15 December 2008 00:00 [Source: ICB]
With their higher margins and potential for innovation, specialty chemicals should be an attractive proposition for Europe's chemical producers. But the diverse sector faces a number of challenges. Senior industry executives from leading specialty producers met recently to discuss their experiences and explain how they are responding
The tail end of 2008 is certainly proving a challenging time for all chemical producers, commodity and specialty alike. Downstream demand has fallen away sharply, especially in the automotive and construction sectors, and production plants are having to be turned down or even idled.
But for Europe's specialty chemical producers this is just one more challenge on top of many. They are already grappling with volatile energy and raw material costs, new competitors in the marketplace, notably from Asia, and the increasing pace of commoditization in the sector.
The shift of demand and growth to developing markets is also putting pressure on companies in terms of where they should invest to serve customers to best effect.
Specialty chemicals cover many different sectors, commented Patrick Jany, CFO of Clariant. "You have to be able to manage this complexity, and where possible reduce it, and then take the value where you can."
Participating at an ICIS high-level roundtable in Brussels on European specialty chemicals, held in association with Booz & Company, Jany added that Clariant's approach is to focus on operational performance and continue to improve its performance in this area.
Clariant, he explained, operates in 18-20 or so markets and is aiming to move into leading performance in each through a strong focus on pricing and cost structures. At the same time, it is looking for growth through investment and participation in developing markets in Asia and Latin America.
"We have a lot of people on the ground there now and are leveraging our European core into these markets there is a lot of growth potential there."
This focus on operational performance is also central to the approach by LANXESS, agreed board member Rainier van Roessel, who has responsibility for its performance chemical businesses. "Since the spin-off from Bayer we have undergone significant restructuring and focused on operational performance. We now have a clear vision of growing the company in the BRIC [Brazil, Russia, India and China] economies and see sustainable growth in these regions."
Klaus Hoffmann, European area president for Dow Corning and commercial global director Europe for core business, picked up on Jany's comment about the diversity and complexity of the sector, which, he said, serves very many industries and has many products.
"Specialty chemicals is a conglomerate of different segments, but with common challenges. We need to manage the complexity and find our own space and niches whilst still trying to expand." He looks on this, he explained, as taking the "get smaller, get bigger approach."
Hoffmann also pointed out that the sector faces many of the issues facing the chemical industry as a whole: the growing difficulty of finding talented people, the poor image of the sector in the public's mind, and having to live with increasingly stringent legislation and regulation.
The issue of the industry's image and reputation, he explained, affects a number of areas, such as approvals to operate, its acceptance by society and the regulations it is subject too. Therefore, it is important to act, as a good reputation is key for the success of the chemical industry.
BUSINESS UNIT FOCUS
Costs and pricing are key issues across the specialty chemical sector, but not ones that can be treated with a single approach across the diversity of the sector, or indeed across any one company. The participants in the roundtable agreed, however, that a key element is to give individual business units the ability to operate according to the conditions in their respective markets. And to stick with only those businesses which have strong market positions.
Since its spin-off, explained van Roessel, LANXESS has sold four business units, accounting for one-quarter of its turnover, to focus clearly on units with the ability to operate on a global basis. "We sold where we were not able to bring the business to top market position, or where we had not got the right resources to develop it."
Cleaning out the portfolio like this has meant it can bring a lot of attention to the remaining core businesses, and has enabled a new philosophy of "price before volume" to be adopted. This has been a cultural change for many in LANXESS, but one that has benefited the company as it has been able to pass on increased raw material and energy costs to the market in a short period of time.
"This is only possible through having a clear idea of each business - reducing complexity, operating [them] as global business units and getting the strategy in place. In the past, we did not have the realization that not every tonne [sold] is a good tonne and that some businesses were not creating value."
Clariant's Jany reinforced this point of business unit autonomy and price over volume. "For the past two to three years, we have really gone into the task of defining the business units and giving them a certain autonomy to run the business themselves and take the right steps to adapt their cost structure and run lean and efficient.
"Then it's about the way you can leverage the market position you have, the innovation you have and the know-how you have and that is by having independent business units run according to their own means and having a mix of commodities and specialties.
"Price over volume is also a major priority, and historically we've not been good at this, but are getting better."
It's also an issue, added van Roessel, of focusing on premium products and adding value to the customer. "It doesn't matter so much, then, if they are commodity owr specialty."
