This case was made possible through the generous co-operation of Datwyler Pharma NV. The case was written by Dr. Yusaf H. Akbar and Pieter Coppens and intended as a basis for class discussion rather than to illustrate either effective or ineffective handling of management situations.
2013 CEU Business School. No part of this publication may be copied, stored, transmitted, reproduced or distributed in any form or medium whatsoever without the permission of the copyright owner. 2
Datwyler in 2012: Emerging Markets
Introduction
Flying back from a visit at the American subsidiary of Datwyler Pharma in Pennsauken NJ, Dirk Borghs, Vice President Special Projects, was wondering how to remain competitive in the low cost segment of manufacturing rubber closures for pharmaceutical glass containers.
Datwyler Pharma was highly successful with innovations in the high end of the market such as the Omniflex 3G coated closures (exhibit 1) for the biotech sector and manufactured all products in own facilities in Europe and North America with high labour costs. The minimum requirement for a low cost manufacturing plant was to produce at the same levels of quality as their current plants in Europe and North America. Dirk gained foreign experience during the expansion of the activities in the US but had never worked in an emerging country. Assessing different locations, Dirk also wondered if Datwyler Pharma could make this leap alone.
Datwyler Group and Pharma Packaging
The Datwyler Group has diversified holdings in niches with potential for differentiation and a distinct market positioning. It is shielded by relatively high entry barriers caused by fixed assets and patent protection. It also benefits from strong growth in their sector. The Group is split into four 3 divisions - Technical Components, Pharma Packaging, Cabling Solutions and Sealing Technologies that focus on the manufacturing, pharmaceutical and data communications industries. The groups strong emphasis on innovation means that it aimed at market leadership in each niche. The Datwyler Group has more than 40 operating companies, sales in over 80 countries, above 5000 employees and generated approximately CHF 1,300 million (1,400 million USD) in revenue in 2011. Datwyler is listed on the SIX Swiss Exchange since 1986. The key financials are summarized in exhibit 2 and 3.
The Datwyler Pharma Packaging division is one of the world's leading suppliers of rubber, plastic and aluminium closures for injection systems, container closure solutions and medical disposable devices. Exhibit 4 gives an overview of the most important products. Its activities in Europe, North and South America, Asia and Australia are coordinated from the headquarters in Alken, Belgium. The company has more than 1400 employees at production facilities in Belgium, The Netherlands, Germany, Italy and USA. Datwyler Pharma realized EBIT of 30 million CHF (32 million USD) on 265 million CHF (282 million USD) revenues in 2011. The CAGR between 2006 and 2011 was 2% when calculated in CHF and 7% in USD. Dirk attributed this success to long-run partnerships with all the major pharmaceutical companies, a global presence and a strong focus on innovation.
Market and competitors
The global market volume of pharmaceutical closure components is estimated at 1,500 million USD annually, of which 10% for injection systems, 70% for containers and 20% for medical disposable devices. The launch of a 4 new product takes 5 to 10 years and, together with the high level of necessary know-how, forms a barrier to entry. 60% of the market is shared between Datwyler and its two main competitors.
Datwyler Pharma currently ranks number two after West Pharmaceutical Services (key financials in exhibit 5). West realized EBIT of 110 million USD on 1,200 million USD revenues in 2011 and grew at a compounded annual rate of 5% between 2006 and 2011. Headquartered in Exton, Pennsylvania and it currently employs 6000 people worldwide. Datwyler knew that West was stronger in aluminium closures for containers and had a higher market share in the more advanced, coated, rubber stoppers. Historically, it had a larger presence in the Americas (including emerging Brazil) and roughly the same level as Datwyler in Europe and Asia. Both were active in all three areas of pharmaceutical closure components. West however grew through acquisitions (notably in 2005). The company now also produces packaging systems for the pharmaceutical industry, medical devices and personal care and consumer products. By expanding from components towards delivery systems, it entered in direct competition with clients. At the same time West became less present in the low-cost segment of medical disposable devices where price pressure is the highest.
