The downturn will accelerate trends in the specialty chemical sector

Specialties refocus

07 December 2009 00:00  [Source: ICB]

 Chris Eyles
The future shape of the European specialty chemical sector came under discussion at the latest ICIS high-level Roundtable in Frankfurt

EUROPE'S SPECIALTY chemicals producers have been as hard hit as anyone in the volume-induced downturn that kicked in during the last quarter of 2008. But the signs are that sales have been recovering since the second and especially third quarters of 2009.

Market conditions are stabilizing, albeit at a lower level than enjoyed in 2007 and the early part of 2008. This is allowing companies to raise their expectations for the full year. However, there is still a large degree of caution, given the lack of longer-term visibility as customers still look to place orders as and when they actually need supplies.

Against this encouraging backdrop, six leading specialty chemical executives (see panel) met last month in Frankfurt to form the 2nd ICIS/Booz & Company CEO Roundtable on European Specialty Chemicals. Discussion ranged from the current situation to the longer-term issues facing the sector, notably the role of innovation, how to address sustainability, and how companies can position themselves for the future, as the market shifts to higher growth regions such as Asia and Latin America and to new emerging end-use sectors.

The picture that emerged round the table was a consistent one - of companies suffering two to three very difficult quarters starting in Q4 last year, but with signs of recovery going into Q3, and with some sectors showing more resilience than others. Also consistent was the fact that this recovery is being led by demand in Asia, and especially China, with continuing softness in the more mature markets of Europe and the US.

Jody Bevilaqua set the scene when he related that Hexion Specialty Chemicals had seen volumes off by 30% overall, but with some sectors down by as much as 50%. "We have seen a rebound since Q2, but sales are still 15-20% down and there has been a shift in volume to Asia and China."

On the outlook, he questioned whether the market would ever be the same again. "We are not sure it will be. We are in dialogue with our customers to see what they understand, but everyone is trying to respond with data that is new yesterday." There is, he suggested, very little visibility ahead at the moment.

Frank Aranzana of Cytec Industries also talked of the very tough times and subsequent improvement in Asia. For Cytec, coating resins was particularly hard hit, with destocking at automotive and construction customers leading to volume declines of up to 40% in Q1.

"Our main priority was to weather the storm and control working capital. We had to adapt supply to demand in coatings in Europe, reducing our fixed costs; we moved volume into our larger plants and rationalised the smaller assets. This has given us a better breakeven level, and we can now cope with the lower demand."

On a strategic level, Cytec has now split its portfolio of businesses into two: those with good potential for growth - such as mining, eco-friendly coatings and engineered materials - and those that can be run as cash businesses. These are the more commodity lines where Cytec is either not in a leadership position or where there is not enough value. Here, Aranzana indicated that the focus will be on operational excellence, while in the growth business Cytec will focus on business development and innovation.

AkzoNobel's Rob Frohn also emphasized the focus on reducing working capital and capital expenditure during the sharp slump, but added that although the company had felt the volume pressure, it had managed to hold margins by cost and margin management. The sharp downturn had even led to some M&A opportunities, he added, pointing to the successful acquisition in Germany of chlor-alkali producer LII, a deal that had proved to have a very attractive pay-back time.

But he views the outlook as still very uncertain. "Quarter four last year we saw volumes weakening, and we are still not sure where volumes will go in 2010, the recovery is fragile and restructuring is definitely not over" he warned.

For Antonio Trius at Cognis, the downturn has been felt but not perhaps as acutely as at many other specialty companies. With 57% of sales into the less-affected markets of cosmetics, homecare and personal care, Cognis has been relatively lucky and has not seen volumes fall as significantly as others.

Quarter one saw sales volumes dip by 15%, with Europe accounting for most of the problems. One area more severely affected was automotive coatings, where volumes fell by 40%. However, in the personal and home care markets, rather than steep volume declines, he explained, there has been a distinct shift to lower cost ingredients as customers downshift from high-quality products to those offering better value.

