Bitter Competition Holland Sweetener Vs. Nutrasweet Company - PDF by efz59986

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									EWMBA 299E– Competitive Strategy
Professor Busse

  Bitter Competition: The Holland
  Sweetener Company versus
  NutraSweet (A)

  Individual Case Report

  September 2003

  Eduardo Haddad - # 16404519
Haas School of Business                                                      299 E – Busse

HSC vs. NutraSweet
Fight or Accommodate?

 Introductory Analysis

NutraSweet in 1986

        One year after it was acquired by Monsanto, NutraSweet was the dominant player in
        the US$ 900 million highly concentrated Aspartame market, where it held 80%
        market share. It had secured the market it practically created through its patents,
        which were due to expire in 1987 in Europe and Canada, and in 1992 in the US. It
        operated as a joint venture with Ajinomoto, a major Japanese chemicals and food
        company, which had sole rights to the Japanese Aspartame market.

        The bulk of sales was focused primarily on a few large customers in the soft drink
        market, like Coke and Pespi, with whom carefully crafted multi-year contracts were
        firmed, therefore tremendously reducing buyer power. The company would offer
        discounts of up 40% of the list price to get clients to use 100% aspartame as a
        sweetener, to make NutraSweet their exclusive worldwide supplier, and to display
        the NutraSweet trademark and distinctive red-and-white “swirl” logo on their
        products and in their own advertising (something like the “Intel Inside” approach).
        Those large clients, as well as the tabletop market which accounted for 15% of their
        sales, were supplied from the joint venture production facilities in the US and Japan,
        which together had over 7,000 tons / year production capacity. Entry in this market
        could be considered hard not only because of the patent protection, but also because
        of the 2,000 tons / year minimum efficient production scale for a $ 100 million plant.

        Although a number of potential substitute products were under development,
        NutraSweet would still enjoy significant market dominance for a reasonably long
        time, since those new products still needed to clear FDA requirements and be
        successfully launched in the market, and cancer related concerns loomed over the
        existing substitutes, saccharin and cyclamate.

        The impending expiration of the patents in Europe and Canada was leading other
        potential competitors to position for market entry. Of those, the most prominent was
        HSC (The Holland Sweetener Company), which was preparing to enter the 545
        tons/year European and 153 tons/year Canadian markets (1997 projected figures
        based on a 26.63% and 27.23% CAGR respectively). Should NutraSweet fight or

  E. Haddad                                    1                NutraSweet Case Analysis
   E. Haddad
                                                                 E. Haddad
Haas School of Business                                                          299 E – Busse

 Case Analysis

The introduction of the case says that Vermijs is considering two scenarios “normal competition” (or
that NutraSweet will accommodate entry) and “price war” (or that NutraSweet will try to deter
entry). Make the case from NutraSweet’s perspective as to why it should accommodate Holland
Sweetener’s entry.

        A presumed payoff matrix might help address the hypothesis that NutraSweet
        would be better off accommodating HSC entry in the European and Canadian
        markets in 1987 (please refer to Appendix 1 for calculation details).

        The projected European and Canadian markets combined indicate annual sales of
        697 tons of Aspartame in 1987. It is known that HSC production capacity will be 500
        tons, which leaves 197 tons to NutraSweet in case they accommodate. It is also
        reasonable to assume that NutraSweet’s marginal cost was lower than HSCs, despite
        their unconfirmed claim that they had a less costly and more flexible production
        process. This is based on the fact that their plant was only 1/4 of a minimum efficient
        scale plant using the normal method. Start-up and learning curve costs would also
        drive their average costs up during the first years.

        Still, the payoff matrix below shows that NutraSweet would have an incentive to
        accommodate HSC entry:

                                        Accommodate              33 , 17
                                        Fight                    0 , 12

        Another key decision factor is the size of the potential (unprotected) market for HSC.
        The combined European and Canadian markets for Aspartame were projected at
        1,800 tons in 1991, still less than 20% of the worldwide projected market at that time.
        And the US, where NutraSweet had patents until 1992, would account for 80% of the
        global market by then – not even including the potential additional gains from the
        “blend” patent extended until November 1996. Therefore, NutraSweet would still
        enjoy significant market share and profits in the next 5 years after HSC entered the

        Moreover, we need to look at the market structure in terms of customers and how
        the companies would interact with them. The bulk of the market was concentrated in
        the soft drinks companies like Coke and Pepsi (80% + of the sales) with whom
        NutraSweet firmed multi-year contracts with built-in incentives to encourage them
        to have NutraSweet as their exclusive supplier. It does not seem likely that HSC
        would easily break into those relationships without going though a major legal
        battle, which appeared to be the case. But it could take several months or even years

  E. Haddad                                       2                 NutraSweet Case Analysis
   E. Haddad
                                                                     E. Haddad
Haas School of Business                                                       299 E – Busse

        for the legal action to conclude, and HSC would not be able to wait that long. More
        likely HSC would focus on the tabletop and other food and beverage products
        market, which accounted for 20% of the market.

