Operational excellence in chemicals leads to shareholder value

26 March 2012 00:00  [Source: ICB]

The North American chemical sector is in the midst of an exciting renaissance. Fueled by a wave of capital investment, commodity, diversified and specialty chemical companies are investing to take advantage of the region's energy and feedstock positioning and favorable investment climate.

Attractive low-cost natural gas is expected to create a broader industrial resurgence and enhanced demand in the long term. Global chemical companies are revising their geographic portfolio weightings, looking to invest more in the Americas.

It is estimated that more than $100bn (€76bn) of new capital investment over the next decade will be targeted in the Americas alone.

DRIVERS OF SHAREHOLDER VALUE

Boardroom meeting, Rex Features 

 © Rex Features

While company strategy is critical to defining business strategy, geographic positioning and investment portfolio, how well companies execute and manage their investments will significantly influence financial performance and shareholder value creation.

Over the long haul, "winners" will be companies that have generated above normalized levels of capital returns through disciplined process management.

A variety of drivers contribute to building shareholder value for chemical companies. One of the most distinguishing metrics is return on capital employed (ROCE). Shareholder value is tightly linked to asset efficiency and ROCE.

The scatter chart at right shows a relatively strong relationship between the average five-year trailing ROCE and total enterprise value over capital employed. While companies below the curve benefit from positive portfolio dynamics and liquidity effects, achieving higher valuations per unit of capital employed, those above the curve generally suffer from a discount due to the cyclical nature of their portfolios or recent lagging performance. The latter require higher ROCE performance to achieve similar shareholder value.

While ROCE is influenced by the quality of industry structure and competitive positioning, creating a culture of operational excellence allows a company to address these dimensions of shareholder value proactively.

Companies tend to be more focused on operational improvement and cost management in the downward portion of the cycle. But the "winners" have focused on creating a culture of operational excellence with clear management frameworks and continuous goal-setting to achieve continuing performance gains.

The focus of programmatic efforts may change throughout the investment cycle, but the level of effort is continuous. In the capital investment wave, it will be important to emphasize good investment decisions as well as effective implementation.

ROCE graphOptimizing the industrial footprint, capital portfolio management and capital project management are all important at this phase of the industry investment cycle.

There is significant opportunity for improvement. In a recent survey of 2,800 CEOs and business unit managers in the US, only 19% were satisfied that their "Lean" programs (those focusing on efficient use of resources for profit generation) had delivered what was intended.

We believe that the difference is adopting a culture of operational excellence. We see significant transformation opportunities that will drive shareholder value, particularly among the mid-sized companies in the sector.

Leading companies that are focused on enhancing returns on invested capital are focused on continuous and programmatic improvement addressing the key levers impacting both the numerator and the denominator.

The chart below illustrates ROCE levers and the three thematic improvement areas for holistic programmatic management: cost management; revenue enhancement; and capital and asset management. While the balance of focus reflects the current state of the company, its specific opportunity areas and competitive positioning, it also reflects positioning in the business and investment cycle.

As the economy improves, we expect cyclical recovery in housing and modest additional recovery in the automotive sector to produce a significant rebound in chemical demand.

With the chemical sector operating near 80% overall utilization and many companies behind the capital investment curve, the focus will remain on increasing throughput from existing assets and also bringing on new capital investments in a timely manner.

The use of "overall equipment effectiveness" and capital project management are in vogue as companies prepare for recovery. Companies employing leading capital project management techniques routinely achieve 1.5-2% higher ROCE performance.

ROCE graph

Examining investment options consistently requires a capital portfolio management process with a sophisticated risk management approach. Companies employing integrated portfolio management approaches consistently make better investment decisions.

The area is a growing best practice that is embedded in management frameworks across most of the larger, more sophisticated chemical companies, and mid-cap companies are employing this approach as well.

DEALING WITH PRICE INFLATION

As the economy recovers, there is a disproportionate risk of commodity price inflation. To deal with potential input price volatility similar to the 2008 time period, many companies are shifting to purchasing and supplier management programs focusing on novel contracting mechanisms and supplier management approaches.

Sales analytics, pricing optimization and sales effectiveness are critical to the creation of mechanisms and communication to passing input pricing through to customers in a timely manner to reduce the profit cyclicality across the value chain.

INNOVATION PROCESS

Longer-term innovation is also critical to support enhanced margins and growth. For businesses, innovation is not an end in itself. Their prime task is to identify the right innovation, and it sometimes requires tough decisions to be made between development projects.

Having the right process to manage innovation in a portfolio and ensuring that the company is taking enough and the right balance of risks with its new product development investment is key. This requires the right level of process structure and discipline with the right risk/benefit ratio and systematic control of timelines and costs.

HOLISTIC APPROACH

In summary, we believe that the winning companies in our industry have increasingly created a culture of operational and process excellence that embodies commercial excellence, capital and asset management, and cost management.

Joseph CooteThis holistic approach leads to strong shareholder value performance with best practice companies consistently outperforming their peers. Shifting the focus and activity level of a holistic management approach is prudent throughout the business and investment cycle, and an important management skill to optimize return on capital, growth and shareholder value.

  • Joseph Coote is senior vice president and global chemical practice leader for Celerant Consulting. He has over 20 years of experience in management consulting and professional services.

Author: Joseph Coote and Vikram Gore



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