2 45% 26% 6% 10% N.M.9 N.M. 49% 1 2 4 4 N.M. N.M. 1

Major Competitorsf Mkt. Share Pampers 31%, Luvs, 17% (P&G] Private label 20% Puffs 17% (P&G); Scotties 10% (Scott Paper) J&J 37%; Always 20% (PG); Maxithins 5%; Priv. Lab. 12% Tambrands 58%; Playtex 26%; J&J 8% Scott Paper 23%; P&G 20%; James River 11 % P&G 30%; Scott Paper 19%; James River 13% Scott Paper 23%; James River 8% Attends 28% (P&G); Serenity 8% (J&J); Private label 15%

2 3 5 4 4 2 325 20 345 89 434

Negligible amount Source: Duff & Phelps Research Report, November 1988.

The companys smallest division (4% of revenues and 3% of net income) operated a business aircraft maintenance and refurbishing subsidiary, and Midwest Express Airlines, a commercial airline based in Milwaukee, Wisconsin. K-Cs international operations provided 29% of company sales and 30% of the operating income in 1989. The companys major markets, on a consolidated basis, were Canada, the United Kingdom, France, the Philippines and Brazil. K-C had several international equity investments; the largest, in Mexico, provided $36 million in net income. In 1989, K-C manufactured disposable diapers in 9 countries and had sales in more than 100 countries. Outside North America and Europe, however, sales of disposable diapers were very low, largely because of undeveloped markets. Also, Kimberly-Clark had abandoned the Japanese market which weakened the potential for expansion into growing Asian markets.

Battiling for market share

Historically,the principal rivalry in the disposable diaper industry had been based on the search for a superior product.However,product feautures were only translated into market share by the more visible aspects of ijfiarketing implementation.

The battle for market share began in maternity wards where both P&G and K-C paid hospitals to distribute disposable diapers free of charge to new mothers. Hospital usage suggested a medical endorsement and was believed to influence mothers to continue using a particular brand once she and th^ baby left for home. Once the free samples and coupons had been used, mothers realized just how expensive disposables would be. In 1989, at a price of 18 to 36 cents each, depending cm size, it would cost $1,400 to $1,700 to diaper one child for 2 1/2 years in brand name disposables. It was estimated that the cost of cloth diapers supplied by diaper services was comparable, but could be up to 20% lower depending on the type of service provided. Generic or private label disposables were about 30% cheaper than national brands but most suffered from distressing performance problems. Cloth diapers washed at home would cost $600 or less. Increasingly, however, price was being discounted as a purchasing criterion.

With up to 75% of new mothers working outside the home, many families often valued time more than money. Similarly, as family size diminished, parents showed an increased willingness to spend money on outfitting babies. This meant that more and more families were prepared to pay fpr quality disposable diapers. In North America, P&G and K-C were estimated to spen<l a total of more than $110 million annually on diaper promotion. This promotion primarily involved commercials and coupons. Retailers often used diapers as ||oss leaders and the companies supported these activities through volume rebates based upon the number of tons of diapers sold. Couponing potentially saved j consumer 10-15% but the unwritten rule was that neither firm would undercut the other.

Manufacturing The production of disposable diapers was capital intensive, The process was a continuous flow of assembly utilizing large, complex, high speed machines. The machines were several hundred feet long with a cost range of ||2-$4 million dollars, depending on speed and features. Usually several machines y^ere grouped at each plant location. As a result of the high capital costs, capacity planning and utilization were essential to profitability. Firms attempted to operate their diaper machines 24 hours a day, 7 days a week. Additions to manufacturing capacity required a lead time of 12-18 months. In addition, most facilities needed several months to work jhe bugs out of new equipment. In the past, uncertain market share forecasts and fluctuations had led, at different times, to capacity surpluses and product shortages for both firms. The competition between P&G and K-C resulted in a history of vyjde swings in market share. Ironically, both firms would have had lower manufacturing costs with reasonable industry stability. Despite technological improvements, diapers were still a bulky product and transportation costs were estimated to compose at least 7% q,f the retail value. To minimize transportation costs, both K-C and P&G had traditionally built regional plants. Transportation costs had been 50% higher prior to the introduction of superthin, super-absorbent technology.

ft

With the introduction of super-thin technology from Japan,it was becoming increasingly apparent that the competitive conditions in North America could not be viewed in isolation. By the late 1980s, competitive condmons in both Europe and Japan were having a significant influence on opportunities and threats facing North American competitors.

