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Dow Corning's Big Pricing Gamble

 
3/7/2005
When Dow Corning noticed a trend toward commoditization, it had two options: panic, or create a sub-brand. Here's how the chemicals giant handled a "strategic inflection point." From Strategy & Innovation.

Specialty chemicals giant Dow Corning caught its competitors by surprise in 2002 when it launched Xiameter, a Web-based discount sales channel whose mandate was to bring in new business as well as retain cost-conscious customers who were fleeing their traditional, high-touch relationship with the company.

Throughout the industry, profit margins for many mature products had been declining for nearly a decade; the strategy that Dow Corning and its competitors had taken to date was to add yet more services to their offerings as a vehicle for boosting margins. By contrast, Xiameter adopted what looked like a radical tactic: Dow Corning customers could bulk order some of the parent company's most established products without the premium prices that reflected added services.

Some industry analysts saw this as suicidal. A two-tiered pricing system, they argued, would undermine Dow Corning's core business; purchasers of premium-priced products—available for a lower price through the Xiameter channel—would think they were being overcharged and would clamor for a better deal. To date, however, Xiameter has been a clear winner: It paid back its original investment to the parent company in just three months.

The story of Xiameter's development and early existence offers valuable lessons not only about the importance of reading the signs that an industry has reached a strategic inflection point but also about how an industry leader can manage the inherent tensions between its established business and the low-end disruption it creates to further grow its business.

The core business
Midland, Mich.–based Dow Corning—a privately held joint venture established by Dow Chemical and Corning Glass Works (now Corning) in 1943—is the dominant player in the silicones industry. Silicon, the second most abundant element on earth, has an extraordinarily wide range of industrial applications, from computers to aeronautics to textiles to beauty products. Dow Corning makes more than 7,000 silicone-based products that are sold to more than 20 end-user markets. Dow Corning's segment share is estimated to be more than 36 percent, which puts the company well ahead of its nearest rival, GE Silicones, which holds an estimated 24 percent share of the market, according to Chemical Week magazine.

Many of Dow Corning's customers are companies in emerging markets or in markets characterized by rapid technological change. "Take, for example, a microelectronics manufacturer in the Japanese cell phone market that is looking to introduce a smaller phone or new services and needs help making its chips run faster," says Ron Fillmore, executive director for Xiameter. "Such a company might ask us to develop silicone products that would be part of the answer. Another example might be a skin-care company that wanted help creating a nongreasy lotion that stayed on the skin longer."

The silicone products used in industries such as these are far from mature, and the life cycle of the end product—whether cell phone or lotion—is often short, with new formulations being tested and introduced all the time. Consequently, Dow Corning's customers in these industries have been willing to pay a premium for the R&D that leads to better-performing and more-innovative products that are also safe and environmentally friendly.

Listening to market forces
In the early 1990s, however, Dow Corning noticed an emerging trend toward commoditization in some of its markets. This meant that as specific products matured, the priorities of clientele within them shifted from wanting help with innovation to wanting to keep costs low. "An example would be dimethyl fluids in the chemical processing industry," says Fillmore. "Customers in this sector started to tell us they didn't want all the additional service we provided. They were no longer looking to us to help discover ways that these fluids could solve new technical problems. They knew exactly how they wanted to use the fluids. What they wanted was product quality and consistency delivered in the most cost-effective way possible."

A two-tiered pricing system, [analysts] argued, would undermine Dow Corning's core business.

This change in what some customers valued—and the consequent decline in profit margins within those market segments—led Dow Corning to conclude that the basis of competition had shifted in parts of the industry. Facing the possibility that such a shift might spread, the company realized it required a more needs-based approach to customer segmentation. Its existing business model, which emphasized selling technical assistance and product testing on top of its core products, ignored price-conscious customers. To meet their needs—and to keep them from migrating to other, less-expensive providers—Dow Corning would have to devise a radically lower cost structure that would allow it to profit solely from selling products.

In 2000, Dow Corning started exploring business models that could take advantage of the commoditization trends. Much of the cost in a business, the company reasoned, is associated with offering customers flexibility and choice around such issues as methods of ordering, order size, order-to-delivery lead time, and shipping and payment terms. By offering just one way of handling these issues, Dow Corning could dramatically rein in its costs. And creating a Web-based sales channel with an automated order-entry system would significantly reduce the need for customer service staff.

Gradually, a composite of this new sales channel's ideal customer began to take shape: companies that bought silicone products in large quantities, that could plan their product requirements two to four weeks in advance, and that could handle their own technical service needs.