Marcus Morawietz of Booz & Company raised the topic of innovation as a further aspect critical to ensuring that specialty businesses continue to develop profitably. It is innovation, he commented, that brings in the higher value-added business opportunities to compensate for commoditization, but the character of innovation has significantly changed in the past years. Today, innovation does not only result from new chemical entities or improved processes, but increasingly from new downstream applications and marketing concepts. Thus, several specialty chemical players will need to adjust their business models.
Jany agreed that there is a change in the way companies approach innovation now. The business units are better at getting intimate with their customers and finding out what they want and where the producer can add value, he noted.
At the same time, innovation at the corporate level is developing closer links with outside bodies, such as universities, and developing in-house incubator units to kick-start innovations that would not have a chance to develop in the business units, with their focus on shorter time frames.
"There is plenty of potential and lots of fields," said Jany, listing areas such as nanotechnology in coatings, white biotechnology and photovoltaics. "We need to be focused on innovation and run a decent process."
Hoffmann remarked that specialty chemical players are facing a "luxury problem" here, in that what they call commodities would be good products for most chemical producers. The major difficulty, he thinks, is in finding ways of handling attractive businesses efficiently or getting out of them before they decline.
Dow Corning, he explained, takes a broad view of innovation and goes much further than just the product, to look at business innovation and service innovation. "Often when you are looking to add value for the customer, that can mean taking costs out as much as offering more."
One example that has gained a lot of attention is Dow Corning's Xiameter, the online business unit that offers commodity silicones to customers with a "no frills" service. This has proved a very simple but successful approach to reducing the costs to serve.
Dow Corning also uses an innovation incubator approach, which has recently found success with the development of a more cost-effective grade of silicon to meet the burgeoning demand for the material in solar cells. The project, explained Hoffmann, had taken five years to come to fruition, with plenty of uncertainty at the time, "but now we are getting pay back and the business is fantastic."
Dow Corning has fine-tuned its incubator approach over the past five years. It is run separately from the main business units and mainly funded centrally, but some funding and people and resources are provided from the business units. This keeps them linked to the incubator and helps make sure that there is a connection between its work and the market, explains Hoffmann.
Successful projects from the incubator are eventually moved out into the existing business units or used to create new ones. "This setup is critically important as innovation is even more critical in the difficult economic times we face right now."
Van Roessel added that LANXESS, too, works closely with customers to ensure there is a close linkage between them, the business and innovation. With the more commodity-type chemicals in the specialty area, he agreed that process innovation to take out costs was just as useful to customers as innovations to improve the product or the service offering.
Jany concurred, noting that innovation is everywhere, in process development, chemistry, yield improvement and new derivatives for existing products with customer benefits. "At the end of the day you are looking for one thing - value creation."
Turning to the question of growth, there was a broad consensus that Europe's specialty chemical producers must follow the market and invest in those regions of the world that are showing attractive growth.
Gone, they agreed, are the days of investing in Asia for cheap production, simply to export back to Europe. Now the driving force is to be in a position to meet local demands in the rapidly emerging markets of India, China and Latin America, for example. And, added Morawietz, specialty producers need to globalize their asset landscape and supply chains as fast as their customers.
Van Roessel explained that LANXESS now has a clear strategy to focus on growth in the BRIC countries, and especially China, through investments in production facilities and via acquisitions. "We need to be present in these growth platforms as growth has slowed in the EU and US." In Europe, he added, it's a matter of getting the cost base down to an appropriate level.
He pointed to the fact that the company is seeing strong growth in Brazil and has just moved to take full ownership of its Petroflex business. Also, LANXESS is seeing strong growth in Asia for its products in the tire market, with China now a larger producer of tires than the US. It is investing in a new rubber plant in Singapore as a platform for future growth.
Jany added that Clariant, too, is focused on overseas growth and is exploiting the opportunities it has. Russia, he commented, is still a little too risky, but in Brazil, India and China the company is active. But, he advised, the market dynamics are different in these countries and can prove difficult.
"Being global is a key approach in our masterbatch business, for example," said Jany. "Mobile phones can be produced anywhere in the world and designs and colors can change very fast now. We need to be there when our customers want product."
Dow Corning is in the same spot, noted Hoffmann. It is investing around the world, both in large base-materials plants and smaller finishing facilities. It is, for example, building a huge base silicone facility in China, to complement its base units in Barry, Wales, and Kentucky, US, with an investment of $1bn (€790m)-plus.
The project is a joint venture with WACKER, he added, designed to spread the capital expenditure and the risk and to ensure that plant capacity is taken up more quickly.