Also, he pointed out, the company has been in private equity hands for the past eight years and has had a priority focus on cash management for many years. "Through portfolio management we have concentrated the company on markets that we believe are growing and have special strengths 80% of our business is now in this area, compared with 40%.

"Additionally, we decided in 2002 to focus on sustainability and green trends and have specialized in renewable raw materials, which now account for 50% of our usage." This trend has been resilient through the recession, and is even strengthening in the US.

The current financial turmoil has also given Cognis several opportunities to deleverage its capital structure, so 2009 will be a continuation of last year, noted Trius.

Klaus Hoffmann of Dow Corning affirmed the hit the company had taken from October last year, and confirmed it had seen strong signs of improvement in Q2 and Q3 this year. "We are enjoying the recovery," he noted, but added that "we are not letting loose on expense control. We are still very cautious and are asking is it a V- or W-shaped recession?"

Much will depend, he believes on the industry sector in question. The US stimulus package in the automotive segment will likely lead to a W-effect as car buying falls off again after the stimulus package is phased out. Similarly he sees construction as remaining depressed for some time to come.

Within Dow Corning, standard silicones volumes have been hard hit, but areas such as silicon for photovoltaics are still showing growth - not as fast but still at a good rate, given the recession. "What has helped us here," he explained, "is that we anticipated some of the changes in the silicone market and had been preparing for the challenge from as early as 2007, expecting a hit in 2010. So we had the strategy in place and just had to accelerate it."

Huub Meessen noted that for SABIC, apart from growth and cost management, two other priorities are presently high on the agenda: diversifying the product portfolio to include specialty chemicals, and innovation. This is the case, for example, for its polyolefins operations in Europe, where SABIC wants to move towards those products that are complementary to those its produces in the Middle East. "There is a strong drive to innovation and differentiation," he noted.

While the big units in the Middle East are dedicated mainly to commodity polymers, the smaller plants in Europe can be used more flexibly for differentiated and speciality products. "They are still cost competitive and can be used to build a differentiated portfolio."

The need for European producers to focus on innovation to maintain competitiveness was taken up by many around the table. And there was a general consensus that the conventional approach of R&D for product innovation was no longer sufficient to achieve a useful return on investment.

Trius pointed out that even in specialties, products today have shorter life-cycles and disappear or convert into commodities more quickly than in the past. So there is a need to bring new products into the market to maintain a certain margin.

"The years of the 20th century were characterised by the equation that 'R&D = innovation' and the fact that new a molecule was automatically a new material or application that people desired. Today a new molecule is nothing - it's just an invention.

"The concept of innovation has changed dramatically, and people are starting to understand that invention and innovation are completely different things. Companies need the capabilities to turn inventions into innovations, and this involves the whole company - sales, marketing and manufacturing - not just the R&D department.

"I do believe the future is going to be there I am very convinced of this and defend innovation, but not the traditional way. We have to open up our innovation and be able to source more technology by acquiring, through cooperation and partnering, and with venture capital, etc It is impossible for a specialty chemical company to be an expert in all the different technologies available."

Aranzana at Cytec commented that there are indeed still positive trends in innovation. He gave as an example industrial coatings, where 70% of products are still solvents-based. "We see growth as these are replaced by eco-friendly products, especially where legislation is driving change (US, Canada, Europe, South Korea). But the solvent-borne products do a good job and we need to get the same performance with eco-friendly products."

But there are other areas too for Cytec, including its mining chemicals business, where customers understand that resources are limited and want to get out more and more product, even from what are now waste streams. There are also innovation opportunities in advanced composites, where weight reduction in aerospace and industrial applications is a prime driver, and in photovoltaics and wind energy turbines.

AkzoNobel's Frohn picked up the point of the green agenda driving innovation. "The drive for sustainable products has increased over the past 10 years. We have had some [eco-efficient] products on the shelf for years now but are now starting to see more demand for them. Customers are appreciating their properties and are in a hurry for them right now"

In this respect, he agrees with Trius that innovation is wider than mere molecules and R&D. "You have to make sure the molecule is OK, but you also have to see how it works in practice - in water, in a gel, for instance. We have to win this battle: we have to change the mindset of research people and manufacturing people [and realize] that sales people are also key: they are the eyes and ears of the company."

