Holland Sweetener Case Analysis

Holland Sweetener Case Analysis

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The Holland Sweetener Company (HSC) is planning to enter the low-calorie, high-intensity sweetener market which is currently dominated by NutraSweet. Below we first analyze our target industry. Next we look at what kind of response should HSC expect from NutraSweet upon its entry into this market. We will also analyze few likely scenarios that could play out and we will try to estimate the likelihood of each scenario. Based on our analysis, we will give a recommendation for HSC to plan their entry into this market.

Industry Analysis

The low-calorie, high-intensity sweetener market has been dominated by one major player, NutraSweet, with annual sales of $711M and about 80% market share (the total market in 1986 was $884M annual sales). NutraSweet, a monopolist in the industry, was able to charge premium prices and successfully capture the majority of the pie. Also, the market was expected to grow 15% annually, with a 70% projected sales growth in Europe and Canada. However, since NutraSweet’s original patents were due to expire soon (Europe/Canada market patent expires in 1987 and US in 1992), a new entrant was threatening to enter the lucrative low-calorie sweetener market – HSC.

Barriers to Entry
Throughout the monopoly period, NutraSweet had successfully built several barriers to entry as a means to protect their leadership within the industry and thwart new entrants.

Manufacturing: Aspartame manufacturing required a high initial capital expenditure (plan construction costs $100M), and long lead production time (2-3 years to bring aspartame production to speed). The facility needed to be run at or near design capacity and experienced MES of 2,000 tones annually. Also, as the first mover, NutraSweet had the advantage of increasing their manufacturing efficiencies (manufacturing costs cut by 70% over the years).

Patent Protection: NutraSweet owned several crucial patents in the U.S. and other regions. Among them were the use/mix patent for aspartame and their manufacturing process patent.

Buyers locked up: The market was dominated by two major customers - Coca-Cola and Pepsi (accounted for ~50% of the aspartame usage). NutraSweet had entered into exclusive multi-year contracts with both of them. This would prevent potential entrants from establishing sales volume necessary to support the minimum efficiency production scale necessary to compete effectively in the aspartame market.

Brand recognition: NutraSweet invested heavily in building their U.S. brand with the introduction of a “branded ingredient” campaign, which required an extensive advertising investment ($30M annually) and resulted in 98% brand recognition.

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Government Approval: Lastly, the introduction of competing product and manufacturing processes required approval from authorities like the FDA in US.

Overall, the barriers to entry in this industry were pretty high.

Substitutes/ Complements
Low-calorie, high intensity sweeteners are used as an ingredient in many products but has no clear complements or substitutes. An argument can be made that sugar is not a substitute to aspartame, as it does not possess the same product qualities as a low-quality, high intensity sweetener. Additionally, we do not consider soft drinks, table-top, powdered drink mixes, frozen desserts, gum, toppings, cereal and OTC pharmaceuticals as complementary products; rather, the manufacturers of those products are customers/buyers.

To manufacture Aspartame, the raw materials needed were L-aspartic acid and L-phenylalanine. L-aspartic was widely available through many sources. However, there were not many suppliers for L-phenylalanine or for the technology to couple the above two ingredients to manufacture Aspartame. So, supplier power was high for supplier of this technology/provider of L-phenylalanine. This was probably the main reason why both NutraSweet and HSC had converted these suppliers into partners.
There were numerous buyers of aspartame such as the soft drinks manufacturers,, powdered drink mixes manufacturers, frozen desserts manufacturers, gum manufacturers, toppings manufacturers, cereal manufacturers , OTC pharmaceuticals and retailers for table-top product. However, soft drinks manufacturers were its major customer (80% of the total aspartame consumption) with table-top product as the secondary (15% of total aspartame consumption) . Notably, the soft drinks industry was dominated by two major players – Coca Cola and Pepsi Cola, accounting for 60% of the soft drinks market. Usually, this would have led to a strong buyer power, however, NutraSweet had the advantage due to its monopolistic position as the sole provider of aspartame. This power could easily dissolve once the patents expire and alternative producers enter this industry.

