Diaper Manufacturers Pay Their Dues

By Karen McIntyre, Editor | January 5, 2006

success requires innocation, global expansion and cost competitiveness

Mention the diaper market to most nonwovens executives and conversations about severe competition, market maturity and pricing pressures will likely follow. But, as the largest market for nonwovens globally, the diaper market is the lifeblood of many nonwovens manufacturers, who have dedicated significant resources to pleasing diaper manufacturers.

According to statistics provided by market tracker Euromonitor, the world baby diaper was valued at $21 billion in 2004, up from $18.8 billion in 2000. The most significant growth has occurred during that period in Western Europe, up to $5.5 billion from under $4 billion in 2000, and Eastern Europe, which increased to $1 billion from $500 million four years ago. Other key growth areas included Latin America, Australasia and Africa, the Middle East and Asia-Pacific, which offset decreases in North American sales.

Drop offs in North American sales have been largely caused by flat birth rates, already high penetration levels and fewer diaper changes per child thanks to technological advances in diapers. Therefore, individual company growth has come only at the expense of stolen marketshare, which has largely been achieved through price manipulation as well as marketing and promotional activity.

In fact, one diaper executive described the market as a commodity created by brands and their pricing strategies where everyone is competing against everybody. Most recently Procter & Gamble announced it would increase prices of some of its diaper brands while lowering them for others. Prices of P&G’s Pampers brand decreased 2.8% and its Luvs prices were dropped 3.8% in December. Meanwhile, Pampers Baby Stages of Development, P&G’s premium diaper line, will receive a 5.4% price increase in April.

The pricing announcement, made in November, came just months after P&G and rival Kimberly-Clark raised diaper prices 5% to offset higher raw material costs, and, while K-C has not yet issued a roll back, industry observers feel it will only be a matter of time before prices of its Huggies diapers are affected.

Pampers is Procter & Gamble’s biggest diaper brand.
Industry observers expect to see continued price wars in the disposable diaper segment, which has become a true commodity market in most world regions. And, as manufacturers are willing to accept tighter margins in favor of higher volumes, pricing will be the main strategy in robbing marketshare in this segment.

“It’s a very, very competitive market,” said Tracey Stewart, spokesperson for AHPMA, a U.K.-based trade association for the disposable hygiene item industries. “Last year was the first time we saw a minor rise in the birth rate in the U.K. so manufacturers are focusing on shifting the marketshare for growth. These supermarket price wars work well for consumers because prices stay down.  Nappies are a known value item. There is very little mark-up on them. An attractive price can draw in the shoppers so retailers are prepared to make little or no profit because they know they will do the rest of their shopping when they come in to buy diapers.”

Procter’s Plans

Analysts have said P&G’s price reduction comes amidst increased pricing pressures from private label competitors such as Tyco Healthcare and Associated Hygienic Products. According to market research, the average price of a premium disposable diaper is 24 cents whereas private label products typically retail for 19 cents per piece. The gap between the two has narrowed in recent years, however, as national brands have become more willing to forsake higher margins for larger volumes in the diaper market.

Industry observers estimate that K-C’s diaper business comprises 11-12% of its total sales while P&G’s diaper business accounts for 2-4% of sales. In terms of these two companies’ contribution to the disposable diaper market, it cannot be overstated. Constantly battling for marketshare, buying up smaller producers and creating new innovation on the market, P&G and K-C more or less dictate what goes on in the market. Currently P&G holds an estimated 32% share of the disposable diaper market with its Pampers and Luvs brands while K-C’s Huggies controls 22% of the market, according to Euromonitor.

In recent years, P&G has seen a great deal of success in its premium line, Pampers Baby Stages of Development, including Swaddlers for newborns, Cruisers for older infants and toddlers and Easy-Ups training pants. The introduction of Easy-Ups training pants has enabled P&G to competee directly with K-C’s Pull-Ups training pants, which created the category a decade ago. While Pull-Ups continue to dominate the training pants category, P&G has been able to achieve an approximate 20% share.

And, despite the success P&G has achieved in its Baby Stages line, the company continues to innovate. Just last month it announced it would add a specialized topsheet to help manage wetness in its Swaddlers and Cruisers lines and add specialized, gender-specific absorbency for boys and girls on its Easy-Ups training pants.

K-C Rolls Out A New Strategy

Likewise, K-C has continued an aggressive innovation program within its Huggies line-up. In training pants, last year the company introduced a patented Wetness Liner and has added fade-and-learn graphics in its existing products to offer parents more toilet training options. Additionally, the company remains optimistic over the success of its Huggies Convertibles product, a hybrid diaper product that can be pulled on like a pant or side-fastened like a typical diaper.

