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E. I. du Pont de Nemours and Co.: Titanium Dioxide In May 1972 the executive committee of E. I. du Pont de Nemours and Co. convened to consider a report from the pigments department concerning the titanium dioxide market. Events had dramatically altered the economics of producing and selling titanium dioxide in the United States. Substantial excess demand had developed, causing producers to reevaluate their capacity expansion plans in this market. Du Pont's executive committee had to determine what Du Pont's response would be-and the likely reaction of its competitors-to the changed environment. Company Background E. I. du Pont de Nemours and Co. (Du Pont) was a diversified manufacturer of fibers, plastics, industrial chemicals and other specialty chemical products. In 1971 it was the seventeenth largest manufacturing corporation in the United States, with reported earnings of $357 million on sales of $3.8 billion. It was a conservatively managed company as evidenced by its longstanding AAA bond rating and its tendency to rely on retained earnings to fund its capital expenditure programs. (A five-year financial summary for Du Pont is provided in Exhibit 1.) Since its founding as an explosives manufacturer in 1802, Du Pont compiled an enviable record of growth and profitability. Historically, Du Pont competed primarily on the basis of technological innovation and tended to avoid cost competition in commodity markets. The rapid pace of technological development, however, and the consequent shortening of product life cycles in recent decades had forced it to defend some of its mature products more aggressively. This frequently meant improving costs and competing on the basis of price. Because its size and technological superiority usually afforded Du Pont a dominant position in the markets in which it competed, an aggressive defense of market share often gave rise to antitrust charges. Du Pont was organized into 10 industrial departments. The pigments department, the second smallest with sales of approximately $180 million in 1971, was responsible for titanium dioxide. Du Pont's involvement with titanium dioxide began with the acquisition of the Commercial Pigment Co. in 1931. By 1972 Du Pont had closed its original manufacturing facility and was operating more modern plants in Antioch, California; Edge Moor, Delaware; and New Johnsonville, Tennessee.Titanium Dioxide Market Titanium dioxide {TiOQ is a white chemical agent used in the manufacture of paints, paper, synthetic fibers, plastics, ink, and synthetic rubber. It acts as a whitening and opacifying agent and has no commercially satisfactory substitute. Two principal technologies exist for manufacturing TiOz: a sulfate process and a chloride process. The sulfate process produces TiD1 by the digestion of low grade titaniferous feedstocks with sulfuric acid. Although this technique does not require highgrade feedstock, it produces large amounts of ecologically hazardous wastes. in the chloride process, titaniferous feedstock reacts with chlorine in the presence of carbon to produce titanium tetrachloride, which is then converted to TiOZ. The chloride process can use either highgrade feedstock {rutile or synthetic rutile) or lowgrade feedstock (ilmenite or lecoxene}. The lowgrade chloride technology {ilmenite chloride} differs from the high-grade chloride technology (rutile chloride) by requiring more chlorine per unit of output and producing more waste. However, both chloride processes produce less waste and safer waste than sulfate technology. Domestic sales of TiD2 were projected to reach 730,000 tons by the end of 1972, with a dollar value of $340 million. The volume of sales had been growing slowly at a 3% annual rate during the previous decade. Since TiC)2 was an ingredient in many final products with cyclical demand, its demand also tended to move with the business cycle. Based upon past experience, the volume of demand could fall by as much as 10% between the peak and the trough of a business cycle. Annual sales were projected to grow to more than one million tons by 1985. TiO2 prices tended to be extremely stable. Between 1963 and 1969 selling prices remained between $26 and $27 per 100 