Managing Director & Senior Partner
Related Expertise: Building Materials
The chemical industry was once a top value creator, generating a five-year total shareholder return (TSR) above that of every other industry in BCG’s annual Value Creators ranking. Today, the industry is one of the more challenged. Its median TSR from 2011 through 2015 was 9.5%, considerably below the 12% median of the 28 industries we tracked. (See Exhibit 1.)
Yet some chemical companies have been able to adapt, developing differentiated business models and generating excellent returns. Indeed, we find an enormous disparity between the best and the worst performers of the 189 chemical companies in our global sample: a spread of 94 percentage points, larger than the spread in any other industry in our study. This disparity indicates that the chemical industry has become a territory of extremes.
We believe that these extremes reflect a fundamental industry trait: chemical companies have multiple distinct options in their choice of business model—each with its own outlook for growth and profitability. This is true not only for the industry as a whole but also for subsectors and individual clusters. In fact, the choice of business model may determine the performance of a company more than any other top-management decision.
Several trends have also affected the performance of chemical companies around the world in the past five years. These trends have shifted value creation among regions and from commodity-driven business models to specialty-chemical-based business models. Among the trends we have observed, the biggest impact has come from the shale gas revolution, the cooldown of Chinese GDP growth, overcapacity in China, rising GDP growth in South and Southeast Asia, and a move toward higher-end chemical products in China.
The difference in TSR performance among regions was not as great from 2011 through 2015 as it was during the previous five-year period, yet we still observe striking regional—and subregional—variation. A primary reason is that chemical companies typically have a strong position as suppliers to local industries—such as automotive in Germany, electronics in Japan and South Korea, and cosmetics in France. Despite the chemical industry’s global footprint, therefore, many companies are heavily affected by their local economies and the types of industries that flourish in them.
Separately, exposure to the emerging markets and Greater China (which in our analysis includes People’s Republic of China, Hong Kong, and Taiwan) has also had a tremendous impact. Of the 99 companies not headquartered in the emerging markets and Greater China that reported their revenue share by region, the ten with the lowest share in emerging markets attained a healthy average TSR of 20%. In contrast, the ten companies with the highest revenue share in emerging markets realized a TSR of only 5.3%, well below the 10.6% average for this group.
We find that companies that earn a high proportion of revenue in emerging markets have been challenged by three factors affecting value creation: advantaged local competitors, the difficulty of establishing a high-performance commercial organization in many emerging markets, and the price sensitivity that is common among customers in these markets. Only companies willing to reconsider the emerging-markets business model and develop locally competitive offerings have an opportunity to succeed—and gain positive returns on the enormous investments they have made.
To better understand the multifaceted landscape of the chemicals industry, we have divided it into five subsectors and about 150 segments within those subsectors. For our 2016 analysis, we have grouped these segments into 18 clusters. While some companies are active in multiple clusters, we have allocated, as far as possible, each of the 189 companies in our sample to the cluster in which it generates the majority of its revenue. We have also created a “diversified” cluster within the multispecialty subsector in recognition of the fragmentation of some companies’ portfolios, especially in that subsector.
In this year’s report, we examined the following chemical subsectors and clusters (see Exhibit 2):
Even though the industry’s overall five-year TSR is below that of previous periods and ranks relatively low among the industries we tracked, some chemical companies are flourishing. In fact, when only the ten companies with the highest TSR in each subsector are considered, it becomes clear that the chemical industry has had some of the best five-year returns. The median TSR for the top-ten chemical companies was 40%, which would place this group sixth among the 28 industries we studied.
These top performers are headquartered in multiple regions. Perhaps not surprising, seven are focused-specialty chemical companies, while two are from the agrochemical subsector and one is a base chemical company. Although not all in this group have made similar business model choices, we see four recurring themes among them.
For large and diversified chemical companies, it may be more challenging to identify the kind of opportunities that have enabled the top performers to excel. Yet these four themes—strong, always-on M&A; the ability to build entry barriers based on complexity; distinct and differentiating customer-centric business models; and anticyclical tactics—should form the foundation of any business unit strategy discussion in diversified chemical companies.
On the basis of our observation of the industry over the past year, we suggest that all chemical companies—across chemistries, subsectors, and even clusters—are applying one of four basic business models, each of which has yielded very different results. (See Exhibit 3.)
The market-based business model offers lessons about superior value creation to the management teams of almost every chemical business. These lessons include the need to support—and even favor—smaller-volume, high-margin products as well as customized technology solutions, investments in small but flexible assets, rapid customer delivery, and the buildup of in-house sales organizations in midsize countries such as Indonesia and Colombia, not just in the largest markets, where every company has a presence. Each of these elements can create market-based advantages for any player.
For today’s companies, taking advantage of these lessons as well as those learned from our top TSR performers will often mean introducing new value-added offerings—offerings that come less from the identification of new molecules and more from the refinement or combination of existing ones. To do so successfully, they will need to continually rethink their position in the chemicals value chain and the focus of their R&D activities. Two possible challenges to this kind of refocusing include the following:
What lessons from our findings can help chemical companies shape their portfolios and business models? While boards and executives in the industry have accelerated the speed of divestitures and acquisitions in recent years, our data indicates that these actions have not automatically delivered the hoped-for results.
From our perspective, the best response is a continual rethinking and adjusting of the business model by the management team. One could believe that corporate transformation is a singular, massive event, or that transformation is primarily about changing the composition of the portfolio, but in our view both are incorrect.
In our view, the true differentiator is—and will be even more so in the future—the ability to have an always-on transformation mindset. Digitalization, emerging players, and feedstock price volatility are just a few of the reasons why chemical companies today need to reevaluate, reenergize, and continually adjust the boundaries of their activities, of their functional layers, and of their operating model.
We suggest two guiding practices to shape the transformation of chemical companies:
In the next few years, chemical executives will need to confront major global challenges—political, economic, and ecological—along with a secular slowdown in growth. Opportunities and risks will emerge from unexpected short-term volatility more often than from long-term trends. In addition, pressure from activist investors will increase in the new normal of low returns.
Shaping the portfolio will therefore be an enormous challenge, perhaps greater in chemicals than in any other industry. Balancing the key tradeoffs of resilience versus coherence and refraining from simplistic solutions will remain essential tasks for executives going forward. Creating value may come less from large-scale portfolio shifts than from granular and constant efforts to elevate functions and operations to a higher level of capability, along with a strong emphasis on the opportunities that digitalization offers to every function and operation.
Shifting the business to the most advantageous positions and deploying the full opportunities of customer-centric business models will require a readiness to challenge the approaches and rules of the past, and the ability to adjust more rapidly than the competition. These will be the primary differentiating traits of value creation champions in the years to come.