A chemical industry in transition needs a practical strategy to combat slowdown

Weathering the storm

07 April 2008 00:00  [Source: ICB]

Part three in a special series argues that chemical companies must adapt to the potential for a major global economic slowdown

Anthony Scamuffa and Jeff Pratt/PricewaterhouseCoopers

"MAY YOU live in interesting times," goes the purportedly Chinese saying, but chemical companies might agree that less "interesting" times would be welcome at the moment.

If current economic conditions were the only challenge, firms could take short-term cost-cutting measures, batten down the hatches, and wait for things to improve.

But the industry also faces numerous systemic, longer-term challenges, including globalization of the industry and skyrocketing energy prices affecting raw material and shipping costs, as well as increases in those elsewhere in the supply chain.

Cost cutting alone cannot solve these problems. In fact, across-the-board cost cutting can undermine progress toward longer-term strength.

What can chemical companies do? The majority of them have attempted to pass through price increases to their customers, but this technique is becoming saturated.

Companies can target costs that canbe cut immediately or delayed without jeopardizing strategic initiatives - for example, nonessential travel or discretionary capital projects.

But it is also essential to cut costs strategically, not only to better weather current economic challenges, but also to better position the company for a new and different future.

Below are some ideas to consider as part of an overall strategy to move forward in a challenging environment.

STICK TO YOUR CORE

Leading companies commit only to those activities that are especially promising or that fit well with the core mission of the company.

Particularly when there are issues negatively affecting a unit's bottom line, we often see these issues addressed individually rather than on a strategic level. This tendency is even truer in a difficult economy, as companies look for quick answers to problems.

Take a strategic look at profitable and unprofitable markets and segments, and pursue only those opportunities that tie in with business strategy and performance goals. Give consideration to divesting or outsourcing those activities that do not fit with your core business.

Consider opportunities to invest in new production or contract manufacturing relationships in low-cost countries in order to manage costs and take advantage of developing market growth.

Relocating production to lower-cost regions can also bring the supply chain closer to customers.

However, low-cost country relationships need to be evaluated in the context of strategic planning and business needs, as well as price savings, transportation costs, intellectual property protections, the risk of supply interruption, and other supply chain risks, such as environmental and ethical compliance.

Consider mergers, strategic alliances, joint ventures and other collaborations to create a more cost-effective and efficient value chain across disappearing borders and to take advantage of emerging markets.

Such alliances may be particularly necessary in areas such as the Middle East, where foreign companies can only retain limited ownership interests.

Chemical companies also cannot afford to ignore China, currently the fourth-largest chemical producer and the fastest-growing chemical consumer in the world.

IMPROVE OPERATIONAL EFFICIENCY AND SUPPLY CHAIN MANAGEMENT

Unlike most other industry segments, the chemical industry covers an extremely long value chain, from raw materials to finished products, and in some cases even recovery and disposal. As a result, effective supply chain management is crucial.

By working with customers and suppliers to plan supply and demand, and improve, standardize and streamline processes, organizations can significantly reduce costs and improve reliability of materials supply, stock holding and distribution, while improving customer service and cash flow.

Sharing inbound and outbound logistics with similar producers located in the same area or even with your competitors may offer an opportunity to lower transportation and logistics costs.

This may include sharing distribution centers and shipping multiple companies' products to a single customer.

Working closely with a third-party logistics provider to find optimal shipping routes and locations of inventory and distribution centers for less-than-truckload shipments can help find opportunities to reduce costs, while increasing service levels.

With rising energy costs and the weakening dollar, analyzing the total landed cost model is more important than ever.

Manufacturing and optimization of the supply chain should not automatically be pushed to "low-cost countries." A seemingly "low" unit price for materials may not be as attractive when balanced with the high fuel costs, weak currency, and risk associated with operating in developing markets.

The drive for globalization and improved supply chain management should also be balanced with supply chain risk management. Risk can come from a variety of potential sources, including environmental, ethical, operational, economic, quality, and social/labor.

Global tax strategies that are aligned with corporate strategy, planning, and operations create opportunities for both financial efficiencies and long-term tax savings.

GLOBALIZATION CAN CUT COSTS

For example, a multinational company operating in high-cost countries can achieve significant cost savings with a coordinated global tax structure that considers the use of delivery of back-office services, pan-regional service centers, and movements of activities to lower-cost jurisdictions.

During times of change, intercompany transfer pricing continues to be an important area of focus for chemical companies.

Not only is it important to evaluate income streams associated with valuable intangible property, but given the significant volumes of inventory that may be sourced from low-cost jurisdictions, it is critical that companies properly evaluate the true arm's length pricing between the buying and selling parties.

Similarly, as companies look closely at supply chain product flow, they should consider the true burden of various customs duties and tariffs, and reevaluate the ability to minimize such costs.

Companies should also quantify the true costs from a sales and use or value-added tax perspective. There may be legal and/or operational changes that could result in a significant reduction to these considerable costs.

Today's interesting times provide chemical companies with more simultaneous challenges than ever before - and business as usual will not adequately address them.

Strategic actions will allow firms to better manage the tectonic shifts taking place that will long outlast the current economic conditions.

LOWER FRAUD, REPUTATION AND MISCONDUCT RISKS

Chemical companies are subject to the same fraud risks as companies in other industries, such as financial statement manipulation and misappropriation of assets. However, the chemical industry has a unique risk profile in a number of areas, including, for example:

Fraud in outsourcing is becoming prevalent, particularly with the outsourcing of production to overseas locations. Contract manufacturers may misappropriate assets by overstating production, by overproducing and misappropriating the excess, and other schemes.

Cargo theft occurs in a range of chemical operations and is costly in many ways. It causes financial loss to victimized chemical companies and their insurers due to loss of product, and it undercuts prices in legitimate businesses. In addition, there are reputational and other losses when products are copied or used inappropriately.

These and myriad other fraud, reputation and misconduct risks can result in a significant drain on a chemical firm's bottom line.

Companies that can effectively leverage their existing management reporting systems and can put effective controls in place to help identify areas where these risks can occur can respond more quickly to prevent significant losses.

Anthony Scamuffa is a senior manager with global consultancy PricewaterhouseCoopers, in the firm's Philadelphia, Pennsylvania, US, office. His specialty is in providing assurance and attest services to chemical companies.

Jeff Pratt is a Director in PricewaterhouseCoopers Advisory Services practices and leads the firm's US Supply Chain Team. He has over 20 years of consulting experience, serving clients in numerous industries including chemicals, high technology, automotive, industrial products, retail, consumer products, hospitality and financial services.

For more information, visit PricewaterhouseCoopers.

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