May 8, 2018

Surge in off-patent chemicals creates a clutch situation for retailers and manufacturers

By Barney Bernstein, Senior Associate

Patent expirations, dried up pipelines, flatlined commodity prices and rising production costs—it all creates a winning formula for generics to claim a bigger chunk of the ag chemicals market. 

Additionally, there’s a considerable imbalance between the number of active ingredients going off patent and new ingredients coming through the pipeline, creating significant pressure on margins for manufacturers.

As generics make it a whole new ballgame, retailers and manufacturers must check their strategy before they step up to the plate.

While grower revenues are contracting, players in every sector are scrambling to lower their own costs so they have a fighting chance of survival. Everyone is in cost containment mode—mergers are the strategy du jour. From the biggest manufacturers and seed companies to the local co-ops. All these mergers are designed to create cost efficiencies, leverage R&D efforts and to keep the entities relevant. In the chaos of this changing environment many retailers and distributors have turned to generic products that provide an acceptable level of performance and improved profitability for them and their customers.

Retailers and manufacturers are at a strategic crossroads: Generics, without a doubt, are making waves in the industry previously dominated by big chem. As branded products and their generic counterparts contend in a tug-of-war for market share, we believe the battle will reach a tipping point.

Benchmarking Study Shows Generics Market Expanding

Last year Entira conducted a retail benchmarking study with retailers in Iowa where we evaluated transaction data to better understand share of wallet and market share among manufacturers and wholesale suppliers. We gleaned some interesting insight into the impact generics are having on each segment of the ag chemical market.

We learned retailers are all-in on recommending generic insecticides. Herbicide markets are in a state of transition, but almost all active ingredients are off patent now and most market leading products have generic equivalents. Fungicides are still heavily branded, but we noticed changes underway with some retailers mixing generic product to create applications with multiple modes of action.

So, what does all this mean? It means we’re at a juncture where everyone—those creating and marketing the chemistry and those getting it into growers’ hands—must reassess their strategy.

Retailers Must Show Discipline at the Plate

Pressure on finances at the grower level is mounting. As a result, their retail partners and bankers are inclined to put more emphasis on their grower’s profitability. But there’s no one-size-fits-all formula for this, and for retailers, it’s about finding the sweet spot for each individual grower.

Should retailers remain loyal to manufacturers by selling branded products and benefit from back-end marketing payments, or should they transition to better margins on the front end from a generic alternative?

As we discussed in an earlier article, “Value Creation at the Farmgate,” the lower price point of generics may entice both growers and retailers because of the profitability opportunity. However, the cheaper product isn’t always worth the tradeoff of losing the benefits associated with branded product, such as performance guarantees and product bundled programs.

There’s much to be said for the security of the guarantee. Retailers like these guarantees, too—there’s great value in their own peace of mind, especially when there’s a performance issue and they can enlist the support of their manufacturer representative.

Proper segmentation by retailers is key to distinguishing between customers needing the security of the branded product and the guarantees that go with it, and those whose needs can be met with generics.

The challenge is determining what that threshold is—and there’s no magic formula. Many retailers are attempting to segment growers based on historical behaviors to gauge which customers need the guarantee and which can survive without it. But this only works for their existing customers and does nothing to help them sell to a new prospect.

Retailers and manufacturers need to understand which growers are likely to switch to generic or lower cost options to produce their crops and why they are switching. When they understand the “who” and the “why,” they can promote the “what”—the crop input package of products and the associated value proposition that can get the grower to say yes. That’s a home run.

Manufacturers Must Keep the Line Moving

For manufacturers to maintain or advance their position, they’ve got to keep the ball in play.

Manufacturers must manage price and volume to minimize degradation of profitability. It’s a tricky balancing act—if volume falls too low, it does nothing to counteract fixed costs that eat into margins. But dropping price is immediately detrimental to the bottom line. The question for them is, “How do we maintain loyalty and provide profitable volume? Are incentives part of the answer? Do prices need to change?”

Larger manufacturers with decent pipelines have a distinct advantage—if you have promising chemistry in the pipeline, you’re in a unique position to add value and stay relevant. But that doesn’t mean you’re out of the woods.

For those companies with drier pipelines, it’s a bit more challenging—particularly if the majority of their portfolio is off patent. The inclination may be to lower prices, but history shows price drops don’t necessarily drive market share. It’s critical to conduct quantitative studies to understand a product’s price/volume relationship within its competitive market. And that information must be relevant for the current market situation. This means that in some markets these studies may need to be repeated before making a pricing strategy decision.

My experience with dropping prices in the face of increased competition is that it can make your position doubly worse—not only do you lose profit margin, but you still don’t achieve the volume gains to offset your manufacturing costs. American Cyanamid tried this approach with Pursuit back in the late 90s, and it failed miserably. Sales of Pursuit took a big hit when Roundup Ready soybeans came into the market. Cyanamid decided to compete by cutting the price of Pursuit. This did very little to boost volumes. Not only did their profits suffer, they didn’t get the boost in volume to help spread fixed costs.

Before manufacturers decide to fight generics on price, they need to know the price-volume relationship for the product. Maybe it’s better to leave those older cash cows alone than to sacrifice profits and margins with price cuts that hope to boost volume, but don’t guarantee it.

Had American Cyanamid kept the price of Pursuit where it was and focused instead on value, they could have milked the cow for better profits.

Growers Need Good Base Coaches

With the influx of generics and private label alternatives, it would seem manufacturers have the most to lose; but retailers are embedded in their own set of challenging circumstances. It’s a new era for ag retailers, and even with new pressures from online sellers, growers still need the knowledge and trust only a local partner can provide.

For the grower, it comes down to the tradeoffs, and whether a lower price is worth losing out on all the benefits that come with a manufacturer’s guarantee or a retailer’s services. And one thing is for certain, they will value anyone who can get them safely around the bases. It’s not as simple as just choosing the lowest price option—there’s a value difference as well, and sometimes…oftentimes, even…that value differential is worth far more.

If you’d like to talk through how to strategically respond to the surge of generic products in the market, contact Barney Bernstein at bberstein@entira.net or 919.830.6527.