The chemical industry needs innovation and access to low-cost feedstock in order to sustain growth and profitability. Over recent years, chemical companies have turned their attention to biotechnology as a potential remedy. In contrast to earlier attempts to use biotechnology broadly for industrial production, the odds that it will deliver on its promise this time are high - the underlying technologies have become tremendously powerful and the need for action is more urgent than ever.

Indeed, the combination of bio-based feedstock, bio-processes and new products offers the potential to revolutionize chemical industry structures. In less than 10 years, integrated biorefineries will play a role comparable to today’s oil and gas crackers. They will make use of row crops, energy crops and agricultural waste as inputs to extract oil and starch for food, protein for feed, lignin for combustion, cellulose for conversion into fermentable sugars, as well as other by-products. Sugar will be the key feedstock of the future, as it can be used to ferment ethanol for transportation fuel, but also for a whole set of new, basic building blocks. Molecules such as lactic acids, succinic acid, propylene glycol or 3-hydroxy propionic acid produced at 20 cents per pound can catalyze the innovation of new chemical product families, similar to the innovation boost based on the cracker chemicals in the middle of the 20th century.

The growing importance of industrial biotechnology can already be seen today in three areas as outlined below.

1.	Fossil oil and natural gas are being replaced by carbohydrates from renewable resources as low-cost, renewable feedstock. In particular, the development of technology to convert cellulosic biomass from agricultural waste or energy crops into fermentable sugars offers the perspective of producing ethanol and other bulk organic chemicals at low cost. The cost of biomass-based ethanol produced on a commercial scale, for example, is expected to undercut the cost of gasoline with oil at $30 per barrel. A first semi-commercial ethanol plant using straw is being operated by Iogen and Shell in Canada. More companies have started their own endeavors in this field, including DuPont, John Deere, Genencor, Novozymes, and Abengoa.
2.	Fermentation and biocatalysis are increasing in importance. Already five percent of all chemical product sales use these modern production technologies today, and more products will soon switch from chemical synthesis to biotech. Chemical companies such as DSM, BASF, Degussa and Dow are investing in new bio-routes for vitamins, amino acids, pharmaceutical intermediates, anti-infectives and bulk organic chemicals such as acetic acid or ethylene glycol.
3.	Entirely new bio-based products are competing against conventional products on the basis of a superior cost/performance ratio, or are even fulfilling unmet market needs. Enzymes, for example, are fast-growing bio-products that make washing powder more effective, allow softer processing of textiles and pulp and paper, and reduce nitrogen emissions from animal farming. Other examples are biopolymers. Cargill Dow’s PLA (polylactide) offers a green alternative to PLA at similar cost and performance - two large-scale plants for further new bio-polymers are under construction - DuPont’s Sorona and Metabolix’s PHAs (polyhydroxyalkanoate).

Overcoming Challenges
On the basis of this outlook, chemical companies have invested several billion dollars over the past years to explore the opportunities. However, it turns out that the path from promise to profit for companies engaged in biotech is a long and arduous one (Figure 1, above). Major projects have been terminated after years of funding and several technology companies have gone bankrupt. On the other hand, some good business ideas are only pursued half-heartedly.

The challenges faced by companies, and the questions that they must answer if they are to capture the potential of industrial biotechnology vary according to the stage of biotech development and the business model they use. The three cases described below show different ways in which companies can capture value from industrial biotech, depending on where they stand with respect to these dimensions.

Case 1: Building a biotech strategy: After years of internal discussions and smaller investments that showed promising results, the board of a global chemical company decided to take a major step in industrial biotech. There were many potential entry points and business opportunities, some of which had internal champions and others that did not appear worth pursuing. However, none had a clear rationale, and there was no clear direction. The company approached the challenge from two sides (Figure 2, below). It determined its distinctive skills and assets through a benchmarking process. At the same time, it assessed the relevant opportunities and threats - both competitors’ recent or announced moves, but also the potential for competitors if the company chose not to enter a specific area. It was essential to think long-term and broadly, to address the needs of the industry and consider its structure 10 years hence.

This produced a list of strategic options: a combination of areas that appeared most attractive for the client to enter and different business models and value chain positions that would match these areas. The next step was to assess these different strategic options against a set of criteria that included economic value, feasibility, risk, investments, fit with overall strategy and portfolio of initiatives. To ascertain the economic viability of individual products, specific businesses were pressure tested. The final decision was made after extensive discussions and more than 80 expert interviews, covering leading academics, government agencies, CEOs of technology companies, product developers and purchasers from downstream value chain participants, executives from retail companies and even competitors. While these interviews are essential, it is also important to remain skeptical and to avoid the ‘common wisdom’ trap. It is too early to determine the financial success, but the company has already achieved alignment between the overall strategy, the level of investment and the organizational set-up. It is now ready to focus its full attention on advancing in the right strategic direction, rather than conducting endless internal debates.

