Creating a strong future for South Korea’s chemicals companies

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For decades, South Korean chemicals companies had a strong footing globally. They performed well because of operational excellence, the advantages of strong regional demand, and conglomerate structure, which provided opportunities for growth.

But today, South Korean chemicals companies face significant challenges. Market entrants from the Middle East with favorable feedstock prices and economies of scale are eroding the cost advantages of the South Korean chemicals companies. Increased sophistication and operating expertise among competitors, along with waning regional demand, is also eating away at South Korean companies’ market advantages. For example, China’s long reliance on South Korean petrochemicals drastically declined as China expanded its domestic produc­tion capacity.

South Korean chemicals companies understand their advantages are fading. So far, however, they have been slow to respond.

South Korean chemicals companies understand their advantages are fading. So far, however, they have been slow to respond. In this article, we discuss ten steps that CEOs of South Korean chemicals companies can take to transform their performance, increase their global footprint, and refocus their efforts on high-growth segments.

The changing chemical industry

From 2001 to 2010, South Korean chemicals companies enjoyed an unprecedented boom, with total returns to shareholders (TRS) growing at 29.2 percent annually, which was 70 percent higher than the returns of their global peers in the commodity segments (Exhibit 1).

Specialized players have historically outperformed diversified players—and we expect this pattern to continue.

In the past decade, however, TRS performance has been lagging behind the rest of the industry. From 2011 to 2020, South Korean chemicals companies had annual TRS growth of 1.3 percent, whereas the commodities segment grew 4.2 percent during the same period. This underperformance came during a supercycle, with above-average return growth in the global petrochemicals industry.

The shifting dynamics of the marketplace are reflected in the poor economic profits of many South Korean chemicals companies. A McKinsey global power curve analysis—looking at the average economic profit of the past five years for companies in the global chemicals industry—found that only chemicals companies in the top quintile have a good chance of surviving the next ten to 15 years. Just four of 30 Korean chemicals companies are in the top quintile, and only 16 companies (53 percent) create value. And even top players will find the market challenging (see sidebar “The chemicals industry power curve”).

For many South Korean chemicals companies, the business model that once brought success no longer fits current market dynamics. Converging trends are likely to increase the pressure on profit margins and demand. A careful reassessment can help CEOs identify what still works—and what should be part of a new strategic approach.

Tailwinds of past successes will disappear

Historically, South Korean companies focused on low-cost production of commodity chemicals such as benzene, toluene, xylene, terephthalic acid, and polypropylene. They also exhibited operational excellence through continual investment in production facilities, modern manufacturing-process control systems, timely capacity additions, and a well-trained workforce.

Now, entrants with sophisticated operations and products are encroaching on South Korean companies’ profit margins (Exhibit 2). The country’s current ethylene production capacity of around ten million tons a year will face competition from an additional 30 million tons of capacity to be built in Asia, mainly in China and Southeast Asia, by 2030. This new capacity will come predominantly through integrated refinery-petrochemical complexes that will provide cost advantages compared with incremental cost reductions achieved by investing in traditional production facilities.

Feedstock advantage may shrink by $400 per ton as cost curve flattens.

Demand is waning

In the past, South Korea’s domestic chemicals market enjoyed reliable growth driven by demand from customers who preferred local suppliers. This demand contributed to growth in petrochemicals similar to GDP growth, and about 150 percent of GDP growth in specialty chemicals from 2000 to 2020. South Korean chemicals companies also set up manufacturing plants in China, where production was cheaper than at home; closer proximity to the Chinese chemicals market meant reliable growth. Indeed, 40 percent of major South Korean companies’ overseas branches and production facilities are in China.1 Most South Korean chemicals companies don’t have a global footprint beyond China.

But China is no longer a reliable source of demand for South Korean production, given the ramping up of domestic production. Also, competition in the region has grown, with the ASEAN-China Free Trade Area making it easier for China to increase imports from countries such as Malaysia, Singapore, and Thailand. As a result, South Korean companies need to find new export outlets even as potential target markets in Southeast Asia, such as Vietnam, are also building domestic capacities.

A strategy for the future

Based on our experience, we have outlined ten actions—in three categories—that every CEO in the South Korean chemicals industry should consider in responding to the changing global market. Companies can also look to chemicals leaders in other markets to see how they have successfully implemented these strategies.