From an economic standpoint, K-C is currently  undergoing a reorganizational plan designed to deliver cost savings while focusing investment on building and growing those businesses that will yield improved margins and higher returns on invested capital.

These targeted growth investments are driven by a proactive and determined focus on delivering the best solutions to customers, shoppers and users in the areas in which K-C is uniquely positioned to achieve the greatest success, according to the company. Specifically, the company will invest to: strengthen its leadership position in baby and child care, adult care and family care; accelerate growth in developing and emerging markets by focusing on the high growth BRICIT (Brazil, Russia, India, China, Indonesia and Turkey) countries; boost R&D spending to better identify and leverage customer/shopper/user insights—and then more quickly transform those insights into proprietary technologies and innovative total solutions that will drive both growth and profitability.

In support of these initiatives and to help improve brand equity and marketshare, the company will allot significant funds in strategic marketing, raising spending levels as a percent of sales by more than 100 basis points from 2004 to 2009. These investments go hand in hand with strategic cost reductions aimed at streamlining manufacturing and administrative operations primarily in North America and Europe, creating an even more competitive platform for growth and margin improvement.

K-C’s new cost reduction initiatives will result in cumulative charges of approximately $900 million to $1.1 billion before tax ($625-$775 million after tax) over a three-and-a-half year period beginning in the third quarter of 2005, and are expected to yield annual pretax savings of $300-$350 million by 2009. Continuous productivity gains during the last several years along with investments in state-of-the-art manufacturing capacity are enabling the company to consolidate production at fewer facilities. Cash costs related to the sale, closure or streamlining of operations, relocation of equipment, severance and other expenses are expected to account for approximately 45% of the charges. Non-cash charges will consist primarily of accelerated depreciation and asset write-downs.

Huggies diapers are the No.1 brand in North America.
By the end of 2008, there will be a net workforce reduction of about 10%, or approximately 6000 employees, while approximately 20 manufacturing facilities, or 17% of the company’s worldwide total, will be sold or closed, and an additional four facilities will be streamlined. In addition, seven other facilities will be expanded as some production capacity from affected facilities is transferred to them to further improve the scale, productivity and cost position of those operations. There is a particular focus on Europe aimed at improving business results in the region. The company intends to consolidate and streamline manufacturing facilities, further improve operating efficiencies and reduce selling, general and administrative expenses while reinvesting in key growth opportunities there.

The initial phase of K-C’s cost reduction initiatives will occur between now and mid-2007 and will include the sale, closure or streamlining of 15 of the facilities and the expansion of three others. After tax charges are expected to total approximately $355-$390 million ($500-$550 million before tax). The company plans to designate these charges as unusual items in future quarterly earnings news releases.

After announcing these initiatives in July, K-C last month said it would invest  $120 million in production in Turkey during the next five years and create approximately 1000 jobs.  In making the announcement, Ari Melamud, the company’s eastern Mediterranean director, said Turkey was one of the six countries the company has prioritized to invest in. “We plan to make Turkey a distribution hub for markets around it,” he said.

K-C has been present in Turkey since 1999 when it bought local firm Ovisan.

Going Global For Growth

Practically complete penetration in developed markets such as North America and Western Europe have increased the attractiveness of emerging markets worldwide. Just as K-C has announced its intention to target Turkey as well as other smaller base markets, P&G has announced its intent to develop a lower cost diaper for emerging markets.

The pattern of disposable diaper market penetration has historically been that newer markets favor less sophisticated—and less expensive—products. Then, as disposable incomes rise, so do consumer preferences. It is with this theory in mind that P&G has decided to develop a lower cost diaper. To achieve this, the company is reportedly bidding low cost machinery and raw materials from around the world.

“We see continuing evidence of innovation focused on the goal of reducing costs,” said Pricie Hanna, of nonwovens industry consultancy John R. Starr, Inc.  “Globally, we still have strong growth from market penetration in the developing markets, as we have seen in the past whenever their economies grow.  It’s been a good year for that.  So, the global leaders have prospered by offering lower cost products designed to penetrate developing markets as well as full featured, global-design diapers at higher price points.”

Because the diaper market is not labor intensive, lower wage bases in developing countries do not significantly drive down the costs of diapers and lower costs need to be achieved elsewhere.

“K-C and P&G have been adept at identifying regional advantages or disadvantages,” said Carlos Richer, president of Richer Investment Consulting Services. “There is no such thing as standard Pampers or Huggies in the world and you can almost forecast what will be the next generation in a particular market. They almost work like a clock.”