Figure 1 – Aspartame Sales Distribution in 1986
In 1986, rivals presented a limited risk to the company due to NutraSweet’s monopolistic position in the production of aspartame. However, the development and subsequent introduction of alternative low-cal high intensity sweeteners, combined with the trend of blending, presented a major risk for NutraSweet’s product. Also, as the patents for aspartame expire in the different regions NutraSweet will face competition from alternative producers of aspartame as well.
NutraSweet’s Anticipated Response to HSC’s entry
NutraSweet’s monopolistic position allowed it to earn generous margins by charging a price premium. Consequently, Vermijs should anticipate an aggressive response to the threat posed by HSC to NutraSweet’s dominance in this industry.
To achieve the minimum efficiency scale required for the manufacturing of aspartame, any new player would need to land either Coke or Pepsi as its customer. This is where NutraSweet would defend its current market leading position. By leveraging its brand equity, deep margins and entrenched customer relationships, NutraSweet could afford to offer generous financial terms in exchange for exclusive, multi-year contracts with the industry’s largest customers. Such a strategy would lock-out Holland Sweetener and make it difficult to find customers to purchase the volume necessary to support a 500-tonne plant. NutraSweet’s ability to leverage its deep margins made discounting a significant threat to the HSC. Although HSC made claims that it could produce aspartame with less cost and more flexibility, the generic aspartame producer still needed to compete against NutraSweet’s gains in operational efficiencies, the strong NutraSweet brand in the U.S. and established relationships with the industry’s largest customers.
NutraSweet may also be expected to continue its pursuit of a differentiation strategy to protect its high margins. It could extend its understanding and application of building a strong U.S. brand to Europe and Canada. The benefits of this approach, however, may only be realized after years of significant investment to reduce buyer power and protect price premiums.

Scenario Analysis
Scenario 1: Price war
As we mentioned above, any new entrant in this industry needs to land either Coke or Pepsi as one of the customers to achieve minimum efficiency scale. For NutraSweet to lose one of them would mean losing a large slice of market share. The only possible way that HSC can lure one (or both) away from NutraSweet would be by offering lower priced aspartame to Coke and Pepsi. As NutraSweet’s ‘branded ingredient’ strategy wasn’t very successful in Europe and Canada, Coke and Pepsi were unlikely to pay a higher price for NutraSweet’s product once a generic was introduced in the market by HSC. The introduction of a second supplier for an unbranded ingredient would greatly increase the buying power of both Coke and Pepsi and would eventually lead to price erosion in the aspartame market. We think that this scenario has a high likelihood to play out on HSC’s entry into the market

Scenario 2: Normal competition
As discussed above, a price war would act like a double-bladed sword and destroy value for both NutraSweet and HSC. Unless NutraSweet forces HSC out of the market, both companies would keep cutting their prices for more market share and suffer from much lower margin. This begs the question - is it possible to avoid a price war?
In game theory, a prisoner’s dilemma scenario demonstrates the ability to avoid a price war, should both parties have the ability to signal or communicate their intent. With HSC’s entry into the European and Canadian market, the prices of generic aspartame will communicate the entrant’s pricing strategy. A lower price could be an indication of the intent to launch a price war, while a similar or slightly lower price could be a message for peace. In 1986, aspartame prices were around $70 per lb. HSC could price its products slightly lower (ex. $68 per lb), which should limit the threat it presents to NutraSweet’s market leadership position. On the other hand, this price would acknowledge NutraSweet’s position as a premium product and established the HSC brand as a secondary player. HSC would need to wait for NutraSweet’s response. If NutraSweet resisted price cuts, the possibility of normal competition would be greater.
The question then becomes whether the market has the ability to support two players. If so, both companies could focus on increasing their profit contributions instead of fighting for market share and thus resisting the Hawk and Dove problem. Both NutraSweet and HSC may find the Nash Equilibrium point and maximize their profits. As given in the case, the total European and Canadian market in 1986 was 550 tonnes. If HSC had to operate at full or new-full capacity of 500 tonnes, a fight for market share would be inevitable due to HSC’s need to reach their MES. So, the market would not be able to support two large players operating at MES. Also, considering the high buying power of Coke and Pepsi and aspartame being an unbranded ingredient in Europe/Canada, we consider the normal competition outcome to be of low likelihood.
Recommended Action
Considering that the price war is the most likely outcome, we expect NutraSweet to act aggressively probably even before patent expiration. If NutraSweet locks out Coke and Pepsi in exclusive multi-year contracts, HSC’s investment in the European plant would not be able to achieve much profit, if any at all. Considering that Coke and Pepsi have a lot to gain from HSC’s entry into the market, HSC should sign up significant supply contracts of aspartame with Coke/Pepsi even before it invests a significant amount in the plant. This way HSC can make sure that it captures a significant portion of the value that it creates.
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