Digitisation disrupts distribution
Digitisation may undermine the traditional distribution route to market as it allows producers to offer product direct to the open market via new channels such as Alibaba.
Earlier this year, German chemical majors Covestro and BASF started using Alibaba in China as a new route to market to reach smaller customers traditionally served by distributors. Covestro has a target to achieve up to €1bn in sales by the end of 2019 via new digital channels and is not afraid of upsetting the traditional distribution model.
In June outgoing Covestro CEO Patrick Thomas told ICIS: “Distributors have been losing business for years in China. When we first started in coatings in China, everything was sold via distributors because we just didn’t know who the customers were. Steadily, we have found our own channels to market, so we are no strangers to changing our channels to market away from distribution.”
He pointed out that other sectors such as electronic components have already switched away from distributors to direct sales thanks to the power of new channels such as Alibaba. Distributors are useful when entering start-up markets to help overcome language and knowledge barriers. “Alibaba has shown how things can change. It’s a logical progression – it’s not about upsetting distributors, it’s about finding another channel,” added Thomas.
Distributors will have to adapt their business models to give buyers a reason to buy from them, rather than going direct to a producer via Alibaba or other similar sites. Offering logistics, tax, customs and regulatory services could be successful.
Udo Jung, senior partner and managing director at Boston Consulting Group, said: “If you do nothing as a distributor, it’s much more of a threat; but if you take the opportunity it can be very beneficial – models will be successful which capture a substantial part of the value chain.”
Alibaba, for example, is just a simple platform for online ordering where buyers and sellers meet. A company such as Covestro using the site will have to organise all the logistics to smaller customers, who will have to deal with all other tax, customs and regulatory challenges.
CHALLENGE FOR COMMODITIES
Customers who want to buy a standard, commodity product might be more motivated by price and choice of supplier than specialties customers where performance is more important, so commodity distributors that can offer a choice may be more successful.
“[Digital platforms] might be an easy ordering interface for smaller customers to compare what is on the market. Platforms may be successful which offer products from different competitors, especially if focused on particular segments like engineering plastics or polyolefins, but only if they offer true choices to the customers,” said Jung.
Customers seeking more differentiated materials could use digital platforms centred on certain vertical segments such as water chemicals, food ingredients, dairy, bakery, cosmetics or beverage.
Jung believes specialty distributors already have an advantage because they are typically quite advanced, with end-use application expertise and industry perspectives already built into their business models. Distributors may not yet be highly digitised, but fundamentally, from an operating point of view, they are multi-supplier, multi-product companies focused on selected applications.
To be successful, multi-product platforms will need to compare different products and provide the customer with a full, all-in delivered price. This is a two to three stage process and the more of those value-chain steps a platform can capture, the more sustainable such a platform will be.
According to Jung, in the mid-term, sophisticated business models akin to Amazon could be more of a threat to distributors than basic services such as Alibaba.
“Amazon provides the full value chain coverage including big investments in storage and transportation. They combine traditional offline investment in transportation and storage with high-end cataloging and search and comparison engine capabilities,” he said.
EXCLUSIVITY NOT A PROBLEM
In specialty chemicals distribution, exclusivity agreements are common where a distributor represents one company to customers of a certain size and geography. Exclusivity can also be double-sided where a producer does not use other distributors for an area.
The lack of choice may not a problem for customers that prefer to use distributors which offer a full basket of products required for an end use. For example, a customer formulating coatings will need resins, hardeners, binders, substrates and pigments, and typically a distributor will offer flagship products from individual suppliers in its portfolio.
“Digital provides distributors with an ideal opportunity to display the link between application and product – such as the range of products suited for a wood coating, for example. This makes it easier to market a vertical value chain approach,” said Jung.
However, he recognises that the digital technology is increasing the transparency of the marketplace with customers becoming more sophisticated and perhaps wanting to try alternative products from different suppliers.
Distributors can lock in customers by offering recipes and formulation support based on the products they supply.
“Price is less important than product performance and the willingness of the customer to pay depends on the success of the product in its own customer market. If a formulation helps the customer achieve growth, then he is less likely to change formulations and try different ingredients,” says Jung.