        HSC may also be taking a “beat and retreat” approach. The fact that they filed a
        complaint with the European Commission may be followed by a retreat or dismissal
        of the legal action in an attempt to sign to NutraSweet that “I will leave you alone if
        you leave me alone”. In other words, they may try to say “I will not try to steal the
        soft drink market from you if you let me take the tabletop & other market. But I am
        willing to go to great lengths in this battle if you retaliate”. That could make
        NutraSweet much more willing to accommodate.

        And lastly, NutraSweet benefited from brand strength given the large advertising
        budget it had, and also from their technological superiority in the production process
        based on their ongoing R&D investments.

        That scenario makes the case for NutraSweet to accommodate HSC’s entry into the
        European and Canadian markets, for they would not pose a real threat to
        NutraSweet’s overall market dominance.

Make the case from NutraSweet’s perspective as to why it should try to deter Holland
Sweetener’s entry.

        Although the impact of HSC’s market entry might be considered low in 1987, it
        grows to a much larger scale when we look into the future.

        If NutraSweet accommodated, HSC could increasingly grow into the European and
        Canadian markets, building more plants, and getting ready for the expiration of the
        patents in the US.

         Also, by accommodating NutraSweet would leave the door open to other potential
        entrants to consider competing either on the European and Canadian markets, or in
        the US market in the future as well. Without its patents NutraSweet’s position would
        be extremely vulnerable to potential entrants, since the market was very attractive
        and there were a number of potential substitutes being developed at that time.

        HSC had made clear its intentions of going after the large soft drink producers when
        it filed a complaint with the European Commission. That is evidence that HSC might
        not settle for the lower end of the market (tabletop and other food and beverage
        products), thus posing a significant threat to NutraSweet’s position.

        We need to also look at the portfolio of business Monsanto had at that time.
        NutraSweet was the second largest contributor in terms of operating income (20%
        over sales), after Agricultural products (25%), and together with Chemicals (17%),
        was helping subsidize all the other money-losing businesses.

  E. Haddad                                     3                NutraSweet Case Analysis
   E. Haddad
                                                                  E. Haddad
Haas School of Business                                                       299 E – Busse

        NutraSweet should fight and drive HSC out of the market. Its dominance in the
        market and production efficiency (they claimed they had cut manufacturing costs by
        70% from 1982 to 1992) would allow them to lower their prices close to marginal
        costs for a period of time until HSC would exit. That would also send a clear message
        to other potentials entrants considering the Aspartame market (building a reputation
        of a tough player – the Sumo strategy).

Evaluate your arguments. Which action on NutraSweet’s part should Vermijs expect?

        Given NutraSweet’s market dominance, the careful crafting of its long-term contracts
        with large customers emphasizing exclusivity, the importance of the NutraSweet
        division to Monsanto’s overall business portfolio, and the potential threat of
        substitute sweetener products looming in the horizon, Vermijs should expect
        NutraSweet to hold on tight to its market and therefore retaliate any entry attempt by
        starting a price war. Since NutraSweet also possessed “blend” patents, it had
        flexibility it could resort to in case they had to renegotiate with large customers as
        part of their response.

        Unless a competitor had too low of a marginal cost as to be able to sustain a price
        war for a long time (something that was not confirmed for HSC; most likely they
        would have high marginal costs in the starting year), it is reasonable to assume that
        NutraSweet would take advantage of its size and lower prices to levels that might be
        considered unbearable to competitors, in an attempt to drive them out of the market,
        or at least to constrain their ability to gain market share.

        Although the short-term impact of HSC entry might be considered low, in the long
        run NutraSweet’s market position could be severely damaged once its patents
        expired in the US and other entrants and substitutes were present to take advantage
        of that.

In light of your answer to the previous question, what should Holland Sweetener do? (If
you think they should not enter, explain why not. If you think they should, how should they
go about it? For example, what markets should they target? should they have a branded
strategy? what should their growth strategy be? what legal avenues should they pursue?

        I don’t believe HSC has the choice of not entering at this point. The case leads one to
        believe that resources had already been committed ($ 17 million loan), and that the
        plant construction had already started.

        Therefore, they should enter, but expect a great deal of retaliation from NutraSweet.

        A less risky market approach for HSC could be to focus on the tabletop and other
        food and beverage products market in Europe first, where DSM possessed relevant
        knowledge of the market. That might make NutraSweet more willing to

  E. Haddad                                     4                NutraSweet Case Analysis
   E. Haddad
                                                                  E. Haddad
Haas School of Business                                                       299 E – Busse

        accommodate their entry (“small is beautiful”). Once they established their presence
        in Europe, they could go for the Canadian market. Those markets would not be
        sufficiently large to justify another plant (20% of projected 1,800 tons in 1991 = 360
        tons), but their establishment in the market could better position them to enter the US
        market once the patents expired in 1992. That would translate into a combined
        potential 2,000 ton market for HSC, warranting at least 4 plants.

        However, HSC had already gone for the jugular when they filed the complaint with
        the European Commission. That might have been a necessary prerequisite for
        breaking into the soft drinks market which NutraSweet so carefully protected, but it
        would certainly trigger a more aggressive response from NutraSweet, since that is
        their stronghold in the market.

