Chemical Manufacturers: The Search for Sustainable Growth

A.T. Kearney's 2011 Chemical Customer Connectivity Index (C3X)

The European chemical sector is rebounding, posting significant growth in the past year, with financial performance for many industry leaders equal to or greater than pre-crisis levels. To maintain the momentum, chemical companies are making ambitious growth plans. But there are still questions: How to achieve sustainable growth in light of financial volatility, market changes and competition from developing markets? What's better: organic growth or acquisitive growth? Is innovation a differentiator? What do chemical customers really want? Findings in the 2011 Chemical Customer Connectivity Index provide answers.

The market for chemical raw materials has heated up in the year since A.T. Kearney conducted its last Chemical Customer Connectivity Index (C3X) survey of executives of European chemical companies and their customers. Demand to refill chemical supply chains is rising, with some strategic raw materials, such as titanium dioxide, butadiene and rare earth minerals, in short supply and most companies reporting price increases. Half of the study's participants report raw material price increases of 10 percent or more in the past year, while another 20 percent of participants report price increases of 30 percent. And debt troubles in the United States and the euro zone, continued global financial instability, and political unrest in the Middle East and North Africa continue to be concerns.

Figure 1: Most C3X respondents expect increased demand in the next year

Amid this landscape, the 2011 C3X study, the fifth in a series since 2008, finds cautious optimism among survey participants as growth continues. More than 90 percent of chemical companies expect demand for chemicals to continue rising in the next 12 months (see figure 1). And while most chemical company executives expect these trends to continue, many fear the pace of growth will slow amid global economic pressure.

This paper discusses the study findings, examining how relationships between chemical manufacturers and their customers have changed since the downturn, the search for new growth opportunities in developing markets, and the impact of mergers and acquisitions (M&A) on the industry (see sidebar: About the Study).

Meeting Customer Needs

As in previous C3X studies, there is a gap in how manufacturers address customer needs. While 40 percent of manufacturers believe they have expert knowledge of their customers' requirements, only 17 percent of customers believe manufacturers truly understand their needs. Also, 70 percent of manufacturers report that their customers' customers define the requirements of their products. Yet only 50 percent of manufacturers meet regularly with these secondary customers; their interactions are typically at trade fairs, industry conferences, or in one-on-one meetings.

Collaboration along the chemical value chain—in the form of joint discussions, collaborative networks, and multi-party partnerships—continues to be rare.

Figure 2: Customers' view on what manufacturers should do versus manufacturers' own view on what they should do to improve the customer interface

Manufacturers say they stoke their customer relationships by offering value-added services, better prices, more and faster innovation, and tailored services, in this order. This corresponds only partially to what customers want—better prices (albeit, they say this less so than in previous surveys), faster innovation, improved processes, access to new markets and customers, and tailored services. The gap between manufacturers and their customers is most apparent in value-added services (see figure 2).

Sales force efficiency and complexity management are other areas where manufacturers' perceptions of what customers want differ from what customers really want. Manufacturers believe sales force liaison and support is very important to their customers when, in fact, customers have other priorities. Improving marketing, sales, and the information technology (IT) interface are all areas where chemical manufacturers can make short-term gains.

As key buying criterion, "price performance" was most important from the customers perspective in the past, with 95 percent considering it important or very important in 2010. Supply chain is now the most important aspect with customers saying reliable delivery (88 percent) and product availability (84 percent) are more important buying criteria than price performance, which is down slightly to 79 percent.

Figure 3: Top five success factors for manufacturers as they deal with their customers

When asked what will be the key factors necessary for growth in the next five years, manufacturers consider their technological position (reflected in R&D and product development, for example) to be crucial as they deal with their customers, followed by customer access and understanding changes in customer markets. Customers, however, rank manufacturers' highest priorities as the ability to comply with regulatory requirements, such as REACH, followed by feedstock availability (see figure 3).¹

From an internal perspective, manufacturers say cost leadership, scale and asset effectiveness, and access to skilled labor are important. With regard to their raw material supply, they value feedstock availability, an understanding of changes in supply markets, and good relations with suppliers from outside markets.

