Market outlook: Marketing new capacities - a non aggressive approach

16 June 2014 00:00 Source:ICIS Chemical Business

Production capacities of the base chemical industry are periodically extended to meet growing market demand. Due to short-term volatility, however, their timing is seldom right: It is either too late to capture the upswing or demand is stagnating when new supply hits the market. But how can a company successfully position new capacity without inadvertently starting a price war or jeopardising the product’s value?

Developing new capacities in asset-intensive industries such as chemicals means ­making significant investments and often involves considerable lead time. Therefore, even in difficult market environments, shareholders demand to get the returns on their investments. On the one hand, delaying the start of production in order to match demand is often not an option once project completion is in its last stage. On the other hand, efficient production means selling a minimum volume (base load).

On top of this, if a company is positioned more upstream in the value chain, its options to absorb new production volume by shifting between products in the portfolio or across customer segments is considerably more limited.

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Careful price planning is required before turning on new capacity

Consider a typical upstream business model: A product is being sold to ten key customers, which account for over 80% of the product sales volume. With global standards for the product, price levels are quite transparent and, respectively, customer sensitivity to price changes is high.

Managers operating in such an environment are usually well aware that uncontrolled prices move downwards, possibly causing a chain reaction and destroying product value, prices and margins alike. Nevertheless, it is still fascinatingly common to focus on volume and try to fill capacity when it comes to defining volume and price targets in order to market new capacities. To lower aggressiveness, companies need to follow three steps: set balanced targets; break down targets into detailed account plans; and evaluate the diverse pricing options to reward customers and protect product value.

BALANCED MARKET-SHARE TARGETS

If a supplier is willing to invest in a new capacity, they are clearly committed to serving their customers in a market and supporting their growth. In return, they can expect to supply a fair market share. The capacity position, therefore, is an important driver for setting the right market-share targets. Market or customer access, driven by cost-to-serve considerations, might influence the translation of capacity shares into market and supplier share targets. If customers or markets are located far away from the plant or are comparatively cost-intense to serve, the appropriate share target might be lower than the pure capacity share. However, the basic assumption holds that the market shares should be aligned with the respective capacity shares.

Now, let’s have a look at the following case (see figure 1): After a period of stagnating demand, supplier B is over-represented in his market compared to his capacity share. Supplier A, who is perceived as having a strong focus on market share, is in fact under-represented. In this situation, supplier C adds capacity, leading to an under-representation in the market. Instead of sticking to and fighting for volume targets which were originally defined, supplier C stuck to his new market share target and strictly controlled his own volume aggression. At the same time, supplier C kept the mid-term volume targets based on his demand expectations. Capacity position and the cost to serve customers drive market-share targets.

DECIDING WHERE TO GROW VOLUME

When new capacity is ramped up, thereby changing suppliers’ market-share targets, they need to develop customer-specific action plans that break the new targets down into volume targets for individual accounts. Since an account-specific volume growth target typically leads to a change in the supply shares – with one supplier gaining and the other(s) losing – it is essential to thoroughly assess which accounts to grow.

capacity shareImagine being a preferred supplier at a specific account for years with a supply share of around 60%. If another supplier with new capacity approached this account, you would likely aim to protect your position and supply share. However, for a second supplier with a minor supply share (8% to 10%) at another account, letting it go might generally be easier. Taking into account such potential competitive reactions helps identify which accounts to grow without causing (too) much aggression.

Growing volume and increasing supply shares is, therefore, more reasonable at existing accounts with established positions and relationships, rather than accounts where you currently have low supply shares and lack stable relationships. Supply shares of 80% to 90% at individual accounts, however, limit growth options from the customer site since they will insist on multi-sourcing or second supplier policies. Using available customer intelligence and mapping the total customer demand and supply shares (as illustrated in figure 2) helps to assess and prioritise accounts for volume growth and volume shifts.

When assessing the opportunities for volume growth and prioritising the accounts, the expected growth rate of the account and 
competitive positioning in terms of product and service performance have to be factored in as well.

PROVIDING PRICE INCENTIVES

Simply lowering prices for targeted accounts in the hope of gaining market volume is risky. Customers might expect these special conditions for their entire volume. Even worse, they might use the lower price to re-negotiate prices with other suppliers and introduce a value-destroying chain reaction, ultimately leading to a price war among suppliers.

It is far better to utilise performance-based price incentives that help link price concessions to performance targets, avoiding inappropriate expectations and unintended price spirals. Incremental volume rebates, for example, applied only to an additional volume offered, are an enormously effective instrument to reward key customers.

Paid as an annual or biannual reimbursement, these performance-based rebates ensure that the negotiated price concession is given only after the customer has reached the targeted volume. These concessions should not be shown on the invoice to reduce transparency for other customers.

mapping supply

Volume rebates can also be used as an effective instrument to protect volume. If, for example, a customer reduces their volume, the rebate can be significantly lowered. Hence, there is an incentive for a customer to keep the volume stable.

Another alternative of giving performance-based price incentives is to link the price concession to the purchase of other products in your portfolio, which avoids cherry picking (depends on legal restrictions).

All these instruments work out only if the sales team is trained accordingly and is able to effectively communicate the price incentives to the customer.

When marketing a new capacity, managers are well aware of the risk of destroying value, but often fail to align their own strategy. Following a non-aggressive approach, they have to connect market-share targets with their capacity position. They have to transfer the new market targets to account plans that have been well thought through at selected target accounts. Furthermore, performance-based price incentives ensure that customers actually fulfil the targeted volume without affecting market price levels. Lastly, information must be communicated clearly to both customers and sales teams to secure internal buy-in and manage customer expectations.

  • Andrea Maessen is a partner at global consulting firm Simon-Kucher & Partners and heads the Global Chemicals Industry competence centre based in Cologne.
  • Jan Haemer is a senior consultant at Simon-Kucher’s Global Chemicals Industry competence center based in Frankfurt, Germany.
By Andrea Maessen and Jan Haemer