However, if the distributor is offering a more mature product, towards the end of its lifecycle, there may be cost pressure. Commodity customers may be more inclined to look for cheaper alternatives.
Where a standard product goes into a mature application that has been around for decades then price, choice and availability become more important.
For commodities it is important to have choices for the same or very similar products and to compare prices between different producers, also to compare lead and delivery times. This can only be achieved in an independent marketplace, although Jung has reservations about platforms owned by producers due to competition law.
Any such platform would have to be a fully independent company, at arm’s length from the parent, with different employees and a highly restricted flow of information back to the parent.
He added that this model could be successful if the producer is the financial owner of that marketplace, but to make money it would need to go far beyond a simple transaction fee to include services such as market insight data, payment insurance, logistics, industry information, product registration plus Reach and formulation support.
“If as the owner I can gain proprietary market insights from the marketplace which I can then capitalise on even though my competitors cannot – that will not work.”
The commodity chemicals industry is likely to be one of the first to have successful, neutral marketplaces featuring products from different producers.
“But there is a chicken and egg situation because the success of a platform will be driven by achieving a certain level of traffic, and that is driven by a certain depth of product offering,” added the Boston Consulting Group’s consultant.
Customers will need to have a high level of confidence that they will see offers from the most relevant producers, and not just scrap material from marginal producers. Currently, some companies are trying to set up marketplaces and giving incentives to generate initial volumes in order to become self-sustaining.
“I think these platforms will come of age now compared to the past – there is a generational change as [millennials] come into decision-making roles. Technological advances are also helping: in the past there was a fancy front-end but behind that there were hundreds of people in the back office doing the matching of data manually.”
KEY ACCOUNT RELATIONSHIPS
The core of purchasing and customer/supplier relationships in chemicals is the key account function, which maintains and negotiates bespoke annual, quarterly or monthly supply contracts with the most important customers.
Jung believes this way of doing business is unlikely to be undermined by digital platforms.
“Will they get their volumes via a marketplace or have annual negotiations with customised pricing formulas, including joint planning to fully utilise the assets of the producer? For the foreseeable future, the key accounts will still have these negotiations, especially as availability can be a key issue in some markets.”
However, spot and futures markets could see a shift to online marketplaces where bespoke deals and relationships are less important.
STRONG GROWTH FOR SPECIALTY DISTRIBUTION
JUNG BELIEVES specialty chemical distribution will grow more strongly than chemical production into the mid-term because of the continuing outsourcing trend. This varies significantly by geography: distributors have a larger share of the market in the US because it is less fragmented on the producer and customer side than in Europe.
Another trend driving growth for distribution is the outsourcing of tail-end raw material supply by chemical producers. Jung said: “Even a company like BASF is using distributors on the supply side for the last 2.5-3% of their ingredients. This helps to reduce complexity in sourcing for their tail-end raw material needs.”
As companies focus on fewer, larger production sites, they outsource sales and marketing to distributors in regions where they no longer have production.
Growth rates vary with the large regional distributors in the range of €800m-€1.5bn sales seeming to have grown faster than the big, full-line global companies.
“This is because they are more focused on the specialties side compared to the full-line players which cover commodities. Smaller distributors are more challenged unless they have a very strong position in a certain geographic area and segment.”
However, the trend towards globalised distributors will continue as they can help extend the reach of global producers into new markets as well as simplifying their supply chains. Most of the larger producers have several hundred distributors in Europe alone and will seek to reduce complexity.
“We will see more global distributors which can leverage the global position of the producers,” said Jung.
Chemical producers will also continue to use distributors to help keep plant utilisation rates up in times of volatile demand.
According to Jung: “It’s not black and white, but in my experience commodity producers choose different distributors at the same time because they, in a way, see distributors as off-takers. Depending on the supply/demand situation they see distributors as channels to market where they can put product into the market to ensure a certain level of capacity utilisation without lowering prices for their core customers.”
On risks to distribution, Jung added: “Some chemical producers are testing digital as an enabler to recapture some tail-end businesses with a direct marketing approach. However, many customers want a basket of ingredients which a single supplier often cannot provide. Distributors who bundle the products of different suppliers are in a better starting position.”