Marcus Morawietz of Booz summed up the discussion, saying that innovation comprising not only chemical products but also "materials" and "solutions" will be offerings for the future from Europe's specialty chemicals producers.

"Materials and solutions will give opportunities that go beyond chemicals. A lot of low-cost producers can't do this, and thus it is a key and differentiating opportunity for Western companies.

"Materials- and solutions-based offerings are also important regarding sustainability - we are calling it Integrated Resource Efficiency - a broader topic that means working together with your customers and customers' customers to create new products - not only chemicals - and new devices for your customer industries that consume less energy or [fewer] resources in total and could be produced more smartly."

On the issue of sustainability, there was less consensus around the table. Although a widely-used term, it means different things to different companies. To Cognis, for instance, it has been embodied in its shift to greater use renewable feedstocks - now standing at more than 50%, albeit only when they have clear advantages over petrochemical raw materials on a lifecycle basis.

Hoffmann at Dow Corning expressed a positive view, believing it is an idea to benefit everyone. In product terms, Dow Corning views it as bringing benefits in terms of water efficiency, for instance in its new technology for use in denim manufacture, or energy efficiency, through its lower-cost polysilicon for solar cells.

"We have to make sustainability an automatic element in what we do. It has to become more a part of the DNA of a company," he advised.

For Aranzana at Cytec the sustainability approach is also a way to generate more customer intimacy, by changing the model by which it does business. For instance, in the mining sector, Cytec sells products for use in alumina production. It found out that customers commonly had problems with heat exchanger scaling, which often meant plant shutdowns. By developing a solution it has created a new best-selling product, bringing added value to the customer, even though it is not technically a mining chemical.

Jody Bevilaqua at Hexion, however, advised some caution on behalf of chemical producers and claims of sustainability. "In the end," he noted, "sustainability will be determined by the customer, and each sector will be different."

A lot of people are jumping on the sustainability bandwagon, but he warned that there were potential downsides when claims were questioned, especially as there is no clear definition of the concept. "With Reach and the idea of full disclosure a lot of people could find out things are not as sustainable as claimed, he said. Frohn concurred with this, noting that it is easy to claim things, but harder to support these claims.

A second trend that emerged from the discussion was that of managing and rationalising existing assets in Europe and investing in new facilities in emerging and fast-growing markets. Several participants estimate that Europe has a decade at most to realign its manufacturing footprint and production capacities to the new market reality.

As Trius noted, the old model of producing in Europe to export to the rest of the world has had its day. "Growth is no longer so much in the Western regions. Asia and Latin America are the growth stories and Asia is key now. If you want to take advantage of this, you can't do it by exporting."

He believes Europe will have to streamline its activities over the next 10 years as the markets will not grow enough to be helped by productivity improvements in European assets and businesses. "We have a lot to do," he says. The problem lies not so much in the higher volume specialty chemicals, which can be produced in large plants, but in the medium volume ones, where the question of where to produce is a real issue.

China is certainly a key target for investment for most of the companies around the table. Frohn described how AkzoNobel is investing in the country through a multisite concept, locating many products on the same site instead of letting the individual divisions decide where to locate new investments. "We decided it was better to go into China in a concerted fashion rather than adding units left and right through different business units."

The first plants [at the Ningbo multisite] are being started up now and the concept is holding firm and looks good for the long term, noted Frohn.

In Europe, he added, where the company has much of its asset base, it is managing the shift of production to Asia on a gradual basis, without causing abrupt change. It has recently, for instance, announced the closure of its Swedish monochloroacetic acid (MCA) unit, which on a delivered basis was its least efficient for this product in Europe.

"We will not do it overnight, but the recession has accelerated some of these moves, as some of our customers are also closing up in Europe and moving to Asia. We will try not to be caught by surprises and adapt to the new situation."