Growth through Customers: New and Old

The chemical industry in Europe has rebounded, so the quest for new growth opportunities now tops most every CEO's agenda. But where will the growth come from? Generally speaking, manufacturers do not believe that new business models or M&A will have a major impact on growth. Rather, they expect to grow organically— primarily from new and existing customers (see figure 4). The following areas will prove vital in attracting new customers and addressing the changing needs of old ones:

Figure 4: Where will future growth come from?

New markets. Manufacturers will be following customers into growth markets such as South and East Asia, and the Middle East (see figure 5). Joint innovation initiatives with customers and new or additional production capacity could help them secure access to competitively priced raw materials, tap into a global human resource and knowledge base, and apply specialized services and technologies at their customers' newly established hubs in these regions.

Technology and innovation. Since hitting the bottom of the global economic downturn in 2008, manufacturers have not made significant changes to their innovation strategies. That may be changing. This year, more manufacturers cite innovation as a means to maintain market leadership and extend product and application life cycles. The key focus of their innovation efforts: to offer new product features to customers and to gain recognition as an innovation leader. Half of the manufacturers spend 2 to 5 percent of revenues on innovation, and another third spend 5 to 10 percent.

What do customers want in terms of innovation: new applications (67 percent), new product features (58 percent), and new chemical products (58 percent). Emerging technologies, including new developments in energy efficiency and alternative feedstock, such as unconventional gas or compounds from bio-refining, are all areas where manufacturers and their customers are focused (see figure 6).

Figure 5: Regions where chemical manufacturers and their customers will build new capacity

Sustainability. Supply scarcity, price volatility and government regulations (to cut carbon emissions) are making sustainability a big issue for manufacturers and their customers. Manufacturers are helping their customers become more sustainable by providing technical services to improve operational sustainability (63 percent), ensuring the sustainability of their own supply chains (62 percent), and providing chemicals made with alternative raw materials (47 percent).

Strikingly, however, customers rank manufacturers' sustainability efforts lower than a year ago in nearly all categories. Are manufacturers missing out on a huge potential growth opportunity in sustainability?

M&A: Ongoing Consolidation

Figure 6: The role of emerging technologies in the chemical industry

Most manufacturers have launched initiatives to improve their market presence in terms of regional coverage, customer penetration and product portfolio. However, only 17 percent see M&A as a main avenue to growth—a surprise considering how M&A has picked up in the chemical sector over the past year. Earnings multiples for strategic acquisitions are at an all-time high, an indication for some strategic players, especially in Europe, to consolidate their market segments.2 Recent A.T. Kearney analyses, comparing earnings margins of leading chemical manufacturers with the development of deal multiples, backs this up (see figure 7).

Volatility in financial markets may lead to more conservative valuations at home, but it is not dissuading new market entrants from South and East Asia and the Middle East from investing in established Western chemical players. The Chinese, for instance, are making an impact in the chemical industry by controlling a growing share of global chemical supplies and becoming active M&A players (see sidebar: China's Rise). A considerable share of manufacturers (15 percent) say that a Chinese company is among the top three competitors in their segment already, albeit other areas are yet without Chinese competition. Half of customers and 27 percent of manufacturers do not consider Chinese companies to be real competitors (see figure 8).

Don't Rest on Your Laurels

Figure 7: Comparison of earnings margins and development of deal multiples

The chemical industry has bounced back impressively from the recession of three years ago, yet there are plenty of potential roadblocks ahead, including an unsteady macroeconomic climate and new challengers from South and East Asia, and the Middle East.

To stand out, European chemical manufacturers must concentrate their energy on how they satisfy their customers' expectations. This is not just about addressing the right issues today, but also about working on what customers will want in the future—and ultimately helping them grow.

Authors

Tobias Lewe is a partner in the Düsseldorf office.

Richard Forrest is a partner in the London office.

Inna Baigozina is a principal in the London office.

Robert Renard is a consultant in the Frankfurt office.