The Next Wave of Innovation
in the Chemicals Industry
Discoveries
in materials science could lead to a new era of growth. Who is best positioned
to benefit — incumbent companies or upstarts?
The
world is potentially on the brink of an age of new powerful materials, ushered
in by innovation in the chemicals industry. But to be central players in this
story, today’s incumbent chemicals companies will need some vital
prerequisites: restructuring of their product portfolios, successful
exploitation of digital technologies, and rewriting business models to generate
higher returns on their investment in innovation.
To
understand the dilemma facing the chemicals industry today, you have to
understand its past. Its history since World War II can be divided into two
broad eras. The first period (from the 1950s through the 1970s) was a time of
constant innovation. Dozens of new chemicals and compounds were discovered and
commercialized. Most of these were plastics and polymers, many derived from
hydrocarbons, particularly petroleum. The high value of these innovations
allowed the chemicals sector to play a pivotal role in global economic
activity.
After
1980, though, the pipeline of new products largely dried up. During the next 30
years, until 2010, chemicals companies focused on growth through global
expansion. It started with demand-led growth in Korea and Taiwan and then
China, followed by new markets in the petroleum-rich (and thus
feedstock-advantaged) Middle East. As these regions undertook ambitious new
projects, many Western chemicals companies moved production into these regions.
They discovered that the returns on investment in emerging markets were higher
than the returns on R&D spending. Moreover, in these global high-growth regions,
new materials were not a priority for customers. Instead, to succeed in this
landscape, chemicals companies needed a competitive cost structure and a plan
for growing market share against local players selling “good enough” products
(products with 80 percent of the functionality at 50 percent of the price).
Innovation was not a primary concern.
But
then, on the heels of the financial crisis of 2008, globalization stalled. As
their products turned into commodities, chemicals companies expanded through
acquisition. As a result, many legacy chemicals businesses are large and
cumbersome. Their R&D funds are spread too thin for them to compete against
more entrepreneurial outfits on long-term research projects with uncertain
outcomes. They rely on revenues from best-selling chemicals that are decades
old. Polyvinyl chloride (PVC) was invented in 1913, polyethylene in 1936, and
polypropylene in 1954. Even specialty chemicals that are highly profitable when
first introduced — including many additives, pigments, and polycarbonates — can
easily become commodities, with producers competing largely on price.
Meanwhile,
innovation in the materials world has taken on a new life — largely outside the
established chemicals industry. For example, the nanoscale revolution — the
remarkable discoveries of two-dimensional, single atom materials such as
graphene from carbon or silicene from silicon — has resulted in new materials
that are lighter, stronger, more malleable, and more temperature-resistant than
any chemical products in history. But despite their potential applications in
technology, healthcare, consumer goods, manufacturing, and the environment,
their immediate profit potential is still unknown. A few startups and academic
research centers are conducting most of the R&D on these new materials —
and gaining most of the initial revenues from them. They are, in effect,
drawing the contours of a new chemicals industry. The incumbent large chemicals
companies, with their R&D centers in a state of neglect, are barely involved.
If
the incumbents remain on the sidelines, the industry could cede the “high
ground” to the upstarts. There is still time for the stalwarts to make up for
their lethargy and profit from nanomaterials and other notable breakthroughs.
In fact, if you look closely, some of the recent strategic steps taken by
chemicals companies hint that the sector may be moving in this direction — and
perhaps poised to recover the mojo it once had with plastics.
Three
new developments could help the chemicals industry lead a new age of materials
innovation.
The quest for portfolio coherence.
Activist investors have been
particularly vocal in the chemicals industry during the past decade, a trend
that’s likely to continue. They see value that is trapped in incoherent and overly
ambitious portfolios, and believe that breaking these companies up will allow
the new entities that emerge to offer more focused value propositions. This
idea is already having an impact. Recently, we have witnessed “big bang”
restructuring deals in various chemicals sectors, including crop protection,
industrial gases, and coatings. When this quest for portfolio coherence is
complete, the chemicals industry will be populated by more targeted companies,
each of which can more fully dedicate its resources to enhancing its individual
market narrative. As innovation resumes, these newly structured chemicals
companies can better harvest organic growth opportunities, rather than
continuing to rely on M&A.
The emergence of digital technologies.
Some chemicals companies are adopting
digital technologies that will allow them to become true materials and
solutions providers to their customers. For example, they are installing
sensors at customer sites to track how their products perform in their
customers’ (and sometimes even the customers’ customers’) operations. The
sensors will allow the chemicals providers to continually improve their
products and will give them a direct relationship with their customers’ end
businesses. Their products will now be embedded in the innovation and
operations functions at automobile, aerospace, technology, hardware, consumer
goods, and healthcare equipment companies, to name a few, where they will
gather data that leads to insights, culminating in stickier relationships and more
sales to each customer.
Business model innovation.
Endorsing portfolio coherence and
digitization doesn’t by itself make a company more innovative. It must
simultaneously align these activities with an innovative business model that
generates healthy, self-sustaining returns from R&D investments. In some
cases, wholly new approaches will have to be adopted, such as outcomes-based
pricing and sharing the risk with customers in implementing new materials and
products. Steps like these can forestall product commoditization while ensuring
high margins.
The
plastics revolution was so world-changing that it sustained the chemicals
companies for decades. With the advent of new materials and their extraordinary
possibilities, chemicals companies face another transformative moment. They
must choose what to be in the new materials age: witnesses or leaders.
by Vijay
Sarathy, Jayant Gotpagar, and Marcus
Morawietz
Published: June
5, 2017
https://www.strategy-business.com/article/The-Next-Wave-of-Innovation-in-the-Chemicals-Industry?gko=e6289&utm_source=itw&utm_medium=20170608&utm_campaign=resp
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