Commoditization in chemicals: Time for a marketing and sales response
Most chemical companies are grappling with increasing
commoditization. Rethinking the commercial operating model can help protect
margins.
Chemical companies are facing a progressively
harsher environment as growing segments of the industry are becoming
increasingly commoditized. Companies have tried hard to reduce operating costs
to help offset this trend, but they have paid less attention to marketing and
sales, where expenses have continued to rise. Many companies’ commercial
operating models are ripe for a rethinking that could help maintain or improve
margins. However, this is not a matter that the marketing-and-sales department
can fix. It is a strategic issue where company leadership needs to intervene,
but taking steps in this direction is proving difficult for many enterprises.
Drawing on our experience in the industry, we offer this article as a thought
starter to help chemical company leaders get moving.
A changing market landscape
Increasingly harsh conditions have
encroached on much of the global chemical industry over the past two decades.
Certainly, the sector has performed well in capital markets since 2000, and a
portion of the industry has enjoyed high profits based on advantaged gas feedstock. For the
majority of players, however, product ranges have become more comprehensively
commoditized, squeezing margins
Companies have mobilized to offset
this trend, cutting costs by improving operational performance. But sales and
marketing has been largely untouched, and our research shows commercial costs
have instead increased.
An analysis of 50 leading global
chemical companies found that over the 2004–14 period, the average sales,
general, and administrative (SG&A) cost as a percent of revenues rose from
13.4 percent to 14.4 percent, a 10 percentage-point increase. We observed a
similar pattern in the evolution of SG&A relative to gross profit.
What has been happening? It appears
that while their colleagues have been taking a lean approach to operations, the
commercial departments have pushed on with traditional marketing and sales
approaches and even added to their expenses. The commoditization trend and new
opportunities afforded by digital technologies make this a good time for
chemical companies to take the offensive and rethink their marketing and sales
operating models.
Let’s review why there is more
commoditization. Production technology for chemicals has become more broadly
available, and there has been a rapid buildup of capacity, particularly in
emerging markets. Hand in hand has come a different type of engagement with
customers from that of a traditional chemical producer which would have
originally developed a chemical to meet its customer’s need: instead, products
are simply sold on price.
The number of chemical producers
has also increased, despite consolidation in more mature Western markets.
Proliferation of producers has tended to encourage capacity additions that have
got ahead of market growth, depressing prices and margins. A good example is
provided by the evolution of polyethylene terephthalate (PET), which evolved
from a specialty chemical to a commodity in less than 15 years.
Similar dynamics are evident in
other products that have historically shown consistent profitability, including
epoxy resins, polycarbonate, purified terephthalic acid (PTA), methylene
diphenyl diisocyanate (MDI), toluene diisocyanate (TDI), and titanium dioxide,
as well as numerous specialty chemicals .
In addition, purchasing departments of customers worldwide have not idly stood by and have become
much more professional in their approach. They have succeeded at pushing for a
commoditization of products to help them secure lower prices. Importantly,
there is little sign of these trends abating.
Still using yesterday’s model
To understand the state of play of
marketing and sales, let’s take a look back. Based on their high-margin model
of 20 or more years ago, the starting point for many chemical companies has been
to make custom grades to lure customers and keep them. This was a logical
commercial approach when comfortable margins could support it—even if the
quantities were uneconomical and these special grades then complicated
inventory management for the producer. Related to this, companies would offer
free service support and generous commercial conditions such as free
transportation or expedited shipping at no extra charge. But many chemical
companies no longer have the margins to pay for this level of service. In the
area of service support, the reality is that many users have become familiar
with the products they use and have little need for service support.
Still, many chemical companies have
some psychological hurdles to overcome before they can change course. With
their long traditions of innovation and technological sophistication, many
companies find it hard to accept that their product lines are becoming
commodities: we have observed that using the word is a taboo in some places,
and this state of denial makes it hard to take appropriate action.
Second, the commoditization trend
that most chemical companies confront has usually occurred gradually. The
process of commoditization is slow and steady, and while sellers can continue
to hope for a return to the good times, the commoditization trend is
unremitting, even in traditional specialty segments like pigments. Minor annual
cost cutting and tinkering with the commercial structure is ineffective:
staying ahead of the curve demands a new way of thinking.
