Chemical Distributors and their Fight for Growth
How are small and medium-sized enterprises dealing with the issue of growth and the pressure to consolidate?
Fewer And Bigger Companies - For a long time, until far into the second half of the 20th century, chemical distribution was a local business with local or regional players. National distribution units were rare and international ones even more so. This landscape has changed drastically in the past 25 years, with the chemical trade moving further and further away from a configuration based on small-scale organizations. The number of market players is ever decreasing while the relative size of the remaining companies keeps growing.
What are the reasons behind the persistent consolidation of the market and the trend toward concentration? They can essentially be attributed to altered market conditions that lead to larger entities enjoying comparative advantages over smaller ones and gaining more and more weight as they do so. The various reasons for this are given in detail below.
Challenge 1: Storage and Transport Conditions
Since the mid-'80s, legislators have been intervening more strongly in the storage and transport of dangerous goods and have brought about ongoing tightening of the relevant conditions nationally and, later, at the EU level, because of several chemical accidents. This led to mechanization of storage facilities and to the considerable expenditure associated with environmentally sound equipping of warehouse and handling facilities, as well as the mechanical devices that are used in them.
While it used to be possible to operate storage plants economically at 10,000 or 20,000 t/a of handling, the considerable expenditure required now to set up and operate a storage facility of this kind leads to a constant increase in the volume threshold required. In the commodities-handling segment, at least, including tank storage and filling, we can assume that the 100,000 t/a threshold has now been reached. Very few small and medium-sized enterprises (SMEs) can achieve and handle this kind of quantity through their head offices and warehouses. Most of them are just too small.
Challenge 2: Bureaucratization of the Processes
The official requirements for handling chemicals lead to red tape, not just in terms of the physical movement of goods but also in the trading operation.
The expense of generating the correct processes has to be dealt with and requires staff, as well as the necessary knowledge and experience. This is much easier for entities with larger handling volumes. For them, employing the skilled workers required is worth it. They are also the most likely to be able to develop and run IT systems that guarantee the necessary high level of automation for these processes. This reduces manual input to a manageable level, which is not possible for smaller distribution units.
Challenge 3: Paring Down Distribution Channels
Manufacturers are confronted with the necessity of making sure that their distribution channels are slim and efficient. Gone is the previously accepted method of taking care of a large number of different chemical distributors, using in-house distribution staff, and intensively penetrating this "channel to market" with a regional structure based on small-scale organizations. Large producers are scaling back their staff and, for this reason, prefer trading partners who purchase and distribute large quantities, preferably nationally or even multinationally. This reduces communication, consultation and support expenditure to a sensible level.
Obstacles To Growth
Considerable adjustment problems arise for a distribution structure characterized by SMEs, but these companies need to recognize that their original, region-based focus is increasingly being squeezed out of the competitive landscape. Chemical distribution has become an expensive business that is capital-intensive and complex. Running and developing these businesses requires increased staff input and more know-how and financial strength. Developing and expanding enough chemical distribution centers of sufficient size costs millions. A three-tier, fully equipped chemical distribution center, for example, can easily cost €50 million.
Against this background, the biggest obstacles preventing SMEs from being active in this field become clear:
- Psychological reasons: People are not willing to look closely and to recognize that the market structures are changing or to realize that waiting much longer means that their company loses its appeal.
- Know-how reasons: Companies realize that very good, skilled workers are necessary for running the business and that they are not easy to find. Skilled workers are expensive and discerning when it comes to choosing an employer. They want a motivating working environment, and they may not adapt easily to patriarchal structures and to companies that are perceived to be old-fashioned with years-old vested rights and hierarchies that are not considered to perform adequately.
- Capital: This is probably where the main problem lies. The monetary requirements for a company to develop and expand its own distribution activities and, for all the right reasons, to acquire competitors are usually limited by the financial strength of the equity investors. These equity investors who, in small and medium-sized enterprises, are normally family members, are only very rarely able to invest further hundreds of millions or even billions into their own company to facilitate and promote the necessary growth in volume and area.
The Power Of Capital
Let's take another look at capital. Nowadays, banks are reluctant to work with borrowers whose equity capital is considerably below 30 %. They also apply key-figure frameworks when evaluating the borrowers that give information about the performance and stability of the chemical distributor. Whether a loan is made depends on the equity capital invested and on the earnings of the company and its ability to make a profit (still measured by the size of the EBITDA today, which is not always favorable). Scope here is limited. Companies that are already below the optimum size - or at least a tenable size in keeping with the market - and whose proceeds are suffering are not normally able to generate the necessary funds for expansion from equity and loan capital. They are simply not able to join the game of "who can grow faster?" These circumstances are difficult to change retroactively if a company expands to an adequate size too late.
Buy Or Be Bought
So what alternatives are available to chemical distributors like Overlack AG - a distribution company that has been run by the same family for several generations - who realize that they are too big to die and too small to prosper in this market in the long term?
In my opinion, there are only two possible paths in this case: The best possible sale of the company to a prospective buyer who is represented on the market or, alternatively, to become a buyer. Overlack also chose this path. It means leaving in the company any equity capital that can be generated in the course of the profit retention. For the shareholders, this means tightening their belts for 20 or 30 years, with the next-but-one generation in mind, doing without proceeds from the company as much as possible and, last but not least, supporting management as risks are taken. A growth trajectory does not have to lead straight to paradise. The retention of equity capital will be bolstered by adequate support from loan capital. The indebtedness of a company that is set up in this way increases significantly. Against the backdrop of market turbulence or unexpected obstacles, there is a risk of failure.
No Time To Waste
However, resulting positive development of the company is not to be equated with achieving the final goal: It would not be wise for a company to rest on its laurels. The large competitors, the nationally and internationally active market players who have developed in the meantime or who have always occupied a leading position in the sector, have grown at a comparable rate during the same period. And new market participants have joined in through a build-and-buy strategy with the help of private equity. Both of these groups, the old multinationals and the reconfigured groups that are active all over Europe now dominate the much older family firms, some of whom have been on the market for over 100 years. We have to look at that and accept it, even if it hurts - and then we need to act.