lbs (This represented a 17% decline in real prices over the period.) After 1969, prices fell below $25, but began recovering sharply in 1972. Capacity Expansion Decisions by TiO2 Producers The National Lead Co. built the first domestic TiD2 plant in Sayreville, New Iersey, in 1918. This plant used the sulfate process as did all subsequent plants built before the 1950s. Du Pont then introduced the ilmenite chloride technology at its Edge Moor plant in 1952. This facility took almost three years to become fully operational because of the formidable problems involved in scaling up this technology from models. As a result, although the chemical process of the ilmenite chloride method was widely known, only Du Pont possessed the operational knowledge necessary to make production economically viable. In 1958 Du Pont again chose the ilmenite chloride process for a large plant at New Iohnsonville, Tennessee. Since this plant was the largest in the industry, Du Pont realized scale economies that lowered its costs slightly below those of its competitors,- however, Du Pont's decision to use the ilmenite chloride technology was based primarily on its access to ilmenite ore, not on cost savings.1 Both the sulfate and the two chloride technologies had roughly identical per unit operating costs for plants of equivalent size. In the late 1950s and early in 1960, large quanties of easily accessible rutile ore were discovered in the beach sands of eastern Australia. As a result, all plants built during the next decade used the rutile chloride technology, including a facility in Antioch, California, built by Du Pont in 1964. By the early 1970s, eight U.S. firms Supplied over 90% of the domestic market for Tit\")1 with imports supplying the remainder. All of these rms were diversied to varying degrees. (Exhibits 2 and 3 detail each firm's capacity, actual production and dollar sales during 1970 to 1972 for both types of technology.) After Du Pont, National Lead {NL} was the second largest supplier of Til\")2 by a wide margin,- however, its share of the market fell steadily throughout the late 1960s. NL had total 1971 earnings of $23 million on sales of $925 million. It was generally less profitable than Du Font and relied more heavily on debt to finance its growth (debt as a percentage of NL's total capital was 35% in 1971). NL was also more highly sensitive to economic uctuations. ln 1971 NL owned T'iO2 plants in Sayreville, New Jersey, and St. Louis, Missouri. Pigments accounted for roughly onequarter of NL's total sales and onethird of its total operating prot. Transltlons In the TIOz Market Between 1969 and 1972 two major events transformed the domestic TiC't2 market. A sudden shortage of rutile ore developed in 1970 and 1971, and ore prices increased dramatically. When per ton prices of rutile ore rose from A$65 {Australian dollars} in the late 1960s to A$110 in 1972, the economics of the highgrade chloride technology were altered radically. During the same period sulfate process plants were forced to make major capital expenditures to comply with newly enacted environmental protection legislation. The combined effect of these two disruptions was to significantly raise TiD2 mill costs for both the sulfate and rutile chloride processes. Whereas previously Du Pont's ilmenite chloride process had only a small cost advantage over other processes, it was now signicantly cheaper than the other two technologies. Following these events, production of "HO, declined sharply as high cost plants began to shut down. Exacerbating the supply problem, the devaluation of the U.S. dollar and the continuation of a tariff on TiO2 cut imports significantly. The reduced supply of 'I'iC)2 resulted in substantial excess demand and the rationing of production among users. Du Pont's Strategic Alternatives in Tit)2 Excess demand created capacity expansion opportunities for producers of TiOz. Du Pont's rivals had two principal alternatives for expansion: upgrading marginally protable sulfate and rutile chloride plants or building new ilmenite chloride plants. As Du Pont's Edge Moor plant demonstrated, this latter alternative required largescale facilities and extensive experience to be made economically viable. An opmalscale ilmenite