Rethinking commercial models to match market realities
The new market reality requires an
overhaul of models for marketing and sales. Companies that are able to align
their commercial business models with the market environment can capture a
substantial payback. We have observed that the right commercial operating model
can yield a 2 to 8 percent earnings before interest, taxes, depreciation, and
amortization (EBITDA) improvement through a combination of commercial levers
and related reduction of complexity and costs on the supply side in
manufacturing, supply chain, and procurement.
Here are four commercial structures
that we find match the requirements of most chemical companies’ situations: the
“heritage” approach, which can still create value when deployed appropriately,
and three alternative structures.
Traditional offering
Where margins remain substantial
and new application development with customers presents clear value-creation
potential, a “high touch” commercial model is still going to be a strength.
This approach works well where customers believe the product offers unique,
high-value properties and understand that the producer continues to provide
technical support and product-development support based on the margins these
prices generate. Where many companies go wrong, however, is in failing to limit
this commercial model to customers that pay the premium prices that can support
it—and they could gain from instead embracing one of the following three
alternative approaches.
A low-cost backbone with gradated overlays of service
that differentiate by customer segment
Clearly, much of the industry’s
portfolio has moved well beyond this point, to where products are in the
semicommodity category—in other words, where they have some commodity characteristics.
The most important indications of potential commoditization are a wide range of
producers, particularly ones from low-cost countries; decreasing technology
barriers to switching suppliers (such as dependence on suppliers for technical
support); and increasing transparency about pricing.
Under this structure, companies
build a commercial model that that has a low-cost backbone providing essential
services and then have the possibility of adding service elements that can be
provided to customer segments that pay higher prices. Customers are segmented
depending on their value to the supplier. The minimum offering provides
standardized service, automated as much as possible to reduce costs. Sales are
made only with standard delivery times and payment terms, minimum order sizes,
and no product customization. This type of service is then differentiated for
higher-value customers—for example, by offering on-demand personal technical
support, product and batch customization, and key-account relationship management
by the chemical supplier. Big data and advanced analytics will increasingly
help to better understand what services customers really need and are willing
to pay for.
Creating a low-touch, low-cost channel
For businesses where customers are
no longer willing to pay for service, a different model is required. Faced with
this type of challenge, a number of companies have innovated. One successful attempt has been Dow Corning’s Xiameter, launched in 2002 as an
Internet-enabled low-cost sales channel that completely unbundled customer
service from the commercial process.
Customers are purchasing online,
sticking to a limited number of grades, and in fixed volumes. The channel
design is optimized for low cost, using digital technologies to enforce the
required business rules.
We expect that this model will
experience rapid adoption as digitally enabled, low-touch, low-cost channels
increasingly provide a level of customer experience similar to traditional,
high-cost models. Some producers are already moving to a “no touch” approach
for a substantial portion of their sales, where ordering and warehouses are
automated to the point that some sales require no human intervention.
Setting up a separate commodity business line or unit
When formerly specialty businesses
face such intense competitive pressure that having the lowest-possible cost
model becomes essential for survival, a completely different commercial model
may become necessary. The model is built around a separate commodity-focused
business unit. Setting up a separate business unit may be necessary because
many chemical companies have trouble managing a no-frills approach alongside
higher-touch approaches: most companies find that the higher-touch approaches
bleed into the no-frills model, undermining its cost competitiveness. The
separate unit should be established with a stand-alone organizational
structure, often with a different set of production assets aligned with the
low-cost model. Experience shows that through establishing separate business
units, return-on-sales margin improvements of 5 to 10 percent are possible,
combining productivity gains from the commercial area as well as from
innovation and operations functions.
Commoditization, followed by lower
margins, is set to continue. Companies that have hesitated to move should now
start to take appropriate steps, including making use of new digital
capabilities that enable the delivery of tailored customer experiences with an
improved cost profile. The rewards for making these kinds of bold moves can be
substantial: as noted, adopting the right commercial operating model and
related cost and complexity reductions on the supply side can yield a 2 to 8
percent EBITDA improvement. What we have set out above does not pretend to be
an exhaustive look at this important topic, but, instead, intends to help get
chemical-company leaders started on identifying the right path in their
marketing-and-sales strategy.
By Jochen Böringer and Theo Jan Simons
http://www.mckinsey.com/industries/chemicals/our-insights/commoditization-in-chemicals-time-for-a-marketing-and-sales-response?cid=other-alt-mip-mck-oth-1612
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