C3X Survey Highlights Paths to Growth in the Chemical Industry
Since the Great Recession, the European chemical sector has experienced a major turnaround and significant volume growth. The financial performance of many industry leaders has reached, and for some even exceeded, pre-crisis levels. To sustain and accelerate this momentum, players set forth ambitious growth plans.
So, how can these plans be implemented and which is the right path-organic growth or growth through acquisitions? How can sustainable growth be achieved in the light of continued global financial volatility and in a landscape of consolidating Western chemical players that face intensified competition from the Middle East or China? The most recent edition of the Chemical Customer Connectivity Index (C3X), published by A.T. Kearney, CHEManager Europe and Westfälische Wilhelms-Universität Münster1), provides answers.
Despite signs of a slowdown in economic growth, the European chemical industry is looking ahead with genuine optimism. This is supported by the latest Chemical Customer Connectivity Index (C3X), a top management study conducted by A.T. Kearney in conjunction with CHEManager Europe and Westfälische Wilhelms-Universität Münster1). More than 90% of the study's participants, both chemical manufacturers and their customers, expect demand for chemicals in Europe to continue to grow over the coming 12 months (figure 1). However, half of them indicate that the pace of growth will slow down compared to what they have seen over the last year.
"The continuing optimistic demand outlook shows that the current upward trend is expected to last. Nevertheless, prospects are moderate, which suggests that chemical players are increasingly anxious about the economic upswing slowing down. The period of rapid growth that followed the Great Recession is over," says Dr. Tobias Lewe, Partner in the Chemicals and Oil Practice at A.T. Kearney.
Although the US has announced a temporary solution to its debt crisis, the instability of the global financial system and continued political unrest in some North African and Arabic countries are having a negative effect on trust in global economic health. This is impacting growth prospects for chemicals.
Over the last twelve months, the prices of chemical raw materials have followed the significant market upswing. Some strategic raw materials, such as titanium dioxide, butadiene or some rare earth minerals, have been running short in supply. In this context, more than half of all chemical manufacturers reported raw material price increases of 10% and more compared to a year ago. Almost every fifth participant in the study saw price increases upward of 30%.
A trend reversal is not expected by the study's participants: More than half of the chemical manufacturers expect raw material prices to continue to rise by up to 10% over the next twelve months; one third expects increases of up to 20% and more.
Mastering the customer interface
Booming chemical demand to refill chemical value chains after the Great Recession, scarce and apportioned strategic raw materials, convergence of customer industry value chains-as in previous C3X study panels, manufacturers appear to fail to address customer needs to the extent expected of them: While 40% of manufacturers believe they have an expert knowledge of their customers' requirements, only 17% of the customers attest the same to their suppliers.
And even worse, while 70% of the manufacturers report that their customers' customers define the requirements of their products, only half of them regularly meet with customers of their direct customers. Inevitably, they are running the risk of failing to develop a comprehensive and more value chain-oriented view.
Interaction along the value chain is typically limited to discussions at trade fairs, industry conferences or in direct one-to-one meetings. Joint meetings or even interaction in collaborative networks and more intense partnerships between different parties along a chemical value chain are still an exception.
In order to improve the interface with their direct customers, chemical manufacturers have focused their efforts on offering value-added services, improving pricing excellence, accelerating the innovation process and providing tailored services.
This corresponds only in part to what the customers would like to see addressed. What matters most to them is pricing excellence-although this factor is no longer as all-important as it was in previous surveys-and accelerating the innovation process, followed by process excellence, new markets and customers, and tailored service offerings.
A major gap can be seen in value-added services: Many manufacturers engage in activities in this field, while they are perceived as value-added by only half of direct customers. The efficiency of the sales force is a second point where manufacturers' own perception shows a clear contrast to their customers' point of view(figure 2).
"The result reveals that chemical manufacturers have to focus their resources and activities better, in a way that is truly valued by their customers-for example by improving support in new markets and for new customer segments. Marketing and sales excellence is one of the main areas we see for short-term improvements," Lewe explains.
When asked about key buying criteria in the past, customers did not perceive supply-chain performance, both in terms of availability and reliability, as a differentiator (but expected it as given). This picture has changed: Customers nowadays consider delivery reliability (88%) and product availability (84%) to be more important than other buying criteria, for instance price per performance (slightly down to 79% compared to 2010).
Success factors for chemical companies
It is mainly the technological position that is crucial to chemical companies with regard to success in dealing with their customers. This is followed by customer access and a good understanding of changes in customer markets. According to the customers though, their suppliers' success will to a large extent depend on their ability to comply with regulatory requirements, such as REACH (figure 3).
From an internal perspective, chemical companies see cost leadership (47%), scale/asset effectiveness (44%) and access to skilled labor (33%) as highly important success factors. With regard to their raw material supply, they value feedstock availability (83%), a good understanding of changes in supply markets (63%) and good relations with suppliers from markets outside their own region (27%).
How to conquer new horizons
"Now that the chemical industry in Europe is back to normal and the Great Recession overcome, the quest for new growth opportunities is coming to the fore again," says Robert Renard, Senior Consultant in the Chemicals and Oil Practice at A.T. Kearney and author of this study. But where will growth come from?
Chemical manufacturers expect growth mainly to take the form of organic growth with new (38%) and existing customers (37%). Customers in turn consider organic growth with new customers (54%) as the most important growth lever, every fourth of them expects growth with existing customers. Changes in the business model and mergers and acquisitions will not have a major impact on growth, according to both groups (figure 4).
Following their customers to markets such as the Far East and Middle East and investing in joint innovation as well as in new or additional production capacities is a key lever for manufacturers looking forward. "Manufacturers are moving East. They aim to secure access to competitively priced raw materials, a global human resource and knowledge base and to be able to apply specialized services or technologies at their customers' emerging manufacturing hubs in these regions," explains Renard.