Move toward performance transformation

In the past, South Korean chemicals companies were adept at embracing innovative technology and adapting to a changing market. To move forward, they will need to double down on technological innovation while making bold strategic moves that demand a longer-term CEO focus. Four actions are paramount:

Embrace end-to-end digitalization. The South Korean chemicals industry is a global leader in digitalization in manufacturing and the rollout of advanced process-control systems.2

Yet there is still room to improve. Few companies have gotten to the point of true end-to-end digitalization, and even the best among them have yet to fully integrate digital-and-analytics use cases piloted in different functions or business units.

Chemicals companies can move ahead on end-to-end digitalization by undertaking a triple transformation across the business involving selective use cases, technology solutions, and organizational change. Only by tackling all three elements can CEOs achieve sustainable and lasting results. In South Korea, we observe a technology-only focus, where, for example, the rollout of an enterprise-resource-planning system is considered “digitization.” However, without a focus on the right use cases and organizational transformation, there may be little to no tangible impact from this new system.

Chemicals companies in other geographies have faced similar challenges, and their experiences may offer some insight. For example, in 2018, Petkim, a Turkish petrochemicals company, embarked on an end-to-end digital transformation focused on impact and value generation. The company set up a digital-transformation team and a digital institute to increase employees’ knowledge and ensure that teams integrated digital ways of working, such as using advanced analytics to optimize the company’s production plan. By using advanced-analytics algorithms, the company increased its yields, through­put, energy efficiency, and product quality, resulting in a 20 percent increase in earnings before interest and taxes (EBIT).3

Ensure leadership continuity for a through-cycle perspective and long-term execution. The traditional executive promotion system in South Korea means that CEOs often must renew their contracts every year. The average tenure of a South Korean CEO is 51 months, shorter than those of global peers (62 months in Japan, 64 months in the United States, and 68 months in Germany). This approach hampers entrepreneurship and the ability to make long-term decisions, especially important in industries such as petrochemicals, where the industry acts in supply-and-demand cycles. Providing CEOs with longer tenure could reverse this problem.

Plan M&A with an eye toward consolidation. South Korea has more naphtha cracker plants than it needs to supply local market demand, although a certain amount of oversupply can be useful to smooth fluctuations and prevent interruptions in downstream operations. The oversupply, however, can lead to unprofitable production, so companies could consider sector consolidation of plants and supply-chain networks—both for their domestic and global business.

For example, the organic pigment sector experienced major consolidation over the past three years, culminating in the acquisition of BASF’s pigment business by DIC in 2019. Through consolidation, the new DIC pigment business is expected to have a strong market position, offer a broader product portfolio and geographic footprint, realize cost synergies, and increase efficiency in opera­tions and engineering.

Create different strategies for commodity and specialty chemicals. Diversified South Korean chemicals companies (those that include specialty and commodity) are the worst performers compared with their peers in Asia, with a negative 5 percent TRS (on a compound annual growth rate basis) from 2009 to 2019. To address the diversification issue, a company should rethink running a joint commodity and specialty chemicals business with the same leadership and retaining the same key performance indicators and decision structures. Instead, a company might consider sepa­rating the commodity and specialty portfolios into two companies or at least two business units.

It is critical to ensure operating models are adjusted accordingly. Commodity chemicals should run as a low-cost, high-turnover business given their small margins. In contrast, a specialty business requires higher expenditures on R&D and sales functions, but margins are higher.

Moreover, commodity chemicals companies can focus their portfolios on products where cost leader­ship is accessible and sustainable through feedstock advantages, operational excellence, and economies of scale. Specialty chemicals compa­nies could diversify their products to gain significant (more than 20 percent) market share in a niche market and aim to become innovation leaders. In short, success factors for commodity and specialty chemicals businesses are fundamentally different.

Tap into high-demand regions

The evolving chemicals industry leaves South Korean companies with little choice but to seek out a broader range of international customers. To do that, they will have to better understand those customers’ needs and be able to communicate with them in their own languages. Three steps are essential:

Get closer to overseas customers. In the future, chemicals businesses must become more focused on certain customer or product segments rather than just on a strong operations orientation, as is the case today.

A focus on customers and products rather than on operational excellence is a hallmark of a specialty chemicals business, which is usually associated with higher margins and competitive advantage. This dual approach enables customer tailoring as well as a customer-agnostic product technology strength that can serve as a platform for renewal across customer-application and market life cycles. One option is to establish business-unit headquarters where most customer industries are located, especially in the critical markets of China, Europe, and the United States.

