Information Insights: Chemical Industry IT Spending Expected to Rise in 2005

27 September 2004 00:01  [Source: ICB Americas]

While growth in spending on information technology (IT)was relatively flat in 2004 among process manufacturers, in-cluding chemicals, spending is expected to increase in 2005. The uptick in spending is primarily driven by the need to use IT as a way to differentiate commodity product offerings and improve customer management tools. While this trend is also evident in the chemical industry, improving supply chain management practices also remains a priority.

IT spending in the process manufacturing industries—chemicals, oils and gas, pulp and paper—showed relatively flat growth in 2004, but there was a redirection of IT sources to certain key segments. “With no growth in IT budgets in 2004, process industry executives limit the funding of profitable growth initiatives to the cost savings from consolidation of applications, infrastructure and outsourcing efficiencies,” says Colin Masson, research director, chemical and process manufacturing with AMR Research, a Boston, Mass.-based consultancy.

While the mix of these growth initiatives differed in each industry, customer management tools were identified as an important area across each of the sectors. “A product-centric culture still permeates the process industry, but the need to differentiate commodity products with services is gaining momentum,” says Mr. Masson. “It is identified as the most important business initiative impacting IT spending across the industry.”

That trend is apparent in the chemical industry, where product innovation and logistics are top priorities in terms of IT spending. “After years of operational excellence in manufacturing, the chemical segments seeks to improve its top-line revenue by differentiating products and services. They currently look outside their own four walls for cost reductions in complex, multimode logistics,” he says.

Although growth in overall IT spending in the process industries was relatively flat in 2004 over 2003, a recent survey by AMR Research shows an upward trend for 2005, particularly for the chemical industry. Overall, IT budgets in process manufacturing industries (chemical, oil and gas and pulp and paper) are expected to increase 4.5 percent in 2005, led by chemicals (Figure 1, above).

“Chemicals’ respondents antici-pate an 8.8 percent increase—46 percent expect increases while only 14 percent anticipate decreases. Last year, only 14 percent anticipated any increase in the 2004 budget,” says Mr. Masson. Within the chemical industry, IT spending as a percentage of total revenues remains at roughly 2 percent, which is on par for process manufacturing overall. IT spending as a percentage of total revenues for the pulp and paper industry is slightly higher at 2.6 percent and spending in the oil and gas industry is slightly lower at 1.7 percent.

The chemical industry spends roughly 30 percent of its IT budgets on software (application and infrastructure), licensing, development andmaintenance (Figure 2, below), accor-ding to AMR Research. For the chemical industry, IT spending in 2005 is expected to increase 5.8 percent for hardware and 5.0 percent for software licensing and development. Spending on telecommunications is expected to increase 3.9 percent and 3.6 percent for networking. Within the chemical industry and the process manufacturing industry overall, the trend is to cut costs in infrastructure in order to allocate more investment in applications that support differentiating products and services. “The process industry will continue to cut IT infrastructure costs aggressively, particularly through the increased use of outsourcing,” says Mr. Masson. “However, dollars saved in 2004 and 2005 will be reinvested to upgrade or replace key applications that support the business in differentiating products and services to lower fulfillment costs.”

With companies moving to meet that goal, AMR Research points to three key trends. First, application budgets are supporting differentiation in commodity markets. “Driven by customer requirements, process industry companies with broadly deployed enterprise resource planning (ERP) infrastructure step up deployments of supply chain and customer-facing applications,” says Mr. Masson.

Second, buyers are dissatisfied with software costs and vendor practices. As in other industries, respondents are frustrated with the cost of enterprise software, the survey reports.

The third key trend is the increased use of outsourcing. “The process in-dustry is happy with its IT outsourcing experience; it will continue to grow spending with IT service providers that can provide a broad range of services globally,” says Mr. Masson.

Application Budgets Support Differentiation

Increased competition is cited as the most important reason for increased IT investment across the process manufacturing sector. “As internal efficiencies improve with stabilized ERP deployments, leaders are turning to inter-enterprise processes,” says Mr. Masson. “Spending on both the supply chain and demand side of the market reflect customer demand for higher levels of responsiveness.”

Almost one-third (31 percent) of respondents to the recent AMR Research survey cite competition as the single most important issue driving future software investment, resulting in customer management applications leading enterprise software implementations in 2004 (Figure 3, below). In 2004, 26 percent of respondents to the AMR survey said they implemented customer management software, with 5 percent expecting to deploy such software in 2004.

