Playing catch-up in e-commerce

03 July 2000 00:00  [Source: ICB]

There is still a lot to play for in chemicals e-commerce. The whole area seems to be one vast, but exciting, experiment in new operational modes

E-commerce in one form or another is expected to save the industry a lot of money, but there are very significant questions still to be answered and it seems clear that no one, whether it be the companies, the dotcom players, consultants or analysts, is really confident that they know what the future will bring.

'It has the near term potential to fundamentally change the flow of information and thus decision making, alter the profitability profile along the vertical chain, and redefine the growth and profitability prospects of every industry player,' say Lehman Brothers analysts, Sergei Vasnetsov and Brian Kennedy.

They believe that 'compared to the recent industry trends [technology innovations, cost cutting, re-engineering, IT, total quality programmes, six sigma and others] the nature and direction of e-commerce will impact the chemical industry much faster and it will be much more pronounced'.

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Late in the day the chemical companies have sprung into action, but press announcements are often ambiguous or vague. The companies are still at an experimental stage and it is not always clear that they know exactly where they are going or how long it will take. But they do know that it is a bit like a gold rush. They have to delineate and stake their claims in terms of the online partnerships and markets they seek to develop. Precisely how they develop them can come later.

Chemical companies in Europe have sprung into action over the past months. The following are only a few examples from BP Amoco and BASF, players now particularly active in the field. BP Amoco's first move was the investment in ChemConnect, followed by the recently launched, but not yet named Chemicals Exchange, and the integrated oil industry exchange. The ambitious chemicals exchange, first announced in May, brings together 12 major global chemical players to launch a neutral and open global e-marketplace for transactions, logistics and supply chain management. It expects to be operational by the end of the year. BP Amoco is also working to develop online systems within the different sales units.

BASF too invested in ChemConnect and is now rapidly expanding its efforts in the online area. BASF is one of the players in the Chemicals Exchange and is part of the online plastics marketplace, Omnexus.

It is also a partner in the chemical company initiative with SAP to use mySAP.com e-business and marketplace technology, along with Degussa-Hüls, Henkel and Metallgesellschaft.

High stakes

'The stakes are high and the rules of the game are being written along the way,' continue Vasnetsov and Kennedy, 'so if you want to influence them you should be in there now. E-commerce will play a role in sorting out who wins and who loses in the chemical industry. Players who do not achieve e-commerce-enabled cost savings will struggle.'

Last year's story was supplier/customer systems links and the steady flood of announcement of chemical company investments in the online exchanges: ChemConnect, CheMatch and others. This year the emphasis has changed both inside and outside the chemical industry. Hub sites, or online communities connecting several producers, their customers and suppliers, information and service providers are where industry has concentrated its efforts.

Only months ago direct, IT links between suppliers and customers were seen as the ultimate in connectedness. Achieving this information pipeline requires compatible IT systems and even then it takes a lot of work on reconciliation of communication protocols. So far only two companies have started pilot programmes: Eastman with a supplier and a customer and Geon with OxyVinyls, a major customer.

'The era of pure play dotcom dominance in e-commerce is over,' says Vasnetsov. Major industrial companies are now much more active in forming and participating in e-commerce companies. In chemicals, companies are forming or joining e-commerce companies of three types: along vertical channels, along horizontal channels and, of course the new and fast growing e-commerce hubs such as Envera and Omnexus.

Chemical companies realise that dotcom companies have been striving to become an intermediary between the chemical producer and the customer. 'Direct access to customer is a valuable position that chemical companies should not give up,' says Vasnetsov, who likens the chemical companies to the chef in the kitchen of a restaurant. There he is 'the value creating centre, but a charming dotcom waiter is collecting tips for learning about customers' wants and needs and then meeting them'. This disintermediation, Vasnetsov believes, can turn the chemical producer into a 'toll convertor' with the dotcom player collecting the value-added margin on the products.

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Cost savings

Schroder Salomon Smith Barney analysts PJ Juvekar and Tim Gerdman see the short term impact of the Internet as being on the back office functions - such as simplified order entry, order tracking and invoicing. They believe automation of these functions could offer savings of $4bn for the US chemical industry if, as expected, it allows a 10% saving in selling, general and administrative (SG&A) costs. This is calculated on US chemical industry sales of $400bn and an average SG&A cost saving of 10%.