Datwylers other main competitor is the family-owned Stelmi company that focuses on its French home market. Its 500 employees realized EBIT of 15 million euro (20m USD) on a turnover of 78 million euro (102m USD) in 2011 1 . Stelmi doesnt compete in the segment for aluminium closures for containers, advanced coated rubbers or medical disposable devices. Competition
1 http://www.score3.fr/entreprise.shtml?siren=642040000 and http://www.verif.com/bilans-gratuits/TRANSFORMATION-ELASTOMERE-MEDICAUX-IND- 642040000/
5 beween Datwyler and Stelmi therefore is limited to the middle and low end of rubber closures for injection systems and containers.
Last but not least, for the low-cost segments, Datwyler also faces increasing competition from numerous smaller emerging market companies who compete with them on lower production cost and affordability.
Options for expansion
Alongside the cost of raw materials, labour is the largest component of manufacturing cost in the rubber closures segment. Thus the motivation to offshore production was to benefit from a lower cost location. However, the decision to start a manufacturing base in a low cost environment would also be influenced by the potential local market and synergies with other companies from the Datwyler holding company. In addition, any location selected by Datwyler would need to meet certain basic conditions including access to adequate logistics and availability of fresh water used for production of components and finished products.
Dirk had three potential locations in mind when deciding on where to invest: China, India and Mexico. All three locations had their advantages and disadvantages. Datwyler considered investing in three different ways: through acquisition, joint venture or greenfield operations. Having looked at the three options, his initial strongest preference was for India but he still had an open mind on the other two.
6
Mexico Mexico had some important advantages in Dirks mind. First, Mexico scores relatively high on the Ease of Doing Business and has labour costs of only 20% of those in Western Europe (see exhibit 6). Second, Datwyler Sealing Technologies already had a production site in the Mexican state of Guanajato, allowing the Pharma division to benefit from the existing knowledge and available services. Third, its proximity to the US market offered favourable logisitics too. Fourth, the investment climate in Mexico was favourable because of regulatory systems that were quite well developed. However, there were also some potential problems with it. First, the use of existing machinery in the current plant is limited due to the specificity of the processes to make rubber for the pharmaceutical sector. Second, a ramping up of the production of price sensitive products (as part of the strategy) requires more space than what may be available at Datwyler Sealing technologies. Therefore it would be possible to transfer only a part of the operation or to invest in additional building space for full scale operations. Third, current activities of Datwylers US plant are highly complex and cannot be consolidated in a new full-scale operation in Mexico. Lastly, relative to the China and India options, the Mexican market has limited potential to sell products locally and the main growth for the industry is located in Asia.
India There were several supportive factors to choose India for an investment in the pharmaceutical sector. The most important benefits related to personnel costing only 5% of the current levels in Western Europe and Indias emerging reputation as centre of excellence for production of generic pharmaceutical 7 products. India was also becoming a major player for branded products and all major multinational pharmaceutical companies had developed a local presence. The medical sector was highly rated in India due to an active exchange of students and practitioners with the USA, resulting in the highest number of FDA approved plants outside of the USA. Nevertheless, a decision to invest in India would imply production that would mainly be exported and only gradually serve the local market as quality standards for the local market increased. Products for the local market were currently supplied by local firms and Datwyler Pharma accounted for about 50% of the rubber stoppers for export. Annual growth was estimated at 10-12% for the domestic market and 30-40% for the export market. Another major concern in India were risks related to Intellectual Property and difficulties in supplying technical support from headquarters. Dirk and his colleagues felt that the latest technologies should not be transferred to India. The consensus among senior management was that Datwylers basic quality would already set a new standard that would be almost impossible to overcome by local Indian competitors. Another perceived advantage of an Indian investment was the knowledge of English language. This allowed for training of Indian managers at US facilities. Nevertheless, Dirk was acutely aware that due to cultural differences, there would be a need for extensive cultural training in both directions. The cost of construction in India is the lowest worldwide and approximately 25% lower than Mexico.
On the infrastructure side, due to limited reliability of the power grid, a substantial back-up generator would be needed and limited availability of spare parts required the maintenance of an inventory locally. Compared with Mexico, India had an unfavourable score on the Ease of Doing Business, but 8 Special Economic Zones provide a preferential policy framework and a single window of clearance was supposed to limit the bureaucratic hassle. The Indian operation could be used as a logistics hub to improve lead-times of imported products for locally based clients too.
Potential business risks for Datwyler were the willingness of non-Indian customers to buy products made in India and of Indian customers to pay a higher price than the local Indian market that currently offers a lower quality.