chloride plant would require capacity of 50,000 100,000 tons per year and would cost between $45 and $90 million. Competitors building such plants would assume the usual risks of technical failure, delayed startups, and so forth. But a risk of declining prices and diminished cash ow from TiO2 operations also existed if many competitors simultaneously chose to add capacity and ood the market. Du Pont recognized both the opportunities and the risks inherent in the TiO2 market and took steps to formulate a strategy for coping with the changed environment. In May 1972 A. 1-1. Geil, vice president and general manager of Du Pont's pigments department, submitted to the executive committee a report entitled \"Opportunities in the TiD1 Business.\" The report described two possible strategies in Tit\")1 that Du Pont should consider implementing: a growth strategy and a maintain strategy. The objective of the maintain strategy was to boost Du Pont' s market share in TiO2 to 45% over the next several years. The growth strategy, on the other hand, called for an aggressive response that would be designed to \"provide cash for Du Pont expansion [in the TiO2 market], but limit competitors' ability to expand.\"2 This strategy required the integration of plans for expanding capacity through 1985, pricing TiOz, and restricting the licensing of the ilmenite chloride process to improve Du Pont' s competitive position in this market. Successful implementation of this strategy required that all three of these tactics be coordinated, since each independently represented a much smaller threat to competitors' expansion moves. Forecasts of total demand for TiOz, capacity costs, operating expenses, selling prices, Du Pont's market share, and Du Pont' s TiCt2 capacity under both strategies are shown in Exhibit 4. Du Pont's market share in 1985 at the end of the capacity expansion program was expected to be almost 65% under the growth strategy compared with 45% under the maintain strategy. Forecast prices for TiO2 were expected to be lower at rst under the growth strategy relative to the maintain strategy as Du Pont's new capacity increased industry supply.3 But they were expected to be relatively higher in future years due to more orderly capacity expansion. Forecast operating expenses were expected to be the same under either strategy. The cost of new capacity was expected to be $900 per ton in 1973 and to increase as shown in Exhibit 4. Further investment in net working capital amounting to 20% of the increased sales level would also have to be made. The capital investment {other than additions to net working capital) would be eligible for a 10% investment tax credit.4 Ongoing capital expenditure for maintenance and replacement were expected to approximate depreciation allowances over time. Thus, should TiC)2 production terminate at any point in the future, it was believed that Du Pont's investment in working capital and the book value of other assets could be completely recovered. Du Pont's pretax operating prot margin before interest expense, but after depreciation on the new capacity, was expected to average 40% under both strategies. This was more than twice the margin that competitors building new ilmenite chloride capacity would realize at the outset. The difference resulted from Du Pont's extensive experience with this production technology and could be expected to erode over time as competitors gained similar experience. In light of the longterm benets and other competitive advantages associated with the growth strategy, the pigments department recommended its adoption. It noted that \"a combination of factors [put] Du Pont in the unique position [of being able] to increase its share of the market by a substantial amount,\"5 and argued that such a unique set of circumstances should not go unexploited. If accepted, the TiD2 growth strategy would commit Du Pont to a massive capital expenditure program that would reach half a billion dollars by 1985. Before reaching a decision, the executive committee had to be convinced that the relative merits of the growth strategy truly justied such an extended period of high capital expenditure. Exhibit 1 Fiveyear Financial Summary, 19671971 {$ millions, except per share and ratio