Chemical Distribution in the Age of Volatility
Old Game - New Rules?
Ups and Downs of Today's Economy - What sort of road lies ahead for the chemical distribution industry in Europe? In the short run it will be determined by the current, increasingly fragile state of the economy.
As Q1 results are being analyzed, differences between industry sectors (i.e., applications) and geographic regions become apparent. As a consequence, the question "How is your business doing?" could elicit statements of great disappointment and concern or quite upbeat answers, such as, "Not quite as good as last year, but overall surprisingly well." This article tries to describe and analyze some of the factors that influence the state of the industry today, as high levels of volatility are a persistent characteristic of the industry's economic environment.
Evolving Business Requirements
From the customer perspective, distribution today is confronted with ever more short-term ordering patterns and reduced shipment sizes, as customers only buy their raw materials, ingredient and additives once they have the order of their customers on their desks. They are no longer prepared to keep large stocks and expect their suppliers to do this job for them. The reasons could be cash constraints because they have to put up with longer payment terms themselves, lack of bank credit facilities or just that everybody has learned to focus on the management of net working capital. Since producers are not prepared to keep extensive stock positions either, distributors have to act as the buffer. This can be a marketable service element, but one needs to be careful to reflect the associated cost adequately in the product pricing.
Suppliers are also regularly analyzing their channel management strategies. On top, M&A activities in the chemical industry, such as the acquisition of Cognis by BASF or Rhodia by Solvay have triggered changes during the integration phase, which can also be felt in the distribution sector. While the majority of the resulting restructuring steps pertain to the strategic posture of the combined entities and their direct sales channel, some ripple-on effects have caused rather significant changes in the selection of distribution partners, leading to the discontinuation of even longtime relationships.
The resulting staffing adjustments and the "unfreezing" of established positions create significant downstream effects and movements. Nothing can be taken for granted anymore, and distributors need to continuously prove that they make a relevant contribution to the value creation along the whole chain.
Core Vs. Periphery
In the large distribution markets in Europe, such as Germany, France and the U.K., the industry is mostly moving sideways, discussions with distributors and reports from industry associations suggest. Demand has held up so far, but prices have come down somewhat over the last 12 to 15 months, so that overall turnover figures show some decline and margins can and will get under pressure. Many companies are looking at ways to become more efficient in what they do and are making structural adjustments.
On the southern periphery, distributors in Spain and Portugal have been buffeted by the overall economic weakness in their home regions. Certain industries, such as construction, have come to almost a standstill. The more adventurous and financially strong distributors are increasingly turning to Northern Africa, i.e., the Maghreb region or countries in Central and South America for new business opportunities. The former region is attractive, as it is growing nicely in some industries, albeit from a low base. The latter is an area into which a lot of cultural and historical business links exist. This is certainly not an option for everybody, but some companies are benefitting from these opportunities.
Regulatory compliance is absorbing more and more management time at distributors. DistriConsult has recently completed a survey that brought up some interesting results. It covered a broad range of companies from EU and non-EU countries. In their responses, 69% of the participants said that they have assigned accountability for the respective strategy and its implementation to a member of their management team and that they have set aside a specific budget position for regulatory compliance. Regulatory compliance was delegated to a department within the organization by 26% of participants. Only a small minority (6%) sees this as a purely operational issue. When it comes to information on the subject, suppliers are normally seen as important sources of information, followed by trade associations.
Regulatory compliance is seen as critical to business success. It also consumes a significant amount of money and resources. Asked whether this subject would create a competitive advantage and a means of differentiation, the respondents were not so sure.
As the second wave of REACH registrations is coming to its deadline at the end of May, more and more news pops up about producers discontinuing the marketing and sales of certain products in Europe, as they don't see it as being economically viable to amortize the cost for registration and subsequent collection and evaluation of information. For lack of data, let alone a systematic survey and evaluation, these snippets are only anecdotes so far. But there appears to be an issue developing, which will quite likely become more pronounced by the time the third wave registration deadline in 2018 cuts in. This may seem far away, but the threat of a further - and in our view significant - reduction of product variety will have an over-proportional effect on distribution, as the smaller-volume products then affected are the realm of the indirect channel.
M&A Activities Go On
M&A activities in the chemical distribution industry continued to make headlines in the first months of 2013, as these transactions are a major growth driver for many companies. In Europe the transactions over the last few months were mainly done by smaller or medium-sized privately held distributors. The rationale appears to be expansion of geographic coverage, such as Alsiano's recent acquisition of Interplast, or Krahn Chemie's purchase of ICH Benelux. A move to enhance industry coverage was Biesterfeld's acquisition of compatriot Küttner to bolster the presence in rubbers and elastomers.
Outside of Europe, Brenntag has been active in the U.S. with the purchase of Altivia, a distributor of water treatment chemicals, and Lubrication Services. Private equity owned IMCD made add-on acquisitions in South Africa, buying Chemimpo, and in India, where the company acquired Indchem International. These large players seem to have turned their focus to other continents where they are either not yet represented as well or where they expect attractive growth opportunities.
Don't Get Stuck in the Middle
This author has long argued that size matters in chemical distribution, to maintain critical mass and cope with an ever-increasing fixed cost burden. This appears to be going even further, in the sense that companies must make sure they really grow their presence to make sure not to get stuck in the middle. They must either be big enough for a broad and comprehensive geographic coverage of large parts of Europe's core industrial areas or they must concentrate on an application specialization in certain industries that allows them an expert approach with high focus. Only then can smaller companies stay competitive and remain on the leading edge of the industry.
Have the Rules Changed After All?
In our view the rules have not changed so much. But the game has gotten more dynamic, if not to say aggressive, as market volatility remains high and visibility low - upstream as well downstream - all along the value chain. Both suppliers and customers are looking to their cost position and try to make sure they are getting good value for their money. Distributors have to make sure they are not getting squeezed on their margins and hence may ultimately find themselves in an unsustainable position. Strong and responsive companies with professional staff will be able to manage the situation and even benefit from it. But marginal players may find it increasingly difficult to maintain a defendable position in an ever more competitive and volatile market environment.