Furthermore, growth momentum is expected to come from technologies that address changing consumer needs. Energy efficiency heads the list of these macro developments, from which both manufacturers as well as their customers expect growth for chemicals. More than half of the manufacturers who participated in the study expect alternative feedstock to grow in importance, i.e. feedstock such as unconventional gas or compounds from bio refining (figures 5 and 6).
Compared to 2010, innovation is seen more as a need to maintain market leadership and extend product/application lifecycles than an activity to trigger growth. That is what chemical manufacturers report. New product features and being a leader in innovation are what most manufacturers (76% for each) consider to be important.
About half of the companies who participated in the study spend 2 to 5% of their revenues on innovation, one third of them 5 to 10%. This means that over the last 2 to 3 years and since the Great Recession, manufacturers have not made any significant changes to their efforts in innovation but might have aligned expectations in terms of short-term growth.
Yet, what customers expect most from their suppliers are new applications (67%) followed by new product features and new chemical products (both 58%). New chemical products that enable customers to address macro developments, such as energy efficiency, are of increasing relevance.
To help their customers become more sustainable, chemical manufacturers provide them primarily with technical services to help them improve their operational sustainability (63%) and focus on securing sustainability in their own supply chain (62%). Another key activity is the provision of alternative raw materials (47%).
"Gaining access to alternative raw material sources, continued volatility, an increase in raw material prices as well as European legislation to reduce carbon dioxide emissions are driving chemical manufacturers' interest in this area," Renard explains.
Strikingly though, chemical customers ranked their suppliers' support lower than a year ago in nearly all categories. "Given the increasing significance of sustainable industrial production, it appears that chemical manufacturers are missing out on growth opportunities in this field and have not yet generated an appetite for more comprehensive services in the area of sustainability," says Renard.
M&A: Consolidation underway
Most chemicals players have launched initiatives to further optimize their market presence in terms of regional coverage, customer penetration or service and product portfolio. Only 1 out of 5 manufacturers sees growth happening through mergers & acquisitions.
Renard says, "This has come as a surprise to us, as we have seen M&A in the chemical sector picking up over the past twelve months. EBITDA multiples paid for strategic acquisitions have been at an all-time high-a clear indication of the strategic attempt by some players, especially in Europe, to consolidate their market segments."
This observation is supported by a recent A.T. Kearney analysis that compared EBITDA margins of leading chemical manufacturers with the development of transaction multiples since 2001 (figure 7). While recent financial market volatility might lead to more conservative enterprise valuations, market entrants from the Far and Middle East might see uncertainty as a good reason to increase investment in established Western chemicals players.
Chinese companies, for instance, are playing an increasingly important role in the chemical industry-in terms of taking a growing share of global chemicals supplies and also as being more active in M&A.
On the manufacturers' side, quite a few say that a Chinese company is among the top three competitors in their industry. But there seem to be areas without Chinese competition as well: Half of the customers do not (yet) consider Chinese companies as real competitors, and neither does a quarter of the manufacturers (figure 8).
If Chinese companies are present, it is predominately via a third party that they supply their products to Europe (66%). Those who operate with a sales force of their own are clearly in the minority (13%).
One point worth noting is that the survey suggests that Chinese companies behaved differently from other industry players during the crisis: When demand dropped, they defended their volume at the cost of lower prices. Defending prices and accepting lower volumes does not seem to have been an option for Chinese companies.
"While many companies still feel a sense of relief that the Great Recession is over, the latest developments suggest that we will all need to prepare for somewhat turbulent times ahead. Manufactures are increasingly being challenged by Middle Eastern and Far Eastern players and securing and maintaining competitive access to raw materials is becoming increasingly challenging. And on top of all this, the economic climate is taking a turn for the worse. To make sure European chemical companies can successfully differentiate themselves from their competitors, it is all the more important that they concentrate their energy on the interface with their customers and try to satisfy their customers' expectations to the highest degree. This is not only about addressing the right issues today, but also about working on what will help customers in the future-and ultimately help them grow," Lewe concludes.
C3X's objective is to analyze the chemical industry from the vantage points of chemical companies and their customers. The survey comprises the views of senior executives of leading European chemical companies and decision-makers in customer industries working at the interface to their suppliers. Participants in this fifth C3X survey, which was conducted in June and July 2011, included executives from more than 15 European countries, representing chemical firms and client companies, which translates into a total of more than 130 executives. The customer industries cover 14 different sectors, ranging from the automotive and food industries to the cosmetics sector.
China's economic ascent has been beyond comparison, with growth rates of 8 percent and more year on year since 2000, even through the economic crisis.
In its recent 5-year plan, the government has formulated the guiding principles for China's positioning. It includes a shift of China's role in the supply chain from a low-cost procurement country to an industrialized global player.
The Chinese chemical industry has not yet reached this goal. It already has strong and large players such as ChemChina, CNOOC, CNPC, SinoChem, and Sinopec, but is still far from being as consolidated as its counterparts in industrialized countries.
In Germany, the top five players in the chemical industry account for two thirds of its revenues, in Japan for forty percent, and in China for far less than twenty. However, M&A activities in China have increased and the state-owned chemical companies in particular are driving consolidation of the industry that will eventually further increase the competitiveness of Chinese companies.
China's chemical industry is still facing problems such as high energy and raw material costs, combined with low process efficiency and quality, organized in fragmented and costly value chains. But the more the government can steer the companies that it owns and influence private Chinese companies to follow suit in improving in these areas, the smaller the gap between China and the industrialized nations will become.