data) Income Statement Sales Net income Cash ow from operations Earnings per share Dividends per share Average shares outstanding {(100) Balance Sheet Net working capital Net property, plant and equipment Total assets Total debt Share holders' equity Total cap ital Book value per share Market value per share3 Capital Sources Cash ow retained External equity nancing {net} Debt financing (net) Total capital added Capital Expenditures Key Financial Flatios Growth rate ('36) Sales Prots Return on sales (as) Return on equity ('34:) Current ratio Debt and total capital (ea) Price earnings ratioa Market valuelBook valuea 1971 $3,343 357 727 7.33 5.00 47,231 $1,221 2,002 3,999 307 3,095 3,402 60.23 143.75 $ 430 21 _91 $ 592 $ 454 6.4 6.9 9.3 11.5 3.5 9.0 19.6 2.4 1970 $3,613 334 634 6.36 5.00 47,257 $1,100 1,923 3,740 216 2,964 3,130 57.67 113.33 $ 433 37 _30 $ 505 $ 471 (0.4) (5.2) 9.2 11.3 3.6 6.3 16.5 2.0 1969 $3,632 356 677 7.62 5.25 47, 076 $1,107 1,303 3,453 136 2,354 3,040 55.53 133.33 $ 423 35 $ 432 $ 391 5.1 (4.3) 9.3 12.5 3.6 6.1 17.5 2.4 8 Based on midpoint of the year's trading range for Du Pont's common shares. 1963 $3,455 372 659 7.99 5.50 46,235 $ 996 1 ,733 3,239 162 2,697 2,359 53.09 162.75 $ 394 23 $ 454 $ 332 12.2 13.5 10.3 11.3 3.6 5.7 20.4 3.1 1967 $3,079 314 533 6.73 5.00 46,153 $ 374 1 ,724 3,071 125 2,557 2,632 50.22 1 63.25 $303 19 J1 $ 394 $ 454 (2.5) (19.3) 10.2 12.3 3.2 4.7 24.2 3.3 284-066 -6- Exhibit 2 Domestic TIO, Production Capacity by Firm Total Domestic TIO, Shipments by Firm, Including Imports 1972 est. 1971 1970 1972 est. 1971 1970 972 est 1971 1970 00 000 % % 00 000 tons 000 tons 000 tons $ millions % $ millions $ millions tons ons tons Du Pont 325 277 252 220 30 222 206 98 NL Industries 230 27 268 268 180 25 209 210 102 33 112 American Cyanamid 90 10 10 82 90 80 11 72 53 24 9 27 SCM 75 9 78 9 78 65 64 9 58 25 26 30 11 3 13 Gulf & Western 70 8 70 70 60 26 4 30 Kerr-McGee 45 5 39 37 45 37 5 31 20 12 4 16 Sherwin-williams 25 3 27 27 30 26 4 21 10 12 4 8 4 PPG = 18 10 Total (U.S. firms) 860 100 841 100 840 100 680 93 666 94 618 91 320 94 296 95 304 41 20 15 21 Imports 100 84 100 840 100 730 100 707 100 676 100 340 10 311 100 325 100 Total 860 Source: Federal Trade Commission, In the Matter of E. I. du Pont de Nemours & Co., Docket No. 9108, Complaint Counsel's Exhibits Nos. CX121A, B; CX223A, B; and CX222. a Excluded exports. b Thousands of tons shipped. c Dollar value of shipments Exhibit 3 Tio, Production by Firm and Type of Process, 1970 (tons 000) Total Productiona Sulfate Process Chloride Process Du Pontb 211 43 168 NL Industries 229 193 36 American Cyanamid 56 47 SCM 51 48 Gulf & Western 33 33 Kerr-McGee 35 35 Sherwin-williams 19 19 PPG 10 10 Total 644 364 280 Source: Federal Trade Commission, In the Matter of E. I. du Pont de Nemours & Co., Docket No. 9108, Initial Decision, p. 11. a Differences between total production and total shipments (see Exbibit 2) represent adjustments to Tio, inventory. b Only Du Pont had chloride process production using low-grade feedstock; all others used high-grade feedstock. Exhibit 4 Tio, Market Forecasts under Alternative Strategies for Du Pont, 1973-1985284-066 -7- Growth Strategy Maintain Strategy Size of Cost of Pretax Average Gross Du Pont Du Pont Average Gross Du Pont Du Pont Marketa New Capacity Operating Expensesb Selling Price Market Share Capacity Selling Price Market Share Capacity (tons 000) ($ per ton $ per ton) $ per ton) %) (tons 000) $ per ton) (%) (tons 000) 1973 752 900 330 540 35 350 555 35 340 1974 774 927 390 640 40 375 665 40 350 1975 798 955 460 750 47 400 760 45 360 1976 822 983 540 880 47 421 890 45 370 1977 846 1,013 580 950 51 443 955 45 381 1978 872 1,043 620 1,010 52 475 1,015 45 392 1979 898 1,075 660 1,070 52 505 1,070 45 404 1980 925 1,107 690 1,130 55 530 1,120 45 416 1981 952 1,140 710 1,190 58 552 1,170 45 428 1982 981 1,174 740 1,250 59 579 1,210 45 441 1983 1,010 1,210 770 1,310 61 616 1,270 45 455 1984 1,041 1,246 810 1,370 62 645 1,32 45 468 1985 1,072 1,283 850 1,430 64 685 1,370 45 482 a Total demand for TIO, is forecast to grow at 3% annually and is not considered to be very sensitive to price. b Pretax operating expense per ton includes depreciation allowances but excludes interest expense