The China chemical distribution challenge

21 July 2014 09:00 Source:ICIS News

By Will Beacham

Beijing trafficLONDON (ICIS)--China is proving a difficult market for multinational distributors to enter. With the exception of Brenntag and Univar, which have taken their first steps, global groups do not play a large part in the country’s distribution market, still dominated by domestic players in a highly fragmented market.

Yet there could be more opportunities for players who take the right approach in this challenging market, and the prize – access to one of the world’s largest and fastest-growing chemicals markets – is an attractive one.  Joint ventures are seen as one of the most obvious ways to gain entry.

According to Krishnan Narayanan, senior executive advisor at consultancy Strategy& (formerly Booz and Company), there is significant market growth of up to 7-9%/year in commodities and specialties for both direct and distribution channels in coastal and inland parts of China, though distributors have not always captured these rates in the past three to four years.

“Growth should be better for distributors, given that they have sets of locals customers emerging as a result of changes to the Chinese economy, which [has] become much more driven by domestic demand rather than exports. That’s leading to companies in end-user industries becoming much more powerful.”

As most of these are medium-sized – and therefore served by distribution channels – one would expect the distribution market to be growing more quickly, but this has not been the case over the past three to four years. Growth rates for distribution have been similar or even lower than for direct in China.

Narayanan says the inland areas of China – which are still developing compared to places like Beijing and Shanghai – are growing quickly. This is especially true where they have significant end industries such as automobiles in Wuhan. These areas can grow at around double the rate of the rest of the country.

“Growth rates from solvents to real specialty chemicals can be anything from 16-18%. So it is still a great place for distributors. In the small to medium-sized enterprise (SME) sector, growth rates for commodity chemicals are higher than for higher margin specialties, which are more difficult for distributors to shift.”

There is a lot of price pressure, which causes margin challenges, especially for those selling commodities. China is, he says, a very difficult market for global distributors to grow in. The market is incredibly fragmented with the top 10 distributors having only 15% of the whole marketplace compared to around 50% in Europe, according to Strategy& analysis.

The biggest player in China distribution is SinoChem and all of the big ones are Chinese. The largest global distributors such as Univar and Brenntag are trying to do things in China but they haven’t been that successful at entering the market on their own, according to Narayanan, though there have been some limited joint ventures (JVs).

He says it is really important for any Chinese JV partner to agree to allow their global counterpart to grow with them into new territories. “Any expansion the local player does in high value, high growth inland areas; it’s not a fait accompli that the global partner will go with them. They would have to invest more and are sceptical about doing so because they’re not really making very much money in China.”

Selling as a distributor in China involves mainly selling to local players as these still dominate the market compared to multinationals. So it would be incredibly difficult for a foreign player to enter the market on their own and be successful.

“Partnering is an obvious fall back, as is not entering at all. But given the prize, it’s difficult to imagine that one would want to stay away too long. The scope, governance and details of any JV need to be carefully thought through. I would advise companies not to sign a JV which is specific to one region, as you won’t benefit from the organic growth of your local partner,” he says.

It is important to highlight to Chinese partners the advantage of a relationship with a global player. If a large, global, proven distributor with a track record in North America and Europe can offer its know-how and some of its processes to a local player that might help distinguish it in this highly fragmented market.

“But they are still selling, as a distributor, to a set of SMEs which are not after know-how and technical solutions. On the flip side if you can say to a local player that they are not differentiating themselves on the market and that adding solutions provision will allow them to sell value-added products; the question then is whether the demand exists yet from the SMEs.”

None of the local distributors have a global profile at all, making it difficult to track M&A. Narayanan says that over the past couple of years, he has seen almost no consolidation.

“One good reason for this is that they’re not making tonnes of cash to go out and buy other players. They are small and have thin margins; also they can’t leverage cash from overseas operations as they are mainly domestic. I can’t see this changing in the short term.”

It is also important to realise that many Chinese distributors are part of larger state-controlled chemical producers.

Narayanan says there is no reason why global distributors cannot be successful in a market where global manufacturers are present. It is very difficult for a global player without a local team talking to local customers to build a business better than the local players themselves.

“A lot of these distributors are still small and family-owned and therefore the talent in distribution here is not significant. But if you can address the talent challenge and go credibly, especially Chinese to Chinese to your customers, then the prize is enormous.”  

By Will Beacham