Identifying the challenges posed by production capabilities in low-cost economies
ICIS Chemical Business and PA Consulting recently asked clients and readers of the magazine to identify the challenges posed by the growth of production capabilities in low-cost economies.
The survey, conducted in March 2006, attracted responses from senior management at 91 major European chemicals producers.
The questions were as follows:
- Which countries/regions generate the greatest threat?
- What are the most important factors behind the emerging economy producers’ increasingly competitive advantage?
- What are the current and potential effects of the growth in emerging markets’ production capability?
- What actions does your business see as a priority to combat the threat from producers in emerging markets?
- How much of your current production do you have in emerging markets?
- How much presence in the supply chain does your business have in emerging markets?
In macro-economic terms, the survey confirmed the widely held view that producers from emerging low-cost economies have an increased competitive advantage in the global marketplace because of lower operating costs and a growing highly skilled and developed workforce.
When it came to identifying where the greatest threat came from, responses varied according to whether the organisation focused on commodities or specialities. In general terms, the greatest threat to Europe was seen to come from China, with 43% of respondents believing this, while India was perceived as the greatest threat in five years’ time (28%). South America was also seen as a leading threat in the longer term.
Commodities saw the Middle East as playing a more central role, because of access to cheap feedstock and the obvious impact of sky-high oil prices. Some even remarked that they saw the Middle East as a greater long-term threat than either India or China. The future will continue to see an ongoing move by petrochemicals to the Middle East and high consumption areas like China.
The survey points to the competitive ability of producers in low-cost economies being helped by lower regulatory and environmental compliance requirements. This, compounded by a rising highly skilled workforce, an increasing ability to produce ever more complex products and a growing customer base is a cause for further concern among European producers.
Additionally, 17% of respondents pointed to the movement of the existing customer base to the emerging markets as being a major cause of the growth in local production capability, with these markets looking for local suppliers. The high costs of logistics would put European producers at a disadvantage when competing with local producers in these markets.
Countering the threat
What do chemicals manufacturers in western Europe appear to be doing to combat these effects? In the case of speciality chemicals, the high entry barriers make it difficult for low-cost producers to compete in western Europe, reinforced by the geographical location of key dominant customers based in the US and the EU. On balance, however, it appears that many more European producers are anticipating a reduced production presence in their traditional markets, due to the pressures to reduce costs.
An interesting aspect of the responses was the feedback on the expansion of low-cost production facilities among European companies. For the past 10 to 15 years chemicals producers have looked east – towards China primarily. They are now also looking at South America and eastern Europe: 22% of those with an existing presence in low-cost economies indicated some presence in eastern Europe, 17% said the same for South America, and 26% indicated a presence in China. However, this holds less true for speciality chemicals that still need to position their assets close to their market and existing customer base.
Some organisations are divesting underperforming units or looking at lean manufacturing. Others are also trying to improve their supply chain by focusing on reducing cost rather than improving effectiveness. To gain maximum effectiveness from supply-chain improvements, it is clear from the survey that European producers will need to look at innovation, rather than simply stripping cost alone.
The largest proportion of respondents said that they were putting real focus and energy into product and process innovation. This is particularly true for specialities, although they are refocusing on innovation at a slower pace than before. One individual pointed to the reduced level of innovation, citing as evidence the declining number of patents when compared with a century ago. Many ‘new’ products are in fact variations of existing products rather than breakthrough innovation or market changers.
Bayer recently announced its partnership with Adidas for polymers used in World Cup footballs, demonstrating how ‘topical’ and successful use of innovation can have a positive impact on business. The survey suggests that cutting costs and managing innovation are familiar themes. However, organisations are faced with the challenge of managing both at the same time.
The future
A consistent concern expressed is the impact of the EU’s proposed Reach chemicals policy and whether it will or will not protect industry inside the Eurozone. Some are optimistic that the European market will see a resurgence when the low-cost economies develop and become ‘more Western’ in their regulations, employment conditions, and ultimately higher cost.
The greater ability of European producers to apply sophisticated sales and marketing approaches is seen as a way to differentiate among European producers, which manifests itself in their ability to anticipate and prepare for market change, staying ahead of the low-cost competition.
The current macro-economic conditions continue to point to an interesting time in the boardrooms of the European chemicals houses, including the cyclical activities of M&A and consolidation, until there are a few major players in the market. Such consolidation will continue to drive cost reductions, and is typically followed by a focus on growth and innovation.
The various sub-sectors are at different stages of evolution so their focus will vary. One market leader predicted that we will see more speciality companies moving to greater regional structures, and establishing a single-sourcing model, for example, a North American supply chain and a west European supply chain. This is already evident with the likes of Dow Chemical, which recently announced a new regional structure to effectively pursue regional growth opportunities.
Supplying emerging markets
The survey shows that ignoring the impact of the emerging economies continues to be something firms do at their peril. Every company should have developed a response for increased customer value differentiation, and many do. They appear to range from moving their production to a greater or lesser extent and to moving up the value chain (as has happened in other industries such as automotive).
In today’s competitive environment, European producers need to focus continuously on making business improvements, attracting and retaining the appropriate skills and talent. Increasingly, innovation is the key. As one respondent commented, ‘only innovators will survive’.
In the next five years, the European chemical industry must develop specialised innovative products that add value to the customer experience.
In addition, the supply chain must be improved considerably to feed these products into the emerging markets.
James Black, a member of PA’s management group, suggests: ‘Though leaders in the European chemical industry are clearly facing significant challenges, they have better opportunities than many other industries. They are balancing strategic options such as consolidation with the relentless pressure to take cost out of the business, whilst also seeking out new areas of growth. Two key focuses will ensure success – a clear view of the value-added angle of the company and an understanding of true cost to serve in your business. It will be interesting to see how the European chemicals industry continues to respond to the threat – and if it has the ongoing appetite for the fight.’
