DairyPak—A "Value Chain” Perspective on Product Line Strategy This case is set in 1988 in a consumer goods packaging division of a major forest products ‘company. The product is the polyethylene coated paper carton for milk or orange Juice. Earte Bensing has some very tough decisions to make in the summer of 1988. As Vice President for the Dairy-Pak Division of Champion ternational he faces: + Declining market share in the growing “branded juice” segment of the domestic paperboard carton market. + A technologically outmoded manufacturing system in terms of the expanding markets. + A very limited output capability that has not grown in 10 years. + A dramatically expanding international market which the corporation has seen as fraught with more problems than opportunities. ‘The capital spending and strategic positioning decisions he must make in 1988 will shape the future of the DairyPak division for many years to come. 1. LIQUID PACKAGING AND THE PURE-PAK CARTON Millions of Americans, Europeans, Asians and South Americans start their day with milk or juice poured from a paperboard carton. Worldwide, paperboard is stil the dominant form of milk and juice packaging today. But the industry has changed dramatically since the “ gabled top” Pure- Pak carton rose to prominence in the 1950s. The Plastic Substitute. Polyethylene replaced paraffin to coat paperboard in 1961. It didn't take long after that before someone in the oil industry thought of making plastic cartons instead of plastic coating for paper cartons. Shell Chemical and Hoover International (now Johnson Controls) changed the liquid packaging industry overnight in 1965 when they combined to introduce the plastic resin pellet and the “blow molding” machine to manufacture plastic jugs. The blow molding machine was, and still is, so easy to use that paper packaging dropped from 82% of the milk market in 1971 to 37% in 1985, aa But the interesting story here is that although plastic captured 100% of the gallon size carton market, it has not eliminated the other sizes of paper carton as many had predicted it would. Plastic is more economical when resin prices are.low. When the price rises, paper looks good. Guessing future levels of ethylene gas prices (the basie driver of polyethylene price) is a notoriously difficult task.8 And the dairy owner also has important non- financial reasons for staying with the paper carton. First, the dairy does not want to be at the mercy of oil companies. By using dual suppliers—paper and plastio— the dairy creates a hedge against volatile Ynput prices Also, as new uses of the plastic resin are created (industrial and consumer uses of plastic containers), the input price will not go lower since the plastic is just a by- product of ethylene gas. Second, the dairy believes that paper is the best product nutritionally. University studies have shown that paper protects milk vitamins and flavor much better than translucent plastic. Also, recent legislation prohibiting the dumping of plastic in Suffolk County on Long Island has created doubt about the long, run viability of plastic ‘The. Competitors. Exhibit 1 isa global overview ‘of the paperboard packaging business. There are five players in the domestic Pure-Pak industry ~ International Paper, Champion, Potlatch, Westvaco and Weyerhaeuser. All of these companies are vertically integrated producers of the carton all the way back to the wood chip. Also, because of the scale and integration economies of these firms, new vertically integrated entrants are effectively shut out. In fact, because of the scale economies in producing a Pure-Pak carton, it is more likely that a small current player would drop out of the industry Georgia Pacific did in 1981 or as Weyco did in the Eastern US. in 1982. International Paper isthe industry leader. IP is considered to be the low cost producer, achieving significant economies with a large and diverse extruding and converting capacity. IP is also the technological leader, with significant investment in aseptic (germ free) packaging and rotogravure printing (state-of-the-art technology). IP has continued to expand capacity, aggressively growing in the non-dairy segments by emphasizing their aseptic, hot fill, and other extended life packages, and aggressively pursuing their own off-shore converting operations (eg. Korea and Japan). Along with these strategies, IP continues to price aggressively. But often IP is considered an unreliable supplier domestically because of their willingness to leave a customer when necessary to grow their off-shore converting operations Champion is currently a strong number 2, with more domestic volume than the other three players combined (see Exhibit 1). Potlatch, Westvaco, and Weyerhacuser all rank ina third tier of competition. All three face difficulties related to quality and inefficient scale. Weyerhaeuser and Potlatch have responded by looking increasingly to export. markets while trying t0 maintain selected domestic niches. Westvaco is holding on to its domestic niche. Exhibits | and 2 summarize the estimated competitive situation for 1988, Outside of the U.S. there are three major ‘manufacturers supplying Pure-Pak cartons: Enso-Gutzeit - Finland - They profess to be the World's No. 1 exporter and the Worlds second largest producer of liquid packaging boar 342,000 tons of liquid packaging and fast-food board was supplied during 1987. Billerud - Sweden - Paperboard production of 224,000 tons in 1988. This corresponds to a ‘world market share of 14 percent. Most of the production is exported. TetraPak is the largest single customer. CIP.