A changing industry landscape and the value of a growth capital partner 11th November 2019
By Flemming Bjoernslev, Operating Partner at Virgo Investment Group
Flemming Bjoernslev, Operating Partner at Virgo Investment Group, offers a chemicals executive’s perspective on today’s
Flemming Bjoernslev, Operating Partner at Virgo Investment Group, offers a chemicals executive’s perspective on today’s business environment, its challenges and opportunities.
The past ten years have seen unprecedented economic growth in the United States. The chemical industry has thrived off of the shale gas boom that sparked a manufacturing renaissance and created numerous opportunities. However, disruption is becoming the new normal in today’s business environment. Now, the chemical industry has to face several, major challenges at more or less the same time:
- The digital transformation of the industry
- Increasing innovation – and its associated challenges
- Uncertainty in the outcome of the US-China trade dispute, along with its impact on the industry’s economy.
Many agree that digital transformation – the use of new technologies – will offer opportunities for the industry. New products and processes will move faster to market, and there will be greater transparency in the value chain. However, these technologies will have an impact on the way we do business. In an industry that is already more capital-heavy than personnel-intensive, manual labour jobs will continue to decrease as digitalization takes over more and more tasks. There will also be many more effects on specific parts of the value chain.
Often the outlier within a company, procurement and supply chain have experienced a great deal of attention in recent years. Senior management now realise how crucial it is to have cost leadership along every step of the value chain. Digital transformation offers a unique opportunity to streamline steps by making key suppliers aware of the trends a company is seeing for their business, and subsequently giving them more time to prepare for the next generation of raw materials that their customers expect to need.
R&D and production
One of the more prominent areas where digital transformation has accelerated is in the area of research and development (R&D). Previously, new chemical formulations were developed and tested according to a meticulous scheme over a lengthy period of time, in order to test durability, and other effects on a specific application, molecule or environment. With the advances in artificial intelligence (AI), we can now simulate these effects in a quicker manner and therefore significantly reduce the time to market.
Finance and administration
Since the introduction of ERP systems 30 years ago, everybody, including smaller chemical companies, run some version of an ERP system today. Undoubtedly this area of a company’s value chain will be less resistant to digitalizing and will see improvements in its operations.
Sales and marketing
This part of the value chain has already seen a lot of digital transformation, most notably through the introduction of Customer Relationship Management (CRM) and e-commerce tools. However, the uptick in use of IoT (Internet of Things) and AI will accelerate the digital transformation process and increase pressure on companies and employees in the chemical industry to adopt these technologies. Still, several studies indicate that a small percentage of companies within the chemical industry – especially small and medium enterprises (SMEs) – seem unprepared for the digital age. A large part of the challenge will be to overcome corporate culture and behaviour, and embrace technological changes.
There are two areas of interest when it comes to innovation – product innovation and process innovation. From 1950 to 1970, we saw a high rate of innovation within the chemical industry. There was a constant flow of new products, and processes to create better chemicals. Since the 1980s however, that rate of innovation has slowed significantly. The larger chemical companies are focusing on conquering the emerging markets: Eastern Europe, Russia and, in particular, China. Increasingly, the return for building up these markets is higher than the return from new, cost-intensive, R&D initiatives.
However, the global financial crisis of 2008 marked a turning point in this development. Since then, the chemical industry has felt the volatility of the overall economy. Cyclical chemical sectors like polymers have become harder to predict. Even the specialty chemicals sector is facing disruptive elements.
Interestingly enough, in recent years the majority of newer innovation in material science is coming from outside the chemical industry, according to consulting firm Strategy& (the global strategy consulting team at PricewaterhouseCoopers). Emerging companies are often offshoots of university research groups that get paired with venture capital, and are free from the inertia of many legacy producers. The large chemical companies have recognised this pattern and are taking different approaches as a result. Some are investing in these start-ups, but keeping them outside of their traditional R&D programs. Alternatively, many of the incumbent chemical players are launching spin-off products and/or new entities which focus on targeted sets of molecules–or core businesses–to yield earnings.
The changes and volatility over the past few years have chemical industry members asking themselves about the innovation of their business models. Historically, the majority of business models were based on cost-plus or value-based methodologies. Now, companies are looking at introducing outcome-based models, sharing the risk with customers in implementing new materials and products. By creating partnerships and new ecosystems, the increased differentiation lessens the challenges of becoming an increasingly commoditized model.
US-China trade dispute
According to Chemical & Engineering News, the trade dispute has already impacted $15.4 billion worth of imported, Chinese chemicals and plastics, and $10.8 billion of similar US exports.
Many see the dispute over tariffs as a way to level the playing field between the US and China. We should not forget however, that the western chemical producers helped China get to where it is today – going in at a time when there was enormous market potential and extremely low costs. Fast forward 25 to 30 years and the Chinese are ready to pursue major business opportunities outside of their home turf – predominantly in Europe and North America.
What we have to bear in mind as we move forward is that these additional import duties will need to be passed on through the value chain, eventually ending up on the consumer’s bill for the final product. The extra costs on exported US chemicals and plastics will have an impact on sales volumes, and it will not be a positive effect.
There is a silver lining, however. First and foremost, US manufacturers have taken precautionary measures, informing their customers about the new duties and providing credit notes should the US and China end up settling. Many companies have also switched their supply focus from China to India and Europe. These Indian and European companies have previously faced the challenges of increased prices and lack of capacity in recent decades.
Further opportunities lie in the area of re-establishing manufacturing capacity here in the US. Starting at the top of the value chain, the Shell cracker plant in Beaver, PA is a great example. It provides relatively cheap, shale gas, and when combined with the fact that Shell will be able to reach 70% of the North American population within a 700 miles radius, it makes for a compelling story.
In the US today, chemical manufacturing accounts for over four million jobs and more than 25% of GDP. According to the American Chemistry Council (ACC), there are currently 334 projects with a combined value of $204 billion. 53% of the investments into these projects have been completed or are underway and 40% are in the planning. While there are opportunities in every step of the chemical value chain, the majority of investments are upstream, in basic chemicals. This is also the area where we will see the largest growth rates – about 4.8% in 2019 and slowing down to below 3% in the following years as the projects move to a more normal pace. Within the specialty chemicals segment, the ACC projects a 2.2% growth rate for 2019, growing in line with industrial and construction sector gains in the years ahead. This means a certain slowdown in the automotive sector, which is currently below 2%. However the construction sector is expected to be on a steady growth path above 2%.
The takeaway here is that the economics of cheap energy, reasonably low costs for raw materials, and a solid outlook on growth, present an opportunity for companies to invest and expand their manufacturing and production capacity in the US.
The value of a growth-capital partner
During my 30 years in the chemicals industry, leading and managing through business transitions, the landscape for specialty chemicals has changed quite a bit. But even during the rocky times the fundamentals for creating opportunities (whether through new products, molecules or commercialization processes) have not changed at their core. Understanding and analyzing business opportunities from a holistic perspective remains key to building successful and sustainable businesses that satisfy customers, employees, business owners and all stakeholders alike. I am convinced that a growth-capital partner is the right choice for help in working through transition periods. A growth-capital partner can support a company by leveraging the team’s experience, providing a growth-centric perspective, and enhancing creativity.
In today’s business environment – where disruption is the new normal – chemicals companies can use the additional help in navigating through these business challenges and achieve the goal of creating new opportunities.
You can listen to Flemming Bjoernslev talk about Navigating Disruptive Innovations in the Chemical Industry at SOCMA Week this December.
Join the Industry Trends Track on Thursday 5th December at 1:10 pm to hear more!