The 26 percent of respondents implementing customer management software in the process manufacturing sector was slightly above the 25 percent of respondents that said they deployed supply chain management software investments in 2004 and the 24 percent that noted spending for product life-cycle management projects in 2004.

However, when measuring both existing and projected spending, supply chain management is cited as the most important area for application spending among process manufacturers (Figure 4, below). “For both 2004 and 2005, companies cite SCM [supply chain management] as the most important application investment,” says Mr. Masson. “SCM also shows the lowest incidence of application replacement—a likely indication that companies are not ready to replace existing best-of-breed applications with ERP offerings that are unproven in dealing with process industry requirements.”

In terms of specific application spending, software for customer management and sourcing are expected to increase the most (Figure 4, below) for process manufacturers. “While ERP’s share of the software budget has dropped significantly from the general manufacturing level of 33 percent in 2003, all enterprise software categories will grow in 2005, “says Mr. Masson. “Executives forecast customer management (3 percent) and sourcing (3.5 percent) to grow the most. However, with no replacements indicated for these categories, this growth may be deployments of maturing capabilities from ERP vendors,” he says.

For the chemical industry specifically, spending on customer management software, which now accounts for 17 percent of the overall applications, budget, is expected to increase by 3.1 percent in 2005 (Figure 5, below). Application spending on sourcing and procurement, which now accounts for 13 percent of chemical companies’ applications budgets, is expected to increase by 3.6 percent in 2005. And spending on desktop software, which now accounts for 20 percent of chemical companies’ application budgets, is expected to increase by 3.4 percent in 2005.

Software Costs Deemed Too High

Although buyers of software in the process manufacturers sectors are generally satisfied with the functionality provided by their applications, pricing remains an important issue. “This year’s IT spending survey corroborates earlier AMR Research data on companies’ attitudes on software maintenance fees,” says Mr. Masson. “While software function impresses, respondents believe that software is too costly to acquire, implement and operate.”

Using a satisfaction index that takes the percentage ranked excellent divided by the percentage ranked either fair or poor reveals that users are most satisfied with their existing relationship with vendors and are relatively satisfied with functionality, according to the AMR study. Although software functionality and product range ranked satisfactorily, respondents noted significant room for improvement in ease of use.

Using the same satisfaction index, the AMR study showed that companies in the process manufacturing sector are dissatisfied with vendor performance when it comes to the total cost of ownership, which is reflected in low scores on implementation, flexibility in pricing and maintenance policies.

Outsourcing on the Rise

The increase in outsourcing is another significant finding from the AMR survey on IT spending among process manufacturers. “In recent years, the process industry has experimented with outsourcing most IT functions,” says Mr. Masson. “Our survey shows that the industry will accelerate its use of outsourcing if IT service providers can provide a broader range of services at the right price.”

Currently, 23 percent of the respondents to the survey say they outsource IT work, and 53 percent say the intend to increase that amount versus only 3 percent seeing a decrease. Overall, process manufacturers plan a 9.4 percent increase in outsourcing IT in 2005. Over half of that growth is expected to be offshore, according to AMR. In 2004, 18 percent of outsourcing was sent offshore by process manufacturers; 82 percent of outsourcing activities was kept on-shore. In 2005, the share of offshore outsourcing is expected to increase to 20 percent, with the share of on-shore outsourcing correspondingly decreasing to 80 percent.

In selecting a vendor to outsource, although pricing is important, it is most often the least satisfied factor in vendor selection, according to the AMR study. “It is no surprise that pricing is the most important factor in selecting an outsourced provider,” says Mr. Masson. However, companies are also the least satisfied with vendors in this area. IT service providers [also] have the opportunity to broaden their range of services, the second most important selection criteria cited by respondents. While outsourcing will be pursued aggressively, companies don’t want the management overhead of dealing with multiple IT service providers,” he says.

Data center operations is the area cited as the most popular one to outsource, with 46 percent of the respondents in the AMR Research survey identifying this as an area in which they outsource. This area is closely followed by hardware maintenance and support (45 percent of respondents outsource this function), application development (45 percent), Web hosting (45 percent), application implementation (41 percent), application management (38 percent) and security (37 percent).

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