Cracking the growth code in chemicals

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Achieving consistent revenue growth has become more difficult than ever for specialty and diversified chemical companies. Over the past ten years, only 15 percent of the world’s top 151 specialty and diversified chemical manufacturers grew above the average global GDP growth rate while maintaining a ROIC above the industry weighted average cost of capital (WACC), McKinsey research has found.

In general, the chemicals sector has outperformed the broader market since 2000, in large part because of increased demand from emerging markets, such as China. More recently, though, that growth has not necessarily translated into higher ROIC for most companies.

Our research on data sourced from S&P Capital IQ explored why some chemical companies outperformed competitors to become what we call “growth champions”: companies with revenue growth exceeding the annual average global GDP growth of 3 percent and ROIC exceeding the average industry WACC of about 7.5 percent. We found that a subset of growth champions we call “organic growth champions”—those demonstrating continuous organic growth from 2015 to 2019—did so by winning market share from competitors rather than by relying on market growth or mergers and acquisitions.

However, the COVID-19 pandemic has created a significant set of challenges that makes organic growth more difficult. Supply chains across the world are broken; the chemicals industry was hit particularly hard because of the global nature of its supply chains. In addition, lockdowns as a result of the pandemic created an acute shortage of raw materials and labor, challenging the production capabilities of many companies. So how should specialty and diversified chemical companies respond in the short to medium term?

Recipes for market-beating profitable growth differ for individual companies, but we believe that, in general, three actions will move the needle:

  • Meet the customers where they are with an omni­­channel approach, and develop bespoke solutions (at scale) for today’s customer journeys.
  • Move from intuition and experience-based decision making to analytics-driven commercial management, especially in pricing and mix management.
  • Tailor contracting strategy to current supply- and production-constrained contexts while selectively negotiating long-term contracts where possible.

In this article, we will look more closely at the chemicals sector’s growth performance and review what companies can do to consistently achieve market-beating profitable growth. Future winners will act now to put their growth strategy in place.

Future winners will act now to put their growth strategy in place.

Becoming a growth champion

Only 16 percent of chemical companies—the growth champions—managed to grow above global GDP growth rates while at the same time delivering a ROIC higher than the chemicals industry’s WACC (Exhibit 1). They produced a 23 percent total return to shareholders from 2010 to 2019. While 23 percent of companies managed to grow at a ROIC that exceeded the WACC, their growth remained below the GDP growth rate. About 17 percent of com­panies grew above the GDP growth rate and had a ROIC below the WACC, while 49 percent of companies neither grew above the GDP rate nor produced returns above the WACC.

Achieving consistent growth has been a challenge for most chemical companies.

Growth champions have also generated significantly higher valuations than other companies. Between 2010 and 2019, the revenue and EBITDA multiples for these companies was 1.5 to 3.0 times higher than the others, suggesting that investors have rewarded them for strong performance.

Our research found a significant decrease in growth coming from market momentum—that is, overall market growth in the sector—between the period from 1997 to 2007 and the period from 2007 to 2018 (Exhibit 2). Market outperformance, or gaining market share, rose in importance as a growth driver.

Decomposition of growth for the chemicals industry has shifted over time, mirroring market dynamics.

For organic growth champions specifically, market outperformance has become a key to their success (Exhibit 3).

Historically, the chemicals industry has relied on market momentum and M&A for growth.

After addressing revenue growth, the natural next question is: how do these companies fare in terms of profitability? The specialty and diversified chemicals sector display a wide range of EBITDA margins, from less than zero to as high as about 60 percent. Growth champions across segments create interesting opportunities for accretive value creation. A winning play is possible even in less obvious segments such as construction chemicals (Exhibit 4), and growth champions across segments pursue multiple opportunities to create dispropor­tionate bottom-line value.

Growth is possible in all specialty chemicals segments.

How should chemical companies think about taking market share profitably? Three actions stand out.

Apply omnichannel at scale

Our research shows that faster-growing chemical companies have used the power of digitalization to serve their customers much more effectively than their slower-growing counterparts. Their share of both digital customer interactions and revenue from digital channels is larger.

The pandemic accelerated the move toward digital and innovative business models for many industries. Omnichannel models have become a must-have for conventional B2B players. In the past year alone, several new online marketplaces (or digital platforms) have emerged and are creating oppor­tunities for players to reach millions of new customers.

Even legacy players and industry incumbents have seen the power of omnichannel and have jumped on the digital bandwagon. For example, a leading fertilizer and agricultural inputs company facing competitive threats created its own direct-to-consumer digital channel. In 12 months, the company attracted more than 60 percent of its customers to the platform. And in 18 months, the platform generated more than $1 billion in sales, accounting for 10 percent of its revenue. Also, the digital channel reduced customer churn to a third of its former rate and increased the customer’s share of wallet by about 25 percent.

Institute analytics-based commercial management

Fast-growing B2B companies have kept up with changing customer expectations, especially through the pandemic, and have built the capabilities to use customer data and create actionable insights to serve them better.

The application of advanced analytics has added value across the sales life cycle, from customer acqui­si­tion to cross-selling, upselling, dynamic pricing, and prevention of customer churn. Companies are going beyond table stakes analytics use cases such as sales planning, account management, and pricing to newer areas such as gathering account-level intelligence on opportunities and threats, identifying opportunities for specific customers, and gaining deal-level insights. Our research indicates that on average, growth champions have benefited from at least a 20 percent productivity increase as a result of employing analytics-led commercial management.

Evaluate terms in current contracts

While COVID-19 has affected almost every industry, the impact on the chemicals industry has been especially severe due to its reliance on global supply chains, the raw-materials shortage, and labor constraints. In this difficult environment, companies initially doubled down on shorter-term sources of value capture. In the first few months of the pandemic, many companies pursued cost optimization projects and drove them to yield good results. However, inflationary pressures are now predominant, and pricing levers are critical. Leading organizations are being proactive in this market environment to reevaluate their contracting strategies. Powerful actions include confirming longer contracts with higher-margin customers, applying clauses in existing contracts that have gone unused (for example, minimum order quantities and service fees), and implementing new and more aggressive clauses to protect pricing flexibility in the face of variable market conditions.

While the chemicals sector has been—and will continue to be—attractive compared to other industries, it will take a sophisticated commercial approach to outpace competitors. As market momentum slows, companies should begin to pay attention to areas they may have neglected in the past. Going omnichannel, investing in a digital-and-analytics capability across the commercial spectrum, and reevaluating commercial constructs will be key.

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