China Monthly: Urbanization may not translate into higher polymers profitability

23 April 2012 00:00  [Source: ICB]

The urbanization of China's population will not necessarily translate to higher profitability for polymers producers as consumers seek performance at a low cost

 Copyright: RexFeatures

Even the middle class in China will remain quite cost-conscious

Copyright: RexFeatures

Every time you come to the subject of China, it becomes ever more complex and uncertain. An excellent example is an article published in the academic journal, Eurasian Geography and Economics, in February, by University of Washington professor Kam Wing Chan.

It questions to what extent China's economy will benefit from further urbanization because of the harmful impact of the hukou residency system that was introduced in 1958, according to media reports quoting the article.

The system, designed to ensure that enough people remain in a particular region in order to keep the country sufficiently fed, has created a two-tier society.

Tier one comprises urban residents eligible for unemployment benefits and pensions. Tier two is the hundreds of millions of former rural residents who have moved to the cities and towns in order to find work, but have not been able to officially change their residency status from rural to urban.

These people are ineligible for welfare payments or free public education as hukou status is hereditary.

Chan, who studied population statistics from China's National Bureau of Statistics and the Ministry of Public Security, discovered that 460m people had urban hukou status in 2010 compared with a total of 666m city dwellers.

The remaining 206m were therefore caught in an economic no-man's land, creating "a pool of super-exploitable labor," he wrote.

New rules have been introduced by the central government, which, under certain conditions, allows migrants to apply for a change of residency status after they have moved to small and medium-size cities.

But the majority of employment is in the big cities, such as Beijing and Shanghai, argues Chan.

If much of this increased urbanization is going to involve former rural residents trapped in severe poverty by Western standards, they will hardly be rushing out to buy BMWs and Louis Vuitton handbags.

"This just illustrates the extreme cost pressures that chemicals and polymer producers are under in China," says an Asia-based business development manager with a global polyolefins producer.

"The opportunities might be enormous, but I don't see the cost pressures becoming any easier in not only China, but also in India, where the majority of people are surviving on very low incomes by Western standards."

The opportunity lies in hundreds of millions of Chinese who will move to the country's cities and towns over the next few decades. Their lifestyles will change, leading them to buy Western consumer goods for the first time.

"Take the example of disposable diapers. Just imagine the potential, but then think of how much a consumer products company can charge for each diaper - a fraction of the price in Western markets," says the business development manager.

"This is resulting in a lot of focus by procurement managers, working for the consumer products companies, on minimizing raw-material costs."

At the same time, polyolefins producers with the right technologies are seeking to differentiate themselves by boosting the sales of higher-value grades into the more mature end-use markets in China.

In the developed southern and eastern provinces, for instance, demand for sophisticated packaging material, with better barrier protection, is rapidly increasing - at a high multiple over the growth in GDP.

But even in these markets, cost pressures are great because being middle class in China is radically different from being part of the same socioeconomic group in the West.

More than 1bn people in China were middle class by 2007, according to an Asian Development Bank (ADB) report published in 2011.

The ADB, however, defined middle class in China as anyone with a purchasing power parity of $220 of daily income.

China's "super rich" were classified by the bank as those earning $100 and above in daily income, rather than the country's millionaires and billionaires.

The end result, therefore, is a middle class which desires Western-style finished goods but at a much lower cost, says the business development manager.

"At the polymers level of the production chain, it means that they want the same level of functionality in, say, flexible packaging, but at a fraction of what you'd be able to charge in the US or Europe," he says.

This can create major difficulties for higher-value polymer producers, as their business models rest on achieving price premiums over commodity-grade plastics, especially if they lack access to low-cost hydrocarbons and/or are not integrated with refining.

Equally, these differentiated producers are anxious to grow volumes in the booming China market.

"One way to grow volumes is to actively look for the opportunities. This involves working with [global consumer products companies] Unilever, Coca-Cola, etc, to suggest more attractive and more functional packaging," says the business development manager.

"You also have to spend time and money with your immediate customer, the processor. This is required in order to make sure he is able, and willing to produce the higher specifications wanted by the consumer products company," he says.

"This involves convincing the processor to buy more expensive grades of polymer. You need to convince the converter that this will result in better returns for him from his customers - the consumer products ­companies," the business development manager adds.

"Technical service teams need to also work on process efficiency to ensure that, while the processor's polymer might cost him more in dollars per tonne, he saves money overall."

 Copyright: RexFeatures

For those in rural villages, the middle class is often still a long way off

Copyright: RexFeatures

"Polyolefins producers often have a production cycle, say 90 days, during which they switch between producing different grades based on minimizing the amount off-spec material," he says. "But as markets in China evolve very rapidly, and are subject to frequent changes in the nature of demand, your marketing team could be demanding a switch in grades during a production cycle that, technically, creates major issues.

Much work would be focused on finding ways of switching grades that satisfy both process efficiency and market demand.

"The sheer number of grades that has to be produced is also on the rise, as markets become more fragmented and complicated. The more grades you produce, the more complex it, of course, becomes in marrying periods of producing each of these grades with market conditions. There is a higher chance of getting it wrong," says the business development manager.

"If you produce a certain grade for too many days, you might be left with too much inventory. This creates the risk that price movements in the wrong direction will mean you end up losing money," he adds.

Accurate market intelligence is becoming much harder to obtain in China, and everywhere, as price volatility and the complexity of demand patterns increases.

The polymer producers that seem to be switched on to this challenge stress the importance of senior people, with long track records in China, continuing to spend a lot of time in the country.

Good relationships, sometimes developed over decades, with key customers are also viewed as essential. Many of these customers started in business as low-value converters, but are now running sophisticated processing lines, requiring big volumes of high-value polymers.

"Some of our customers, making high-value packaging materials, tell us 'we will add capacity based on whatever volumes you can supply.' Growth is very strong," says a sales and marketing executive with the same global polyolefins producer.

Growth is one thing, but making good money is something almost entirely different.

Follow John Richardson and Malini Hariharan's Asian Chemicals Connection.

By: Joseph Chang
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