All three industry participants also agreed that it is essential to operate these overseas plants with the same safety, health and environmental (SHE) standards as in Europe. In this respect, noted Hoffmann, it was preferable to build anew rather than acquire positions through joint ventures, as these could present challenges over accounting, ethical and SHE standards. And van Roessel warned that "high standards are a must. Is does not matter where problems come up, they impact everywhere."
Jany and van Roessel both agreed, though, that there would be opportunities for growth through joint venturing and acquisition as the specialty sector continues to consolidate. This, said van Roessel, also brings the opportunity for improving the asset base through restructuring - to get worldscale plants and economies of scale.
Jany pointed out that Clariant was moving toward have one major plant per region in some of its more commodity lines, like functional chemicals, but that for other products, the need to be close to market and offer good logistics meant that local plants are required. It has, for instance, 55 masterbatch plants around the world to serve customers locally with fast response times.
Consolidation and growth will see some global players emerge but leave some niche regional players, believes Hoffmann. Some markets are already fully consolidated, added Jany, such as surfactants, while others hardly ever will, such as textile chemicals. But it is clear, added van Roessel that a lot of smaller specialty companies have quietly disappeared over the years.
Companies with the drive to stay in the market will need to find a sustainable model, based, if the roundtable participants are right, on business unit focus, robust pricing strategies, innovation and geographic expansion.
MARCUS MORAWIETZ, BOOZ & COMPANY
For some years, the specialty chemical sector has faced increasing pressure on growth and performance. The key challenges stem from accelerated commoditization, declining rates of and shifts in innovation, rising cost pressure from Asian competitors, increasing bargaining power of customers, and limited transfer of raw material cost fluctuations.
New strategies have been launched to address these challenges. Initiatives have mainly focused on short and midterm measures, such as selected portfolio optimization, adjustment of business models, pricing initiatives, operations and supply chain optimization and product pruning.
While such measures address immediate performance issues, they do not typically lead to the kind of bold strategic actions which will distinguish the winning companies in the next few years. All these instruments were leveraged regardless of the ownership - either by private equity or by industrial players.
In contrast to the slow developments of the past, Booz & Company expects a significant increase of competitive dynamics in specialty chemicals. The future changes of the specialty chemical landscape will be mainly triggered by new out-of-the-box strategies, by consolidation through downstream integration or by new market entries from nontraditional suppliers.
Consequently, the competitive landscape will be modified by the emergence of three main types of players: integrated specialty majors, specialty chemical conglomerates and niche players.
The integrated specialty majors will evolve from large petrochemical and basic chemical companies through increased and focused downstream integration, a process that has already started at, for example, BASF (acquiring Degussa Construction Chemicals), Dow Chemical (purchasing Rohm and Haas), and SABIC (taking over GE Plastic, etc). These integrated players will leverage their feedstock and raw material access and will benefit from portfolio and technology synergies along its value chain.
Specialty chemical conglomerates will comprise several different businesses and obtain leading positions in the majority of these segments. As synergies in raw materials, technologies and/or customer markets are typically limited in these kind of setups, conglomerates will need actively to manage their business portfolios to ensure a high overall performance and should establish focused incubators to develop new business segments.
To further differentiate from integrated specialty majors and niche players, they will be also be obliged to establish innovative business models. Many will have to offer solutions and services not just products. Furthermore, these conglomerates will even start to go beyond the chemical value chain in selected market segments.
Examples for this type of specialty chemical players are Evonik Industries, DSM, AkzoNobel, Clariant, Altana, etc. We believe that the further these companies are exposed to the above mentioned challenges the stronger the pressure for change will be in the midterm.
If these conglomerates only realize a limited "parenting advantage" for its businesses, they might be consolidated into the integrated majors and/or split into niche players.
Niche players will also be an interesting segment in various dimensions in the next years. We anticipate an increased M&A activity amongst the niche players to actively drive segment consolidation. Others will be interesting external growth candidates for larger players to complement its portfolio and due to its performance which often outperform the specialty chemical top quartile.
Driven by these significant changes, we expect the specialty chemical industry to enter a new era. The current economic crisis will accelerate these developments.
Patrick Jany, CFO, Clariant
Rainier van Roessel, board member for performance chemical businesses, LANXESS
Klaus Hoffmann, European area president for Dow Corning and commercial global director Europe of core business
Richard Verity, vice president, chemicals and energy
Marcus Morawietz, vice president, chemicals
John Baker, global editor, ICIS
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