Japan Historically, Japanese consumers had enjoyed better quality cloth diapers than consumers in Cither countries, thus slowing the acceptance of disposables. Following World War II, national standards were introduced for cloth diapers as a means of improving Overall hygiene. The standards resulted in the development of a highly effective two layer cloth diapering system. The use of cloth diapers was further encouriged by a Japanese traditionwhen a woman became pregnant, her mother-inlaw would present her with approximately a thousand cloth diapers. As a result, cloth diapers became a common gift at baby showers and the use of disposable didpers was strongly resisted by Japanese women. In recent years, however, the consumer benefits provided by disposables have become more apparent. Changing roles of women in Japanese society have also led to a rapid growth in thdi demand for disposable diapers. Procter Ik Gamble s competitive experiences in Japans diaper industry were remarkably similar to its experiences in North America. In the early 1970s, P&G enjoyed a mlrket share greater than 90% of the Japanese disposable market However, as in North America, the product had performance problems and total market penetration was weak. P&G's biggest problem was complacency. In 1982, P&G was miking its diapers with old fashioned wood pulp. In the same year Japan's UniCharm Corp. (1989 sales: $600 million) introduced a highly absorbent, granulated pUlymer to soak up wetness and hold it in the form of a gel, keeping babies dry lohger. In 1984, KAO Corporation, a Japanese soap maker (1989 sales: $4 billion) launched a similar brand of super-thin diapers under the brand name Merries. P&G did not begin selling its polymer-packed Pampers in Japan until January 198.'). By that time P&G's share of the Japanese market had fallen below 7%. Uni-Charm controlled almost half the market and KAO about 30%. After P&G's initial setback, the company recommitted itself to the battle and enjoyed several important gains. The reintroduction of Pampers and a premium Luvs helped P&G's market share recover to a level of 15-20%. In recbmmitting to the Japanese market, P&G recognized that Japanese product technology was years ahead of U.S. levels. Being well positioned in Japan meant that P&G would have greater access to Japanese technology which could be exported bifck to the U.S. to use in its battle with K-C. Kimberly-Clark was not a major competitor in this market having sold its interest in its Japanese equity company ill 1987. By 1989, the Japanese market had not yet reached the same level of maturity demonstranfed in the U.S. While the market was worth over $1 billion in 1989, market penetration for disposables remained under 50%. These penetration figures were also for parents that used disposable diapers on "occasion". Many families. combination of used disposables and traditional cloth diapers. Japanese parents

changed their babies more frequently (twice as often) as North American parents and therefore used many more diapers. Industry estimates indicated that the Japanese market, if developed to the same degree as the L7.S. (85-90% penetration, most of which was exclusively disposable), would be almost as large as the U.S. This was despite a population size of less than half. There was tremendous opportunity for growth in the Japanese market. Faced with intense domestic competition, Japanese firms historically showed little interest in moving internationally. However, there was growing concern in North America that Japanese preoccupation with domestic competition was beginning to change. In 1988, KAO acquired Jergens Ltd., the U.S. producer of personal care products, and several analysts speculated this was the beachhead for a major U.S. thrust into the North American market for personal products, including disposable diapers. There was also speculation in the press that UniCharm had begun negotiations with Weyerhauser to set up joint production/ distribution operations in the U.S. Weyerhauser was a large, integrated U.S. forest products company that held a 50% share of the low-priced, private label market for disposable diapers. It was known that Weyerhauser had been considering a major move into the mid-priced segment for disposables. Europe The development of the disposable diapers industry in Europe was also decidedly different than in North America. Europeans began producing disposable diapers using a two-piece system in the early 1960s. Unlike the North American industry, however, the European industry did not experience a high degree of rationalization. There were two main reasons for this. First, Europe was composed of very different, often protected national markets thus limiting production, marketing, and distribution economies. Second, no large, European industry leaders emerged and foreign competitors from North America and Japan were preoccupied with domestic competitive battles. As a result, several strong country-specific firms emerged. Penetration of disposable diapers varied widely across Europe. In Northern Europe the market had long been saturatedin France, for example, 98 out of 100 diaper changes were done using disposablesand consumers appeared to be increasingly preoccupied with environmental concerns. Many consumers were experimenting with a variety of alternatives to disposables. In Southern Europe, penetration levels remained much lower and the market less sophisticated. Here, the percentage of women employed outside the home was lower, and many observers felt that these markets offered significant growth opportunities. European disposable diaper sales were growing much quicker than sales of most other household products. The development of a unified internal market for Europe promised potential industry rationalization opportunities. Since the mid- 1980s, both P&G and K-C had re-focused attention on Europe, achieving some success. However, by 1989 the market was still fragmented with neither firm enjoying the dominant position experienced in their domestic market. In weighing opportunities in Europe, both P&G and K-C had to determine whether limited investment capital for expensive market development would be better spent at home or overseas; and if overseas, in which market? Also of concern was the potential reaction of European firms, both overseas and in North America, to the perceived aggressiveness of U.S. firms in their home markets.

