ICB: Innovation and R&D move eastwards
Heidi Finch
11-Aug-2016
Innovation can help pave the way to long-term success in the chemical industry. It provides more favourable returns on average compared to other investments and holds greater job creation potential.
There are signs of a shift in research and development (R&D) spending from the US and EU towards emerging markets, especially China but also India and the Gulf Cooperation Council (GCC) countries in the Middle East.
Getty Images R&D spending could rise by more than €25bn in China by 2020 while the EU sees only €9bn
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But while the innovation process and R&D growth in emerging markets hold promise, they are not without their fair share of challenges. These need to be recognised and addressed, argue consultants at Arthur D Little.
R&D spending provided the average highest returns – at 5.7% – for US shareholders across industries over an average five-year period during 1985-2015, relative to the sample average of all types of investments, according to an analysis by the consultancy, based on a study by US investment firm BlackRock. While the data varied slightly across industries, the results hold more or less the same for the chemical industry, notes Arthur D Little partner Michael Kolk.
Innovation is generally the “best way to invest over a longer period of time”, provided there is sound strategy and other important and relevant success factors are all in place, he says.
“I am not saying innovation is the solution to all challenges, but I think it is fair to say that for the vast majority of chemical companies, it is a critical factor for longer term success.” However, Kolk adds, there is a need to take a long-term perspective.
INNOVATION CAN TAKE MANY FORMS
Innovation involves companies using their know-how to develop new products, processes, services and business models, thereby creating value and meeting untapped needs in the industry and society as a whole.
On the product side, organic light emitting diodes (OLEDs), lithium ion (Li-ion) batteries and photovoltaic (PV) solar panels represent innovation success stories in the chemical industry over recent years, but it is worth stressing that they have all been slow burners.
OLEDs were first developed in the 1990s, but it took until the 2010s for large-format OLED TVs and OLED displays in smart phones to gain momentum.
The initial research for Li-ion batteries was carried out in the 1970s, but the first mass market launch did not develop until 1991 and it was not until the late 1990s that they became widely used in consumer devices.
Also, mass-market solar panels were first developed in the 1960s. However, it was not until the late 2000s when the global market for solar panels took off.
Breakthrough innovations take longer to reap any benefits, estimated to take five to 10 years for the first revenue to be generated, according to results from Arthur D Little’s Global Breakthrough Innovation Survey. The survey was carried out around 18 months ago and looked back over the past decades, says Kolk.
It took at least a few decades, for instance, for DSM’s ultra-high molecular weight polyethylene, Dyneema, to be developed for different applications across end-use sectors. It is a prime example of a longer-term innovation.
Technical and commercial hurdles to innovation, uncertainty and changing circumstances represent challenges to innovation, as do “brakes in the market”, according to the consultancy. To have success in the area of innovation, it is necessary to have support within the company from the top down, he says, as well as more widespread support through the value chain and by way of partnerships at several levels.
While innovation involves gaining support for an idea both within the company and in the wider market, it also centres on choosing the right areas to focus on, which can represent a big risk and a difficult decision to make. Kolk argues that electric mobility (E-mobility), autonomous driving and lighter weight materials are key areas for innovation. But the burning question is which solutions will be the most successful.
Larger, well-established chemical companies will want to bet on a number of mega-trends and develop competencies so that they will be able to win in various outcomes. “It makes sense to maximise the breakthrough potential and minimise the risk and complexity,” Kolk explains, although individual company strategies and how much risk is involved will depend on the type of company.
R&D IN DEVELOPING REGIONS
Companies outside Western economies are beginning to up their game in innovation. It is, for example, a broad strategic aim in the GCC countries, according to Arthur D Little analysis, based on data from the 5). While the GCC countries represent only a marginal share of chemicals R&D expenditure globally, that share increased by 44% in 2014, according to data from the Gulf Petrochemicals and Chemicals Association (GPCA).
The GCC is a feedstock cost-advantaged region, but it is in the early stages of the R&D investment path compared to Asia in terms of moving towards more fine/specialty chemicals and in receiving investment from Western countries, notes Arthur D Little’s Robin Francis.
There is also evidence of a shift in spending in relative terms towards Asia. More than 40% of chemicals R&D spending was made in Asia in 2015, although most of this spending was made by chemical companies based outside Asia, according to Arthur D Little estimates for 2015-2020, using earlier
R&D spending could rise by more than €25bn in China by 2020 while spending in the EU climbs by just €9bn, research from Arthur D Little suggests. The disparate spending pattern would reflect the shift of growth in the industry over the past decade and more towards China, which now is the largest chemicals market by sales and market share.
