The disagreements between the young founders and the investors smoldered over the next few months, during which time VMG wrestled with production snags and inventory snafus. By fall the company was running out of cash, but negotiations with the limited partners (who needed to approve any new financing) were going nowhere. Slowly but surely, moreover, some of the investors were losing confidence in VMG's management. One week before Thanksgiving a group of limited partners took a vote. With no dissenters, they decided to throw the founders out. (See "The Enemy Within," April 1987.)
On the day of the vote, Wagner broke ranks with his fellow founders and negotiated a new job for himself (temporary, as it turned out) at VMG. Pitassi and Klemp stuck together; neither of them could imagine going to work for people they couldn't trust. Their first impulse after hearing of the vote was to talk to their attorney; when they returned to the plant, the locks had been changed. "One day," Pitassi says, "we were young guys at the top of everything. We were being interviewed on TV and in the newspapers and were driving identical white Cadillacs. And then we became nobodies overnight."
To get beyond their feelings of bitterness and defeat, Pitassi and Klemp wanted to immerse themselves in something else. So they set up a couple of folding tables in Klemp's unfinished basement, installed a phone, and starting exploring possibilities for another business. While doing some consulting in the consumer-products area, they soon began writing a new business plan. The business? Another diaper company. The place? This time, they'd head for Houston. It was well-placed for raw materials and distribution by land and by sea. What's more, no regional diaper brand had yet staked out the South.
On the face of it, it made a lot of sense. Between them, Pitassi and Klemp had amassed a huge amount of knowledge about the disposable-diaper market. And if they had proved anything in their short tenure at VMG, it was that there truly was a niche in this industry for quality products priced $1 or so beneath the national brands. Consumers liked getting competitive products for less money, particularly when family budgets were being squeezed. Retailers, meanwhile, found that they really could use the regional brand to make money in a category that was usually a money loser. "We had given birth to this concept," Pitassi notes. "And nobody we knew could articulate it as well as we could."
But could Pitassi and Klemp really do the same thing twice? On some days they had their doubts. They wondered if their navetÉ hadn't been a huge asset the first time around, more important, perhaps, than any experience. "We worried," says Klemp, "that we knew too much."
As they approached prospective investors, they pitched their formula for doing business. "Investors weren't interested in a revenge story," notes Klemp. "They wanted a good investment." Everyone they met with asked the same basic question: how could they sell against the likes of Procter & Gamble and Kimberly-Clark? Using industry data and the record of VMG, Pitassi and Klemp would present their case: just as they'd done in the Pacific Northwest, they'd create a "smart-shopper choice" for diapers in the South.
It took them more than a year to fund the business, during which time their anxieties ebbed and flowed. A couple of times a month they'd drive 12 hours from Portland to San Francisco for meetings with venture capitalists or individual angels. "We must have done it 30 times," notes Pitassi. A lot of people simply weren't attracted to the deal. Even if they were, Pitassi and Klemp didn't hesitate to turn prospects away. "We had learned the words due diligence, and we thought a lot about how we wanted the company structured," notes Klemp. Some investors wanted too much equity for their money; others had a bent toward getting too involved in management, a red flag if there ever was one. Finally, after Klemp and Pitassi had spent almost a year shopping the deal around, Ron Keil, the former owner of a Portland grocery chain, made the decision to invest $500,000. Because of his background, the investment gained instant credibility. By August 1987 the new company had raised $2.4 million from a total of about 60 individuals.
* * *
The moment Pitassi and Klemp had their initial funding, the new company, originally named Veragon Corp., was a blur of activity. The first diapers wouldn't be produced for 10 months, but the challenges the company needed to meet before then seemed endless. There was a facility to rent, a production line to design and order, a broker network to establish, and retail relationships to cultivate. All would have to be done on a thin budget. And in the meantime, both Pitassi and Klemp had to relocate to Houston.
One of their first official acts was to recruit an operations manager from P&G, Terry Tognietti, to become the third partner. Tognietti, then 31 (with 9 years of diaper experience), had recently spearheaded a P&G development effort that resulted in the first differentiated boy and girl products for Luvs. P&G didn't let him slip away easily; Tognietti had to sign an inch-thick agreement prohibiting disclosure of critical information for two years.
Once Tognietti was in place as Drypers' operations chief, the three partners (Pitassi was in charge of sales and marketing; Klemp headed finance) spent several months laying down the key planks of their strategy. In some areas, they could retrace the pattern from VMG; in others, they needed to be flexible. From day one, for instance, they knew they had to have the right product -- a diaper with all the important features of the big brands. The exact specifications were a moving target, however, dictated by the evolving standards P&G and Kimberly-Clark set for baby dryness and comfort. The pricing goals were clearer: the partners wanted Drypers to be positioned at least $1 a package less than Pampers, Luvs, and Huggies. And beyond that, they wanted to give retailers room for profit they didn't have selling the national brands. The potential for boosting store profits was the main lever they hoped would win them a footing in Texas supermarkets.
During the 1980s many retailers had seen their margins on Pampers and the other brands evaporate as mass merchandisers like Wal-Mart and Kmart promoted them at, or near, cost. In Texas and elsewhere, supermarkets treated those brands as "loss leaders" -- items they needed on the shelves to pull parents into the stores. The hope was that, once there, customers would drop money on other things, like baby food, where there was higher profit. Chains had already moved toward increasing profits in the expanding diaper category by adding their own lower-priced "store" brands, which were gaining rapidly in the market. By early 1988 store executives in Houston and other parts of Texas began to hear the Drypers pitch.