In 1989, almost 19 billion disposable diapers were sold in North America. This produced an estimated 4 billion to 5.5 billion pounds of discarded diapers. In some residential landfills, some tests showed that disposable diapers constituted as much as 20% of the total volume (industry studies showed a much lower estimate of less than 2%), leading to widespread criticism of the industry for the non- biodegradable nature of the plastics in the product. (It took an estimated 250 years for a plastic disposable diaper to bio-degrade.) Environmental groups had highlighted concerns about potential health risks for sanitation workers and the threat to ground water. By 1989, legislation taxing, regulating or banning the sale of disposable diapers had been introduced in 11 U.S. states. Most punitive measures were scheduled to come into effect in 199294 giving competitors some time to react. There were signs that the seriousness of the environmental problem had not fully reached either P8tG or K-C. In public statements both companies cited studies showing that the laundering of cloth diapers used 6 times the amount of water as was used in the manufacture of disposables and the laundering created 10 times as much water pollution. P&G went even further by arguing that its disposable diapers were 60% to 70% biodegradable. Richard Nicolosi, vice-president in charge of P&Gs worldwide diaper operations, commented: "We don't think mothers are willing to give up one of the greatest new products of the postwar era". Although K-C had a note in its 1989 annual report citing the potential seriousness of the threat, the company had been reticent about specific plans for dealing with the issue. According to Tina Barry, VP-Corporate Communications at K-C, "were working with out suppliers to find a reliable plastic that is bio-degradable. But we haven't come across any plastic material that breaks down and maintains product- performance and reliability. Many industry observers believed that unless environmentally friendly disposables were introduced, cloth diapers would continue to gain in popularity. By 1989, cloth diapers had captured 10-15% of the total North American diaper market. In the late 1980s, both Fisher Price and Gerber had begun to re-examine this market and had introduced form fitting, two-piece diaper systems. The strategy reflected an appreciation that cloth diapers could be sold either directly to consumers or to diaper services. The R&D effort for the industry had a clear challenge, but by 1989 no promising technologies had been introduced to address the rising environmental concerns. This was in contrast to the Japanese market where the market leaders had avoided or minimized the use of non-biodegradable plastics. It was also recognized that Japanese firms had considerable technological experience with biodegradable external retaining fabrics. Both P8tG and K-C had yet to adopt such technology and were sceptical of biodegradability claims. Product Diversification As the North American disposable diaper market became saturated, both P8tG and J K-C sought other market opportunities that might utilize the technological j| expertise gained from their diaper rivalry. One avenue that seemed particularly I attractive was increased development of incontinence products (similar to diapers) |9

Current Issues 'for adults. Incontinence products appeared to be an ideal product extension for the super-thin technology utilized in disposable diapers. With the improvement in incontinence product performance, sales and market penetration had exploded. It was estimated that sales would reach $1 billion in the U.S. market by 1990, and that the potential size of this market could eventually exceed that of diapers. Of the 31 million North Americans over 65, it was estimated that about 10% had a problem with incontinence. An aging population would allow total market growth opportunities as well as growth through increased penetration. The fight for market share was shaping up to be a replay of the disposable diaper war, with the same players. A difference in this competition was the contrasting strengths possessed by each firm in the distribution network. P&G dominated the institutional distribution channel while K-C was the leader in the commercial/retail channel. KimberlyClark had broken important new ground in this market and strengthened its distribution position by successfully developing a television advertising program that tastefully promoted the benefits of its incontinence products. Recent Events On November 1, 1989, P&G announced the appointment of Edwin Artzt as the company's new CEO. Artzt, who was chosen for the position over an heir apparent, had directed P&Gs international operations since 1984. In that capacity he had been responsible for the company's spectacular recovery in Japan, particularly in diapers, and its double digit growth in Asia and Europe. Managers at Kimberly-Clark wondered whether the appointment of Mr. Artzt signalled a shift in P&G's emphasis away from the U,S. marketplace. They also speculated whether his appointment was designed to strengthen P&Gs access to new Japanese technology that could produce mere environmentally friendly diapers. In response to these concerns, managers at Kimberly-Clark wondered what sort of action to take, either internationally or in Nortji America. With external pressures mounting, the nature of the competition in the North American disposable diaper industry showed signs of change in 1989. For the first time, neither of the two competitors had introduced major product improvements; rather, they made style changes. In the summer of 1989, P&G introduced His and Hers diapers with designer colour patterns and special absorbent pads strategically placed for boy and girl babies. P&G had backed the introduction with a huge advertising and promotional campaign which made it difficult to gauge the true market share impacts of the new products. In response, K-C had developed a similar product and was in the test marketing phase. It was estimated that a similar national product introduction for K-C would cost $50-75 million. In responding to mounting competitive pressures, (j>oth K-C and P&G recognized that balance between short-term and long-te([m perspectives was essential. The focus of this balance was, however, the basis of considerable uncertainty.