In 2011, for instance, Belgium-based Solvay moved the headquarters of its Special Chem Global Business Unit to Seoul because of the presence of major customers in the semiconductor industry. Since then, it has invested more than $1 billion in the country. Solvay and Ewha Womans University partnered to open a joint research and innovation center in Seoul. These moves have allowed the company to work more effectively with South Korean customers in the electronics sector.

Recruit and develop internationally, including for the CEO. Diversification of talent is essential for South Korean chemicals companies, and it starts at the top. They would benefit from more leaders who have experience competing globally. It is increas­ingly important for senior management and relevant business-unit leaders to understand international markets and local business practices and cultures.

For example, the Japanese company Mitsubishi Chemical Holdings recently appointed a Belgian, Jean-Marc Gilson, as the first foreign CEO of the group to accelerate its portfolio transformation and globalization efforts.

Consider switching to English as the corporate language. Adopting English as a more broadly accepted corporate language will help South Korean chemicals companies expand global businesses, stay closer to their overseas customers, and accel­erate the efficiency of internal collaboration across different regions. The German company BASF uses English as the primary language of communication within the group, which has around 110,000 employees in businesses in more than 90 countries.

Manage the portfolio of businesses

In a rapidly churning market, yesterday’s successes seldom prepare a company for tomorrow’s surprises. A company that manages its portfolio of businesses today with an eye on future opportunities is likely to best outperform its peers. Three actions have proved especially valuable in other industries:

Sell businesses, even if they’re profitable. Historically, it has been difficult for South Korean companies to sell off parts of their businesses, especially if those parts were cash cows, earning a positive return. This challenge was mainly because of the cross-shareholding structure of South Korean conglomerates, a vertical integration of value chains within groups, and an expectation that the petrochemicals industry’s profitable period would come soon, considering the cyclical nature of the industry.

However, it is becoming more important for companies to achieve scale in areas in which they have a true regional or global advantage, rather than running a multitude of businesses that might be subscale or not fit in the core strategy. In fact, companies that regularly divest and refresh their portfolios of businesses outperform the markets. Identifying those businesses and selling them off, whether they have a positive return or not, will be critical for South Korean chemicals companies in the future.

Look beyond the currently attractive markets. South Korean chemicals companies tend to place too much emphasis on what seem to be the most attractive market segments. For example, in the field of mobility-related polymers, several South Korean companies announced they plan to enter the market despite strong international competition. Having several companies move into the same market could cause market saturation and lead to disappointing results. In contrast, making big bets in seemingly less attractive markets such as cosmetics or construc­tion chemicals might help companies build a competitive position.

Consider the company INEOS, founded through a management buyout of bp’s Antwerp petrochemicals site. Through purchases of unwanted petrochemicals assets from several other companies, INEOS became one of the largest chemicals companies in the world. INEOS’s recent big acquisitions include all of bp’s remaining petrochemical assets in January 2021, the North American business of National Titanium Dioxide Company Limited from Tronox, and the composites business from Ashland Global Holdings.

Make bold international M&A moves. South Korean chemicals companies have been mostly inactive in the M&A market. From 2010 to 2019, total M&A in chemicals was valued at about $600 billion4; the Korean share was worth approximately 3 percent of the total. By comparison, the South Korean industry makes up around 8 percent of total revenue in the global chemicals industry.

If South Korean chemicals companies want to establish a long-term competitive position in global markets, they should consider making big moves in international M&A, followed by smaller ones to complete their portfolios. Then they should pursue superior asset management by integrating these acquisitions into their operations rather than buying and leaving them alone.

For example, after setting up its biotechnology platform by acquiring Gist-Brocades, the Dutch multi­national DSM scaled the business through many strategic acquisitions, such as Roche Vitamins in 2003, Shanghai Pharmaceuticals in 2005, Martek in 2011, Tortuga in 2013, and Twilmij in 2017. These cross-border acquisitions were accompanied by several collaborations and joint ventures. Today, DSM’s nutrition business unit accounts for 79 percent of total sales.

The chemicals industry has been a powerhouse in the South Korean economy. As the global landscape shifts and new competitors and technologies emerge, South Korean chemicals companies are at risk of falling behind. Savvy CEOs can take steps now to ensure their companies’ place among the global chemicals leaders of the future.

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