Because diapers are so technologically advanced in North America, Western Europe and other developed regions, there is a lot of room to lessen sophistication in gateway products for emerging markets, Mr. Richer added.  “In my present experience, when you are making diapers, you are taking simple raw materials and making a complex product,” Mr. Richer added. “That’s really working in favor of P&G and K-C. There are huge opportunities for savings in the cost of a diaper.”

Mr. Richer added that not just P&G and K-C have these opportunities. Even smaller diaper manufacturers could lessen the sophistication of their diapers to focus on untapped markets.

Among the strong areas of growth are the Australasia region, which has seen 20% annual increases, albeit from a low base. This growth in the diaper market has been attributed to a high number of households where both parents work, establishing a need for convenient, disposable products to replace washable items. However, declining birth rates have been a major inhibitor of volume sales with manufacturers relying on premium products to generate value.

Stretchable materials, such as this component from Tredegar Film Corporation, continue to be a strong growth driver in diapers.
Meanwhile, rising disposable incomes have driven demand for diapers in Eastern Europe, particularly in the region’s largest market, Russia. Rising levels of disposable incomes have encouraged consumers to take advantage of the widening range of products available, as many key markets increased investment in the region.

In many countries of Central and Eastern Europe, penetration levels for disposable baby diapers are as low as 30%, leaving a great deal of room for future market growth. However, pricing in these countries must be significantly lower than in their Western European markets—hence the need for less sophisticated diapers. However, the expansion of the European Union and many of these countries’ inclusion in it have created opportunities for smaller manufacturers located in the region.

In Latin America, diapers have registered strong growth in most markets, driven by a rise in the number of women in the workforce and subsequent increased demand for convenient disposable items. Furthermore, these markets have benefited from aggressive manufacturer activity, particularly on the part of the sector leader, K-C, which has launched value-added products.

While diapers and pants registered growth in some developing markets in Asia-Pacific, driven by increasing pressure on parents’ time, these products continue to be viewed as expensive luxury items by consumers who continue to favor more economic cloth alternatives.

Babying The Market

Increased line speeds and other technological innovations have created a severe overcapacity situation in the baby diaper market, creating a situation that at least one diaper industry observer calls the “bleakest times yet” for the diaper market.

Mr. Richer, who served as commercial manager of Absormex, a Mexican diaper manufacturer before starting his consultancy, estimates the diaper overcapacity to be at 20% or even as much as 30% in some countries, such as Mexico. This situation was brought on by diaper technology as well as the addition of one new player, Irving Personal Products, to the market. (Irving Personal Products, based in Canada, entered the diaper market two years ago.)

And, some argue that it is the branded leaders that have contributed most heartily to problems in the diaper market. “Diapers are a commodity-type item now and I think what the brands have done in terms of their own pricing strategies has created that,” said one diaper executive. “I think when you deal with a shrinking birth rate, a category that on some level has engineered its own decline—the products work better than ever so there are fewer changes per day—and a high penetration level, everything becomes more price driven.”

Additionally, the price cuts and increased competition have slowed innovation in recent years as manufacturers are hesitant to initiate major design changes in diapers unless lower costs or increased volumes are guaranteed.

Material suppliers may be frustrated at the slow rate of acceptance of newly developed materials, said John R. Starr’s Ms. Hanna. “The intensity of competition is making diaper marketers cautious as they select which innovations they invest in. Leaders want to be sure it is an innovation that is going to be exclusively theirs and provides the value to distinguish their products and command enduring consumer loyalty.”

Still, improvements continue on a smaller scale throughout the diaper value chain. P&G and K-C are constantly announcing improvements—the most recent being P&G’s specialized topsheets in its Baby Stages line—and smaller companies are working hard to follow suit. One area where experts are particularly noticing interest is in stretchable materials such as those found in Pampers Swaddlers and Cruisers in the Baby Stages line.

“A key target for private label manufacturers is to answer retail partners’ requests for products that imitate the leading brands. Effective and affordable stretch components are a current priority for private label manufacturers,” Ms. Hanna added. “Retailers want their store brand equivalent to have comparable stretch components, but these components are among the most highly defended from a intellectual property point of view.”

And, Ms. Hanna added, the stretchable components must be aesthetically pleasing. “There is still a lot more that can be done on cost effective elastic solutions. A lot of technology is delivering interesting options for that,” she added. “I see evidence of people looking at many different technology alternatives to achieve their stretch component needs.”