In late 2001, Dow Corning created a standalone team to develop this new sales channel and housed it in the company's Midland headquarters to take advantage of Dow Corning's recent $100 million investment in SAP, which provided integrated ordering, invoicing, fulfillment, and accounting functions. At the same time, however, Dow Corning wanted to create the look and feel of something fresh, "something we could designate as a new measure of value for Dow Corning," says Scott Fuson, chief marketing officer for both Xiameter and Dow Corning. So in addition to locating the team on its own separate floor in the building, Dow Corning gave it a name—Xiameter—that had no prior meaning in the marketplace.

The Xiameter team members were handpicked from the ranks of Dow Corning's 8,800 employees. "The criteria that drove our staffing choices were a passion for the customer, a proven track record of delivering results, a willingness to take risks, and the ability to function in a fast-paced environment," says Fillmore.

Launch and early results
When Xiameter team members interviewed advertising agencies to help brand and position the new sales channel, they were told it typically took one to two years to launch a venture properly. Yet only six months after its formation, the Xiameter team came out with a fully automated Web portal that functioned in 50 countries worldwide. Today that number has increased to 82, and new countries are added as customers require. Not surprisingly, the portal emphasizes transactional sales as opposed to relationship sales. Dow Corning has more than 7,000 offerings, but the Xiameter portal sells just 400 items.

A customer can place an order, then receive acknowledgement of that order, confirmation of shipment, and an electronic invoice without having to interact with a Xiameter employee. A required minimum quantity for each product order—typically, a truckload's worth of material—helps Xiameter consolidate freight costs. (Small-volume purchasers do not qualify for Xiameter's cut-rate prices; they must buy directly from Dow Corning or through a local distributor.) Predetermined manufacturing lead times and standard terms for credit help Xiameter reduce costs further. Rush orders incur a 10 percent surcharge because they require human intervention to establish the product's availability and review the delivery schedule. Similarly, there is a service fee for orders placed by phone or through regular mail to cover the additional personnel involved.

Although Dow Corning does not divulge sales and earnings figures by product, Fillmore says that Xiameter experienced double-digit growth in its first year of operation and that its contribution to Dow Corning's overall financial health has been "very favorable."

Future growth
As other silicone products mature and the need for continual refinement and testing on them diminishes, they will be added to the items already offered through Xiameter; eventually, Dow Corning expects that a greater percentage of the sales of these products will take place through the Xiameter channel.

Though the same products Xiameter offers are available through Dow Corning, the two brands attract and serve very different clientele.

Xiameter also is considering developing a roster of products with which to compete in nonsilicone markets, such as those for mineral waxes and certain rubbers. In addition, Xiameter is thinking of making its Web-enabled sales channel available (for a fee) to other chemicals companies looking for new outlets. "These additional products would have to be complementary to our silicones and provide value to our customer base," says Fuson.

Xiameter's search for new, more profitable markets will not come at the expense of Dow Corning's value-added silicone business. Nor will Xiameter ever offer product testing or technical assistance. "However we decide to grow, we're not going to intentionally compete against ourselves," Fillmore emphasizes. Customers who need help coming up with new product formulations can continue to buy this expertise through the Dow Corning channel.

Thus, Xiameter's expansion is predicated on maintaining a sharp distinction between the brands through needs-based customer segmentation. Though the same products Xiameter offers are available through Dow Corning, the two brands attract and serve very different clientele. The Dow Corning brand is aimed at companies wanting technical assistance, research support, and the expanded services involved in determining which chemicals will provide a particular performance capability, feel, or experience. Xiameter's brand, on the other hand, serves the narrower market segment for which price is paramount.

Thanks to this careful delineation of Xiameter as a sub-brand of the overall Dow Corning brand, Xiameter's creation has not caused conflict with Dow Corning's existing channel partners. Channel partners, by their very nature, provide tailored offerings that better meet customer needs. Xiameter's stripped-down, no-frills approach was intentionally designed to serve a different market segment than the one the channel partners serve. "Xiameter's strategy has never been to disintermediate Dow Corning's distributors from their end customers," says Fuson.

Far from being a threat to Dow Corning's core, Xiameter has become an important element of Dow Corning's expanded service offerings. In 2002, the company revamped its brand identity to emphasize "meeting customers' needs exactly," says Fillmore. In accordance with this new approach, Dow Corning has started to offer consulting services to chemicals companies looking to enter new geographic markets or to improve the efficiency of their operating processes. "So now," Fillmore continues, "whether customers want ongoing technical assistance with new formulations, help with expansion or business-process improvement, or the lowest base price, we've got an offering for them."

Reprinted with permission from "Dow Corning's Push for Organic Growth," Strategy & Innovation, Vol. 2, No. 6, November-December 2004.

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Loren Gary can be reached at lgary@hbsp.harvard.edu.