Back in Europe and the USA, there were fears that price pressures from Datwylers customers to benefit from lower labour costs in China, India or Mexico could lead to a faster transfer of production and deplete the current plants leading to job losses.
Entry Mode
Acquisitions Datwyer Pharma initially visited 2 local producers but considered an acquisition unviable mainly because of unrealistic acquisition prices; too wide a gap in technology and the fact that the targets were present in non- regulated markets only. This option was quickly eliminated.
Via a joint venture Datwyler Pharma identified a long-term partner in India that could take up to a 26 percent share in the Joint Venture. This gave the minority shareholder strong legal rights and could slow down growth in case further investments were needed. That partner would bring in experience in manufacturing for the pharmaceutical sector; play a key role in the setup of the plant and 9 manage the day-to-day operations. The partner currently focused on pharma contract manufacturing; was one of the leading glass suppliers to the Indian pharma industry and marketed Datwyler products in India.
Working with a local partner would limit the necessary support from the European Headquarters by using existing Indian sources on a project basis. The partner could also transfer reliable key people from current plants to take up key positions in the new plant. The challenge would be to find the right balance between freedom for the Indian entrepreneur and sufficient control on the business exercised by Datwyler.
Due to the location of the partner, the area around Vapi was preferred. As the envisioned partner did not have any space available in existing plants, synergies would limited mainly to the previously mentioned expertise and use of shared services.
The Gujarat region, where Vapi is located, is among the most industrialized states in India. The region is strongly oriented to investors and has developed Special Economic Zones (SEZ). SEZs are dedicated to thematic activities such as chemistry and offer large tax breaks if exports represent a large share of total revenues. They also offer advantages in terms of reduced custom duties for imported components. The town of Vapi is 180 km north of Mumbai, at the southern end of the Golden Corridor. The region had a high concentration of chemical plants and servicing companies. The downside was the related pollution, necessitating environmental due diligence of the real estate and production surroundings. The region had a sufficient availability of workers. Dirk felt that quality of life for expats would 10 be a challenge here and so considered only short term and limited posting for Datwyler managers from HQ.
Fully independent A third option was the Pune area in the state of Maharashtra, which had a significantly higher standard of living due in part to the presence of the IT and automotive sectors employing numerous local employees. This option would be exercised through a greenfield investment.
As there is no need to be closely located to a regional partner, there are more options concerning implantation. This can lower the initial real estate investment. A site selection by consultants hired by Datwyler identified a SEZ near Pune as the best choice. Pune benefitted from strong manufacturing industry and had a growing number of international flight connections. The presence of manufacturing, more specifically automotive, was important as it may attract a whole range of companies providing technicians and spare parts needed to run a manufacturing plant of rubber stoppers. It is also well connected via railway and expressway. Pune-Mumbai is one of the six biotechnology clusters in India. There appeared to be sufficient workers available and the international environment with hotels, universities and other international businesses is more attractive to expatriate staff than in Vapi.
However, the risks of venturing alone carried with it several disadvantages. First, not having a local partner required additional support from the headquarters or hiring local consultants raising cost and complexity. Second, labor unions were more militant in the state of Maharashtra than in Gujarat presenting a risk of labor disputes. Dirk was concerned to learn of an 85 day 11 strike in 2009 at the factories of Bosch and Brembo in Pune 2 . Third, any greenfield investment would require longer lead time before the plant could come fully online thus pushing back the cost advantage that Datwyler would gain by investing in India.
China Faced with the risks of an Indian investment, another option could still be to re-investigate the option of China. Datwyler Pharma employed a business development manager locally for some years and had been close to an acquisition of a Chinese manufacturer there. The problems of doing business in China were however well known: language, IP protection, trust and pricing for assets.
Dirk realized the decision to invest would have a major impact on the company and on his colleagues at Datwyler who would be responsible for the implementation of the project. Developing a new plant in an emerging market would be his most challenging project till now. There were also rumours that West Pharmaceutical Services was searching for land to set up an operation in India too. As the first mover advantage on the market is important to impose standards of product and quality, the decision has to be taken quickly.
http://www.westpharma.com/en/Investors/Pages/AnnualReport.aspx * the scope of products manufactured by WPS is larger than Datwyler Pharma and goes beyond the segment of closures for the pharmaceutical sector.
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