Longer term, they expect e-commerce will result in lower inventories as a result of instant, transparent pricing and the ability of customers and suppliers to exchange information. The US chemical industry carries around $55bn of inventory at any given point. Using a typical inventory sales ratio of 14%, a 20% inventory reduction would mean $11bn less capital tied up in stock. At the industry's average cost of capital of 10%, this results in savings of $1.1bn.

The million dollar question is, who gets these savings? Analysts and the industry itself fear that the billions of dollars in cost reductions made possible by e-commerce will disappear downstream to their customers. The only winners will be the first movers - the ones who are ahead of the pack and even then only for as long as it takes for the others to catch up.

For the industry as a whole, Vasnetsov sees chemical e-commerce as yet another factor pushing the industry along the experience curve which results in lower peak-to-peak prices and profit margins. Vasnetsov expects chemical prices to gravitate towards the lowest common denominator with narrower spreads in regional prices, spot and contract prices and large and small volume buyers. Transparency and competition will remove unjustifiably high margins. He believes that, especially in specialities and intermediates, a lot of the gain will be passed on to buyers, arguing that many of these products are not really specialities and simply do not add enough value to justify current margins. In commodity markets spot prices will become more volatile in the short term, reflecting instant supply/demand situations, and yet will be less volatile across the whole cycle. Trough prices will not go lower, but it could lead to lower peaks that last for a shorter duration - another negative for the industry.

Integration is key

The cost savings achieved from lower inventories and efficiencies may not be equally shared throughout the chain. Vasnetsov sees e-commerce as offering most benefit to integrated chemical players. Integration through the product chain ensures some of the benefits of connectedness - supplier/customer information exchange, computer linkage and data sharing - remain with the chemical producer.

It is also hard to imagine that the level of connectedness between customer and supplier that produces these cost savings can be easily embarked upon by chemical industry players. Sharing inventory information, rather than hiding it, would be an almost revolutionary step for some markets. Buyers and sellers in commodity markets have traditionally seen themselves in adversarial relationships. Can the cut and thrust of the traditional chemical industry customer/seller situation disappear overnight?

In addition, can connectedness really magically remove all the traditional caution. If it is to work it seems likely that customers will have to be bribed to drop their information barriers and the bribe almost inevitably will be the seller's prospective cost savings.

But what happens when a customer wants to de-link from his supplier? Will the level of mutual knowledge and costs involved make the break up prohibitively expensive both in terms of monetary cost and business risk? Vasnetsov agrees these are major issues. He thinks that it may well only be possible for a major chemical supplier to have this sort of tightly aligned, utility-type, relationship with one customer. He thinks it might well be commercially dangerous to attempt to link and share information with several customers. It increases the risk of relationships breaking down and then problems of sharing commercially sensitive information and costs of disconnection do apply.

Has the fear of claustrophobic connectedness encouraged the industry to embrace the e-commerce hub concept? Here, different problems arise as authorities worry about the anti-competitive potential of several major players grouped on the same transaction sites.

The benefits are obvious: lower costs of developing a system and a community of interested parties aggregating their activity on one central site, a bit like an out of town shopping site. One shop won't pull the customers away from the city centre, but several will and big names are an important attraction. It should become a virtuous circle of activity, but the problem is that the regulators fear it will be less than virtuous.

It is up to the industry, therefore, to come up with the appropriate safeguards, in terms of independent administration of the site, ensuring players are not excluded and that there is no question of collusion in terms of information aggregation or pricing. If these issues are tackled, the 'one-stop shop' advantages to a buyer are obvious.

E-commerce is not patentable and Vasnetsov's belief that early leaders in e-commerce would use their knowledge advantage to influence the rules and lock in their strategic customers and suppliers with direct and close ERP links, could come unstuck on anti-trust grounds. He says: 'Leaders will be using these links as powerful leverage in pricing, volume and valuable information flow and displacing smaller and belated competitors and perhaps forcing them into toll supplier arrangements.' Achieving these sorts of benefits on a hub site could be extremely difficult if the appropriate anti-trust checks are in place.

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