Case 2: Identifying the right opportunities: Another chemical company already had a clear biotech strategy in place and had built the capabilities, assets and networks required to implement it. Execution was already successfully under way in several business units, and new bio-based products and processes had started to generate healthy profits. However, the company was wondering how best to apply biotechnology to a recently acquired business. In particular, it was seeking ways to change the old chemical production processes to new, more competitive synthesis routes (Figure. 3, above).

The project scope expanded into a complete review of the company’s core product strategies, which included a detailed assessment of competitor’s cost positions, anticipated moves and market trends. This was important because a new biotech process can easily take five years or more to develop, so it is critical to understand whether it will result in a distinctive cost position after that time. Since China was an emerging threat, a team in Shanghai focused on collecting Chinese competitor intelligence data for several months. Regulations and customer sensitivities also change - would there be a ‘bio-based’ premium or a ‘genetically modified’ discount for a product produced by fermentation?

The scope was also extended on the technology side. While one team investigated the potential for new biotech routes, a competing team tried to optimize the existing process, including analyzing different locations, and a third team searched for the best alternative chemical routes. In the end, biotech was just one of the solutions. Each potential solution was assessed, and the one was chosen with the best risk/reward ratio.

Of the 15 products under investigation, biotech was the best solution for four of them; in three cases a new chemical processes was found; two products were moved to China; two were stopped completely and will be bought instead from a low-cost producer, and the others will benefit from incremental improvements to the existing process and assets. So even though the impetus for the project was to see how biotech might have an impact on the company’s processes, the outcome was an improvement of every process in a variety of ways. By 2010 it is predicted that costs will have fallen by an average of 60 percent for these 15 processes.

Case 3: Preparing the launch and market development: This company was on the final step of the staircase towards profitability in industrial biotech. It had a strategy, a highly capable organization, an innovative product, and a new production facility. Its problem was that the potential market applications for its new bio-product were so numerous that it was impossible to pursue them all simultaneously with its limited resources. It was also becoming clear that the product was not equally suited to all applications and that each market required a different product positioning. The company was looking for a go-to-market strategy for its new blockbuster-to-be (Figure 4, below).

The full list of potential applications and addressable market segments were assessed against (a) the relative strength of the new product’s value proposition to the customer in terms of price and performance compared to existing offerings; (b) the size and attractiveness of the addressable market; and (c) the ease of capturing the value, i.e., the time and effort it would take to develop the product applications and markets and the hurdles for adoption of the product along the value chain. The last point required a lot of attention because consumers had already expressed considerable interest in some of the applications and the economics looked attractive. However, interviews with companies along the value chain and supporting analyses showed that the investment of intermediaries in the value chain made adoption very unlikely. In other market segments, retailers were concerned about the brand risk and were not willing to proceed without a further demonstration of fitness-for-use and safety. These segments were therefore put on the back burner, but will be reignited once results from other segments support this market case.

In the end, a handful of segments were chosen as top-priority targets for immediate focus and specific targets, marketing strategies and implementation plans were put in place. In some other market segments and geographies partnering was the preferred strategy, mostly because partners had better customer access or application technologies than the company. The company has changed its strategy and its underlying assumptions fundamentally in the course of the project. For example, it has learned that consumers are not willing to pay a premium for its green product. It also learned that it needs to price the product on the basis of long-term positioning rather than current cost, that it needs to build another plant in a low-cost environment, that it needs to provide value chain intermediaries with an incentive to adopt its product, and that it is sometimes necessary to work with smaller ‘attackers’ as initial commercialization partners to demonstrate proof of principle, create market pull and get the ‘big fish’ to adopt a new product. On a more tangible level, the increased focus, clear product positioning and partnering has already resulted in a number of major market introductions over the past year.

Finding the Right Answer
Finding the answer to the problems companies face in biotechnology is not a miracle, nor is it a trivial matter. Often, the answer flies in the face not only of the core beliefs of the companies concerned, but also of the received wisdom of the experts. Due to the novelty of biotechnology and the uncertainties involved, classical project approaches that rely on fact-based analyses alone are just as inadequate as management decisions based on gut feelings. The best results are achieved when visionary thinking is combined with critical, fact-based assessment, business judgement with sophisticated analyses such as Monte Carlo simulations, internal expertise with challenging external views. A dedicated effort with senior management attention can be a catalyst in getting to the right answer in a timely manner - too many companies stay engaged in the same debates for years, and waste valuable resources and productive time. This is a time of change and opportunities - companies that ‘wait and see’ run the risk of missing out, while overly enthusiastic pioneers may end up sinking big sums into the wrong investments. A deliberate approach that considers all aspects of the available potential is needed to find the best way for each company to turn the promise of industrial biotechnology into profits.

Jens Riese is an associate principal with McKinsey’s Frankfurt office. Rolf Bachmann is a partner in McKinsey’s Zürich office.