= Montreal, Canada - Three plants (Quebec, Ontario, and Alberta) convert CIP's polycoated stock into cartons for milk and juice. Its plants have a capacity of only 34,000 tons per year. The Purs:Pak Customers. There are four groups of customers who form, fill, and seal Pure-Pak cartons, Champion's position in these four segments is summarized in Exhibit 3 Domestic dairies. In 1976 there were approximately 10,000 dairies across the US., processing and distributing milk and juice, Fewer than 1,000 dairies survive in 1988, but dairies are still the largest purchaser ‘of paperboard cartons in the U.S. Today, a typical dairy is a large regional packager of many private brands of milk and juice, The dairy's product is usually considered a commodity — no ability to achieve a price premium for the brand name. Industry-wide, dairy profit margins are quite slim. Overall, the profits come from the very high ‘urover rates from being the sole supplier in a region. ‘Overall, this segment has declined 3% per year over the last five years, but now has stabilized. Differentiated _juicers. The second largest segment is the high quality, differentiated juice packager - = basically Seagrams (Tropicana), Coca-Cola (Minute Maid) and Procter and Gamble (Citrus Hill). This segment was created in the 50s by Tropicana. Coca-Cola entered in the 1960s using its Minute Maid brand name. Procter and Gamble entered in the 1980s with a new brand name (Citrus Hill). In the past five years, chilled Juice sales have increased more than 82 percent, ‘compared with 17 percent for the whole juice industry. In 1988, it is estimated that chilled will outsell concentrateDairyPak 9 for the first time, buoyed by America's craving for convenience. This is the fastest growing segment in liquid packaging today (approximately 10% a year). The segment is extremely competitive as one would guess from the three key players, giants in consumer products: "An orange juice war is intensifying as major players try to squeeze bigger shares" (Wall Street Journal, 4/27/88). The big three juice processors represent over 50% of the ready-to-serve orange juice market ~ clearly, a great ‘opportunity for the paperboard industry. The big three customers want high impact ‘eraphics to market the juice, a technologically advanced carton that retains essentials oils, like limonen-d in orange Juice, and a carton that will hold the juice over 50 days (versus 14 days for milk). This customer is willing to pay for the differentiated carton, 1988 Domestic Share Of Market for Ready to Sere Orange luge Tropicana 27.3% 11,000 tons 13,000 Minute Mats 17°79 71000 10.000 Cis ih 3% > 7000 Dales 459% 18.000 15.000 Total i = 39,000 2.000 “ The third segment for polyethylene coated board includes “ovenable board" (frozen food dishes or microwave dishes) and Pure-Pak tons used to hold such non-liquid items as nails or mothballs. This market has grown slowly. Overall volume and volume per customer are still low. Overall this is only 4% of Champion's volume. ‘The International Market bby Destination (000 fons) 198519861987 Far East 214 33 248 Europe 50 56 39 ‘Australia 30 35 36 ‘Africa 30 28 35 Canada 9 7 33 S, America 30 29 29 America 2B 8 Ia Caribbean 3 5 7 Middle East 2 10 6 Other 14 u 4 Total 395432 BT Uncoated Rolls 94 116 Coated Rolls 2m 1 336 Converted Cartons 29 16 29 Export. The fourth group of customers for the Pure-Pak carton is the export market. Worldwide production of Pure-Pak cartons was estimated to be slightly over 1,600,000 tons in 1987 with only 1/3 (562,000) of that used in the United States. The intemational market has grown by over 16 percent in the last 3 years alone, with consumption increasing by over 100% in some countries as shown in the accompanying table 11, CHAMPION DAIRYPAK - THE EVOLUTION OF A "HARVEST" STRATEGY DairyPak began operation in Cleveland, Ohio with 12 employees in December, 1047, a one of the orignal licensees ofthe Pure-Pak technology. By 1950, DairyPak shipped 540 million cartons - over $5 million worth andthe company needed another plan 10 mee the growing demand, Expansion included converting plans built in Athens Georgia in 1951; Clinton, fowa in 1952; Fort Wort, Texas in 1954; and Moristown, New Jersey in 1958. These five similar converting plants remain intact today as Champions mi and ule ‘sare convenes Since the early 60s, Champion has produced about 250,000. tons. of polyethylene. coated board annually. Until 1980, virually all these tons were Converted by the five DalryPak plans and sold to dries ‘The primary goal of Champion was to be the low cos prodieer in & eommodty markt The intusion of plastic containers inthe 19608 damatically affected the paperboard carton industry and Champion's perspective on DatyPak, Champion watched to see what the dlr indusry would do. A consling Study by Boor, Allen Hamion in 1968 that cieulated throughout the industry suggested that by the md-80s not 2 single paperboard carton would be s0K.. Champion's feaction was to Watch and. wait. While Champion Watcted and waited the paper carton didnot de, bu the Champion “infrasiucture began. 10. gel old. and technologically outdated. In fact, since a new machine to produce the raw paperboard was but in 1965, very few Capital improvements were Inplemetted or Canstered Ul the summer of 1988. Of Champion's 33 converting machines, 29 were installed before 1963 “The Siation it_1988, In the early 80s, the explosion ofthe juice market created new opporuiniis for the PuR-Pak Carton = opportunities for which Champion wis unprepared "The following shows the changing markets for Champion