Chemical Distribution in China
Service and Product Offerings Have a Lot of Growing To Do
Undeveloped Market - ICIS, a provider of marketing intelligence on the global chemical industry, published a report in July on the top global chemical distributors. Led by Brenntag with $10.1 billion in sales (2010), at the end of the list, there was a Canadian distributor named Interatlas Chemical with sales of $10 million.
And not a single one of these 160 companies is headquartered in China.
Numerous Chinese distributors have sales easily exceeding $50 million - companies such as Topship, Golden Bridge or the distribution arm of Sinochem. After all, the total Chinese chemical distribution market is estimated at €16 billion (2009), so it certainly has the size for bigger players. But apart from indicating the limited understanding of Asian chemical distribution markets in the Western world, the list may also be interpreted to illustrate a broader point, namely the immaturity of chemical distribution in China.
A number of aspects are proof of this early development stage: the limited product portfolio of Chinese distributors, their limited focus on specific customer segments and industries, and, most importantly, their very limited service offerings.
At Your Service
Let us take a look at a smaller U.S. chemical distributor, Hubbard Hall, with 2010 sales of about $48 million, and compare this company to a typical Chinese chemical distributor. Despite the limited size, Hubbard Hall offers a broad range of services:
- Blending and packaging
- Customized formulations
- Storage and handling of chemicals
- Laboratory analyses
- Tank cleaning
- Safety training
- Process audits
- Drumless delivery services
Such service offerings are quite typical for chemical distributors in the developed markets and account for a large share of their sales and margins. In contrast, Chinese distributors of similar size primarily focus on trading and logistics of chemicals. With a few notable exceptions such as Zhong Yung (which offers tolling, blending and marketing information services not available from its competitors), their service offerings are quite limited.
Coming back to our example, Hubbard Hall provides a broad portfolio of materials including electronic chemicals, heat-transfer fluids, metal treatment and finishing chemicals, paint stripping chemicals, phosphate coatings, rust prevention chemicals, and water treatment chemicals.
Again, this is a fairly typical portfolio for a Western chemical distributor, with its large share of relatively specialized formulations.
In contrast, most Chinese chemical distributors have only a rather limited portfolio (often just 20-50 different chemicals, none of which are formulations), and instead of sophisticated formulations for specific industries, their products are mainly basic solvents and/or plastics.
Consequently, while Western distributors frequently specialize in specific customer industries and try to offer them as broad a portfolio as possible, Chinese distributors are more driven by volume products and tend to focus on only the biggest customer industries.
An Undeveloped Market
This does not mean that chemical distributors in China do not have an important role. Given the vast geographical expanse of China and the higher importance of intimate customer knowledge (not least with regard to offering and controlling payment terms), particularly Western companies definitely need distributors to serve large market segments. However, at the moment, the distribution market may indeed be regarded as immature compared with Western markets.
In China, most distribution is in price-sensitive segments with low margins (1%-4%) rather than in the higher-margin (5% and above) segments in which services are important and which are much more important in Western distribution markets. The reasons for this difference are manifold.
Chinese distributors prefer to focus on trading large volumes of a limited number of chemicals rather than on maximizing their margins. Chinese suppliers of chemicals prefer not to involve distributors at all, which for them is easier to do than for Western chemical companies as they have existing networks and customer knowledge in China and their cost structure is not too different from that of Chinese distributors.
Finally, many Chinese customers - even small ones with very limited technical knowledge - are extremely price-driven and reluctant to pay for any services. However, in the long run, rising quality standards and the need of chemical companies to focus on their core customers will drive chemical distribution in the country toward Western standards.
Finally, some words on the size of the chemical distribution market relative to the total chemical sales in China. Will chemical distribution grow at the same speed as overall chemical sales? There are a number of contradictory factors at work here:
- The share of third-party distributors as part of total chemical distribution is low compared with other countries (6% in China compared with 13% in the U.S.), indicating substantial growth potential.
- However, China has many more small chemical customers than developed countries (according to some estimates, 75% of customers are small compared with 20% in Germany). For chemical producers, the situation is similar. As the industry consolidates and thus both producers and customers get bigger, the share of direct sales is expected to increase at the expense of distributors.
- As multinational companies increase their sales in China in line with overall market growth and get more familiar with local market conditions, they will aim to sell a larger share of their products directly, bypassing distributors. On the other hand, multinational companies will increase their standards for their local distributors and will try to reduce their numbers. Bigger distributors may profit from the resulting consolidation.
- For larger domestic chemical producers, their willingness to involve third-party distributors may increase as they rationalize and increasingly focus on their core competencies. Similarly, customers will aim to reduce internal complexity, increasing the demand for distribution services such as one-stop shopping and customer-specific offerings (packaging, labeling, mixing, recycling, etc.).
- The further regional expansion of China's chemical industry toward Central and Western China should at least initially boost distributors in these regions.
- Finally, when more and larger chemical distributors get established in China, they will become more attractive to principals as their capability to offer countrywide distribution and value-added services will increase.
Investing In Distribution
Overall, chemical distribution likely will grow faster than the overall chemical market. This aspect and the growing maturity of chemical distribution (with the corresponding higher value creation), make chemical distribution an attractive long-term business proposition in China. As a consequence, Brenntag in 2011 acquired a 51% stake in Chinese distributor Zhong Yung Chemical, with the remaining 49% share to be taken up in 2016.
As Zhong Yung is a distributor focusing less on volume and rather on value added, Brenntag's investment also shows the belief in a gradual evolution of the Chinese chemical distribution market along Western standards. We expect both further China acquisitions by Brenntag and similar moves by the main global competitors in the next few years.