        Assuming this is a way of no return, HSC will have to look for ways to making
        inroads into the soft drinks market in Europe. Apparently, the legal move is the right
        one since they will not have a share of that market unless they break the exclusivity
        of the contracts NutraSweet had firmed with Coke and Pepsi.

        Also, it is reasonable to expect that Coke and Pepsi would welcome at least one more
        supplier, since it seems very risky to have all their Aspartame orders in the hands of
        one single supplier (more likely so in the case of Pepsi who had less market share
        outside of the US). Once the exclusivity would be broken, I would think the soft
        drink companies would be sensitive to lower prices, which HSC supposedly could
        offer once it became fully operational.

        Less stringent contract terms could also be attractive to them and in fact might be
        very effective instruments to steal sales form NutraSweet, such as not forcing them
        into exclusivity or allowing them to blend, and also attacking the “branded
        ingredient” approach from NutraSweet by not branding their product. I would think
        Coke and Pepsi have enough challenges branding their own products and adding
        the NutraSweet logo would be stealing “mind share” thus damaging brand recall.

        If the strategy proved successful in Europe, HSC should then look into the Canadian
        market. The same basic “formula” would have to be deployed there whereby legal
        actions would be taken to break the exclusivity of the contracts, coupled with lower
        price and less stringent contractual terms.

        If success was achieved in both Europe and Canada, HSC would be extremely well
        positioned to take advantage of the expiring patents in the US in 1992. By then they
        would already be regular suppliers to Coke and Pepsi, and a share of the US market
        would almost be a guarantee.

        Of course this is wishful thinking and assumes they will not be significantly affected
        by NutraSweet’s retaliation – a low chance scenario in my mind.

  E. Haddad                                     5                NutraSweet Case Analysis
   E. Haddad
                                                                  E. Haddad
Haas School of Business                                                      299 E – Busse

        A potentially more creative and less risk strategy for HSC might be not to go head to
        head with NutraSweet. Instead, they could target driving Ajinomoto out of the
        picture by offering to be a lower cost production alternative to NutraSweet.

        If they could successfully prove that they have indeed a less costly and more flexible
        Aspartame production process, they could approach NutraSweet and offer to replace
        Ajinomoto in the joint venture. That way, they would complement NutraSweet’s
        strategy and not compete with them. They would reap much larger benefits since we
        are now talking not only about Europe and Canada but the entire global market
        (with the exception of Japan maybe, where Ajinomoto had exclusive rights).

        Even if not successful, this initial approach could be a first step in their strategy
        before deciding to have a direct confrontation with NutraSweet in the market. It also
        gives HSC an opportunity get to know NutraSweet more closely and therefore to
        learn more about their values and strategy.

  E. Haddad                                    6                NutraSweet Case Analysis
   E. Haddad
                                                                 E. Haddad
Haas School of Business                                                            299 E – Busse

Appendix A

NutraSweet Game Theory Calculation

Basic Data From the Case

Market Size
                                                        1986         1991          CAGR            (proj)
US                                                      5,100       8,000           9.42%          5,581
Europe                                                   430        1,400          26.63%           545
Canada                                                   120          400          27.23%           153
Japan                                                     40          80           14.87%            46
RoW                                                       40          120          24.57%            50
Total                                                   5,730       10,000         11.78%          6,405
Payoff Calculation
European and Canadian Market Size (1997 projected)                    697          tons/year
HSC production capacity:                                              500          tons/year
Assumed Cost Structure for NutraSweet                   Millions       Lb            $ / lb
  Sales                                                  711       10,157,143         70
  (-) Operating Income                                   142       10,157,143         14
  (-) Fixed Costs
        Patent annual charge (given in the case)         173       10,157,143         17
        Technological Exp (inferred @ 9%)                64        10,157,143         6
        Marketing & Admin (inferred @ 18%)               128       10,157,143         13

    = Marginal Cost (MC)                                 204       10,157,143         20

Assumed MC for HSC (NS * 1.50)                                                        30

NS Fighting Scenario
  NutraSweet Market @ 100%                                            697          tons/year
  Fight Price (assumed; could be lower based on
MC)                                                                   28             $ / lb
  Fight Payoff ((Price - MC)*Market in lb)                            12            US$ Mi

NS Accommodate Scenario
  NutraSweet Market @ 697 – 500 tons / year                           197          tons/year
  Accommodate Price (assumed)                                         60             $ / lb
  Accommodate Payoff ((Price - MC)*Market in lbs)                     17            US$ Mi
HSC Accommodate Scenario
  HSC Market @ 500 tons / year                                        500          tons/year
  Accommodate Price (assumed)                                         60             $ / lb
  Accommodate Payoff ((Price - MC)*Market in lbs)                     33            US$ Mi

  E. Haddad                                         7                 NutraSweet Case Analysis
   E. Haddad
                                                                       E. Haddad
Haas School of Business                    299 E – Busse

  E. Haddad               8   NutraSweet Case Analysis
   E. Haddad
                               E. Haddad

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