Sven Uwe Vallerien from Booz & Company mentioned that several leading specialty companies are envisaging a "split" supply chain, where the basic chemical synthesis step will be conducted in the Middle East and the value add specialty synthesis steps are being done in the traditional Western countries. One example might be surfactants.

Hoffmann at Dow Corning agreed with these two. The company has been streamlining its European assets base for 10 years already, he noted. It now has three major sites in Europe, while 10 years ago in had three in Germany alone. "This has turned out as a strength and we are now making fine tuning adjustments in Europe but taking bigger hits elsewhere. "Our strategy now is to produce locally for local markets."

As a result of this approach, Dow Corning is making large investments in China, in basic materials and formulated materials.

Although there is undoubtedly some way to go until the recession is behind us, companies are turning their thoughts to what the future holds for them. Will the recession produce its own lasting changes, or simply accelerate those that were under way before the crisis?

Booz's Morawietz believes there may well be fundamental changes afoot (see panel). His vision for specialty chemicals also considers several companies that are going to transform themselves to go into activities beyond chemicals.

While the 1990s was the era of life sciences, and the past decade has been driven by a strong focus on specialties and China, he argued, by 2020 several specialty chemical companies will have selectively transformed away from classical chemical business to increasingly become materials and solutions providers, not only chemical manufacturers.

The competitive landscape of the future, he predicted, is expected to be populated by specialty chemical holdings, which are even larger than today's specialty chemical portfolio holders, a number of these so-called transformed companies; and mid-sized players with a special technology or regional niche - besides few large integrated majors with broad value chain coverage.

Rob Frohn commented that AkzoNobel is already a large specialty chemical concern. The key here, he noted, is as ever, to be the number one or two in the market segment - "this in future will be our bread and butter." You also, he added, need to be global and to hold a leading position in technology in question. But of course there will also always be niche players."

In the past, he explained, M&A had been used to build market share, but typically you pay up front and that could be risky. Now people are talking about solutions and cooperation to create efficiencies and take out synergies. The use of joint ventures to capture growth and invest in new production capacity with less capital for parties involves.

"It is also a lot less risky to work together in a joint venture for three years to develop a market and then take the decision to take the profit out, as it is done in other industries."

He sees this approach increasing in future, especially as companies are still under cash pressure from the volume slump. However, working with customers in such joint ventures is difficult and rarely possible as the chemicals are often only a small portion of their input costs. It makes more economic sense to work with industry players to spread the risk and avoid overcapacity.

Morawietz sees opportunities arising from megatrends-driven discontinuities in the major customer industries and end use sectors, for instance, in automotive, where new power train concepts are coming through in electric vehicles, for instance. The area of renewable energies is another, and biotechnology another.

Richard Verity of Booz stressed that discontinuities in the end consumer markets will create opportunities for specialty chemical companies "requiring them to innovate and have a view of technology beyond the chemicals value chain". If this is true, he noted, it is very encouraging, especially for high-cost European specialty chemical companies."

Besides these discontinuities, said Morawietz, additional growth opportunities might result from "smarter, more effective offerings, which will optimize the value chain. Furthermore, companies might even be rewarded by product performance not just product quantity."

But the identification of the appropriate sectors ("which companies are willing to pay for service?") and the implementation of new services or innovative pricing concepts offer and will be key, ie, new skills and capabilities in sales and marketing are required, etc.

However, Trius, among others, remained unconvinced. On the issue of specialty chemical companies providing more and deeper customer service, he warned that the pendulum has been seen to swing more than once. The debate around insourcing and outsourcing services such as paint operations in the automotive sector and fine chemical manufacture in the pharma sector has swung both ways and caught producers out more than once, he noted. "You have to be careful. There has to be real value added."

Jody Bevilaqua echoed this point, noting that most of chemicals had moved away from the contract manufacture craze 10 years ago. Trius added that the problem is in the offering - you have to offer to do something better and there has to be real valued added. Ecolab, he suggested, has managed to do this with its service offering on cleaning chemicals.

