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Datwyler in 2012: Emerging Markets

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.
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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
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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
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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/

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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.


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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
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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
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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
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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
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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
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strike in 2009 at the factories of Bosch and Brembo in Pune
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. 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.




2
http://www.imfmetal.org/index.cfm?c=21201
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Exhibit 1


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Exhibit 2
Stock performance of Datwyler (1998-2011)

http://www.six-swiss-exchange.com/shares/security_info_en.html?id=CH0030486770CHF4


Exhibit 3
Financials for the Datwyler Group and Datwyler Pharma
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Exhibit 4
Overview of Datwyler Pharma products


15


Exhibit 5
Financials of West Pharmaceutical Services

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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.


http://finance.yahoo.com/q?s=WST&ql=1
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Exhibit 6
Ease of Doing Business and hourly wages, table with main countries
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