The Age-Old Debate

As long as they have been on the market, disposable diapers have been criticized by environmental groups for their impact on the environment, particularly their drain of natural resources and their contribution to landfills. The buzz over diapers’ environmental impact has been particularly strong in the U.K. recently with government officials actually earmarking funds to convince parents to use cloth, rather than disposable, diapers.

Procter & Gamble is rolling back prices of its Baby Dry products, reportedly to go up against private label diapers.
In response to this funding, disposable diaper advocates are refuting claims that disposable diapers are a threat to the environment. These claims have been reinforced by the results of  a government-commissioned life cycle assessment (LCA), coordinated by the U.K.   Environment Agency, that shows through independent analysis that  disposable nappies have no greater impact on the environment than cloth diapers.    

Specifically, the study confirms: neither disposable nor cloth diaper systems can claim overall environmental superiority and  the differences in the impacts between diaper systems are not significant enough  to voice support for one diaper type over the other on the basis of environmental factors alone.   

The Environment Agency stated,  “The study, which looks at and evaluates the environmental impacts arising from every stage of the life cycle of disposable and reusable diapers, found that there was little  or no difference between their impact.

AHPMA’s Ms. Stewart blamed the problem with waste on the way government handles waste, not individual contributions to landfills. Currently, the U.K. is preparing for a landfill directive that will force better management of what is being sent to landfills through recycling and other measures. “The main issue that we are facing is a waste debate,” Ms. Stewart said. “We have known for a long time that there is not an environmental issue (with diapers). Now, that’s been proven.

In the U.K., disposable diapers make up only 2% of municipal waste but only 0.1% of landfill contributions. And, the amount of diaper material being disposed has been decreased severely in recent years already as products have become 40% thinner, Ms. Stewart added.

Recovery Ahead

In the same breath that he described the diaper market as “the bleakest ever,” Mr. Richer said he sees good times ahead. During the tough times, diaper manufacturers will  fight for survival and the weakest players will be forced to exit the market, correcting the overcapacity situation and easing competition.

“It’s going to correct itself automatically. These cycles have a tendency to balance themselves. I call them purging cycles,” Mr. Richer added. “Not everyone will survive. Only the strongest companies can survive. Either that are they are forced to reduce their own outputs.”

Web Exclusive: Interview with Carlos Richer of Richer Investment

Carlos Richer is the principal of Richer Investment, a diaper business consultancy. In March 2005, he retired from his position as general director at Absormex, one of the largest independently owned disposable baby diaper factories in Latin America, after serving the company for 21 years.   

NWI: You have been quoted as saying the disposable diaper industry is going through the most bleak time yet. What is causing this dire situation?

CR: “It’s been a very difficult price war cycle for everybody. This situation, with raw material prices, particularly with superabsorbent polymers and oil and all the impact has really been affecting the smaller companies. I am seeing the same picture everywhere. There are a few exceptions. For instance, there is a good economic situation in North Africa where they are even exceeding their capacity. But, that’s not the case many places.

NWI: What must the diaper market do to come out of these tough times?

CR: It’s going to correct itself automatically. These cycles have a tendency to balance themselves. I call them purging cycles. Not everyone will survive. Only the strongest companies can survive. Either that or they are forced to reduce their own outputs.

NWI: How does the diaper market vary from one region to the next?

CR: It’s that they do not have a standard product. You can taste Coca Cola and it’s the same everywhere you go. But diapers are quite different depending on where you are buying them.

NWI: How are raw material suppliers dealing with these dire conditions? How will they survive?

CR: I think you have a lot of mixed results here. A lot of them are in bad shape, suffering from solidarity. But that’s not the general case for everybody. A few are doing quite well. The whole situation of promoting the idea that there is a scarcity in SAP supply is putting some companies at an advantage. I don’t know if it’s done on purpose or not. It depends on who you are listening to. You will see critical comments.

NWI: How have fluctuations in raw materials changed the diaper as we know it today?

CR: Raw materials have always come down to an issue of performance and cost. You now have diapers with very low grams per square meter that also feature high water barrier, thanks to the replacement of carded materials with spunmelt nonwovens. In that particular case, you can make products as low as 12 grams that are similar in performance to products made10 years ago, which were 18 grams per square meter.

This has been a win-win situation for the producers who are using fewer materials. And for the retailers who can fit more diapers on shelves and for consumers who have a smaller product.

NWI: How have machinery suppliers dealt with overcapacity and maturity in the diaper market? How can they continue to make money?

CR: One of the main issues has to do with costs. Good diaper design requires evolving the product. Even if you don’t need new machines, the makers need to add modules to be able to compete in the market. Companies not investing in new production technology will not do well. All of these companies need to be involved to be competitive. This is one of the situations today that is so important.

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