There are also problems, commented Meessen, that as you go further down the value chain to offer innovations and services, you begin to compete with your own customers. The developments in battery technology are a prime example, noted Bevilaqua. The new developments reset the ground rules but it is best, he thinks, to supply the best materials you can for this application rather than move into battery manufacture per se.

This point was emphasised by Trius, who commented that whatever the discontinuity presenting the opportunity and whatever the solution, the essential things are what you provide to the customer - not necessarily in the end manufacture - and whether you can capture the value in the product.

In all this, innovation will play a key role for the European producers. It seems the company of the future may not be that far removed from the vision already outlined in corporate strategies - a focus on renewed innovation, closer customer contacts, a careful but managed decline of assets in Europe and selected investments in growth markets, both regional and technological. The challenge to succeed lies ahead.


Marcus Morawietz/Booz & Company
Although the current economic situation looks to be stabilizing and pressures on demand and pricing have started to dwindle, the specialty chemical industry faces significant issues. Short-term challenges result from managing the recovery from the crisis, while mid-term issues arise from balancing accelerated commoditization against opportunities driven by mega-trends.

These issues are expected to cause fundamental structural changes in the competitive landscape and will drive the emergence of new strategies and innovative business models.

According to our "recovery scorecard," which comprises three early indicators (confidence, financing and demand), there are no signs of a quick recovery, but for a stabilization at a low level.

In fact, we expect a mid-term timeframe for the global recovery from the current crisis. And even if growth does start in 2010, it will take years until prior-crisis performance levels will be reached again. During this timeframe, Booz & Company anticipates three major stages in the crisis recovery: "Survive as cash king," "Leverage the position" and "Emerge as winner."

Given that we are still in the first phase, players should focus on a thorough tracking of the early indicators to prepare themselves for the upturn. Therefore, a set of specific strategic and operational measures needs to be ready for immediate execution to fully leverage market opportunities in any economic upswing.

Besides implementing such strategic and operational measures, specialty chemical players need to carefully assess their future strategies, as it will become fully transparent - at least in the subsequent phase "Leverage the position" - whether their portfolio maintains a real specialty character.

Monitoring pricing power, margin squeeze, etc, will serve as key indicators to anticipate commoditization as early as possible. This is essential, as we expect the future specialty chemical landscape to be even more differentiated in "real" specialties and commoditized products after the crisis.

The players, which will rigorously adapt their strategies accordingly, will be best positioned to "emerge as winner" from this crisis.

Besides crisis-driven changes, Booz & Company expects a major "redefinition" of specialty chemicals in the next 10-15 years. One challenge will stem from the existing and continuing trends such as accelerated commoditization, declining rate of "classical" innovations, etc, which will put additional pressure on the specialty-share in portfolios and further enforce the competition.

Thus, specialty chemical players will not only need to revise their strategies to differentiate themselves from low-cost-country competitors or downstream-integrating companies, but also to develop innovative business models enabling continued profitable growth despite a higher share of commoditization in the portfolios.

As a potential upside, discontinuities induced by mega-trends, integrated resource efficiency (IRE), and a new growth theme "Solutions & Materials" will provide new and attractive opportunities for profitable growth in specialty chemicals.

By leveraging these new opportunities, selected specialty chemical players are expected to even go beyond the chemical value chain or enter adjacent value chains due to even higher value creation potentials - thus a new kind of "transformed specialty chemical players" will emanate from today's league.

More information on Booz & Company

Frank Aranzana, president of specialty chemicals, Cytec Industries

Jody Bevilaqua, president, epoxy & phenolic resins, Hexion Specialty Chemicals

Rob Frohn, board member for specialty chemicals, AkzoNobel

Klaus Hoffmann, European area president, Dow Corning

Huub Meessen, managing director, polymers, SABIC Europe

Antonio Trius, CEO, Cognis

Marcus Morawietz, vice president, chemicals, Booz & Company

Sven Uwe Vallerien, vice president, chemicals and pharmaceuticals, Booz & Company

Richard Verity, vice president, chemicals and energy, Booz & Company

John Baker, global editor, custom publishing, ICIS

By: John Baker
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