China’s share of the global chemicals markets was about 9% in 2003, but this had risen to well above 30% by 2013. Europe accounted for about 30% of the market in 2003, but its share had declined to just under 20% by 2013, according to Arthur D Little analysis of Cefic data.
Absolute market size; being close to the end market; technology and expertise; manufacturing cost advantages; and strategic goals in R&D footprint have all played out positively for China. They have underpinned rapid growth in chemicals R&D expenditure in the country, which jumped from some €1.5bn in 2003 and is estimated to be around €10bn-11bn this year, according to Arthur D Little analysis. “China is a very big market; it makes sense to have local production and local R&D spending. More sales means more R&D spending,” says Kolk. “It [the growth in R&D spending in China] is not just because of the market but local know-how.”
China’s government encourages partners to the country who have R&D spending as part of their proposal and it can open the doors to valuable things such as resources, money, and access to favourable locations, where there are interesting technical clusters. “These incentives can take many forms,” adds Friederik van Oene, partner at Arthur D Little.
While R&D spending in China grew rapidly between 2003 and 2013 relative to developed areas, due to demographic and economic megatrends, R&D intensity (R&D spending as a percentage of sales) in China lagged in relative terms, dropping from 1.1% to 0.7%.
This is because China has been in the early stages of the R&D process, which starts with local R&D for local consumption and requires lower-quality innovation. Over time, however, R&D intensity should grow, reflecting more sophisticated local demand and more advanced chemicals R&D. “R&D intensity in China is catching up, as more infrastructure is being built,” says Kolk.
It is worthwhile for European chemical companies to tap into the more sophisticated local demand needs in China and develop different products using lower cost raw materials or different types of technology in the emerging markets, says van Oene. This is known as “frugal innovation” and can be exported to benefit other countries in the world, he added.
When moving to emerging markets, multinational companies typically first focus R&D at the local level. But some add global competence centres over time, according to the Arthur D Little analysis. By 2020, for instance, it is estimated that 50% of BASF’s R&D will take place outside of Europe, with 25% in the APAC (Asia Pacific) region. DuPont has decentralised research activities in more than 90 countries, with 12 main innovation centres, of which nine are in the emerging markets, according to Arthur D Little research.
It is important to scale up R&D activities from a local and regional level to global technological centres of excellence to consolidate the innovation process. However, it is worth noting that while Asia is growing, this does not mean that the majority of centres of excellences are there yet, remarks van Oene.
While the expansion in R&D spending to China has brought some benefits, there are also challenges that need to be addressed.
There have been cost advantages in producing in China, but this is becoming less the case, as salary costs are not that low anymore. In addition, there is a great deal of economic uncertainty, with slower than expected economic conditions, currency volatility and the ongoing concern about overcapacity.
Intellectual property (IP) protection remains a challenge, because of the high turnover of staff in China, which means that there is a risk in knowledge being leaked to competitors.
The language barrier has been challenging to the R&D process in China, and non-local companies have also faced cultural differences.
India is also on the R&D radar of multinational companies, and some companies have built and strengthened their R&D presence in the country, but not to the same extent as in China. While India is not in the same league as China in terms of global chemicals market share, chemical sales or R&D spending, R&D intensity in India is disproportionately favourable, says van Oene. This is mainly attributed to India’s focus on the more advanced pharmaceuticals sector, for example.
OUTLOOK IS POSITIVE
While sales and R&D spending have been directed towards faster growing, emerging markets in the sector, chemicals R&D is still strong in Europe. It is of high quality with strong clusters of scientists with decades of experience and a strong historical advantage.
However, it is important that European players take advantage of these factors and that the culture and mindset among European players is conducive for innovation, says van Oene.
“Over 40% of chemical innovations now come from Asia,” warned president of the German chemicals trade group, the VCI, Marijn Dekkers, recently, who went on to say, “Therefore, politicians and companies must act now to make sure that we are still competitive in 10 to 20 years. This will require a culture change to make it easy to be innovative.”
In order to achieve a more favourable and sustainable innovative future there is often the need to navigate through a number of market-related and economic challenges. It often takes time for the innovation process to gain traction and for there to be widespread support before it becomes a reality.
Both emerging markets and developed areas have their part to play in nurturing and consolidating the innovative process, encouraging a culture and mentality of positive change to address local needs and challenges to benefit the global market as well as sustainable innovation.
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