Specialty and diversified chemical companies have more difficulty achieving consistent revenue growth. The McKinsey Global Institute found only 16 percent of the world’s top 151 specialty and diversified chemical manufacturers going beyond global GDP growth and maintaining a return on invested capital (ROIC) above industry-weighted average capital costs (WACC).
Increasing demand from emerging markets, including China, has contributed to the high performance of the chemicals sector since 2000. However, the growth did not offer a higher return on invested capital (ROIC) for most companies.
According to McKinsey research, market momentum – i.e., market growth in the sector -declined significantly between 1997 and 2018, while market outperformance, or gaining market share, rose.
Growth scenarios in the chemical industry
Examining the growth and profitability of chemical companies worldwide reveals it is hard to achieve both. Four scenarios illustrate this:
Scenario 1: No Growth, No Return.
Among the chemical companies, 49 percent grew below the GDP growth rate and produced returns (ROIC) below the weighted average cost of capital (WACC).
Scenario 2: High Growth, Low Return.
Approximately 17 percent of companies grew above the GDP growth rate and had a return on invested capital (ROIC) below the weighted average cost of capital (WACC).
Scenario 3: Low Growth, High Return.
A total of 23 percent of chemical companies achieved a return on invested capital (ROIC) more significant than the weighted average cost of capital (WACC), but their growth was lower than the GDP growth rate.
Scenario 4: High Growth, High Return.
A mere 16 percent of chemical companies worldwide generated profitable growth. These growth champions exceeded global GDP growth rates while delivering a higher return on invested capital (ROIC) than the weighted average cost of capital (WACC). From 2010 to 2019, they returned 23 percent to shareholders.
A significant difference was seen in valuations between growth champions and others. During 2010-2019, the revenue and earnings before interest, taxes, depreciation, and amortization (EBITDA) multiples of the champions were 1.5 to 3.0 times higher than their peers, suggesting investors were rewarded with success.
How do growth champions function? The secret is winning market share from competitors rather than relying on market growth or acquisitions.
A successful growth strategy combines economic profitability with expansion in free cash flows because a firm’s basic objective is to create shareholder value by achieving economies of scale and profitability.
There are many challenges to organic growth. Chemical industries have been particularly affected by supply chain disruptions. In addition, the pandemic created raw material and labor shortages.
So, how should specialty and diversified chemical companies respond to this in the short to medium term? How can chemical companies take market share?
Companies have different strategies for profitable growth, but in general, three actions will move the needle:
Personalized Solutions and Omnichannel Approach
It’s the era of consumers, and companies must tailor everything to the latter’s liking to enjoy sustained growth. Delivering bespoke solutions at scale through omnichannel will help companies meet customers on the latter’s ground.
Chemical companies that leverage digitalization to serve customers enjoy increased digital customer interactions and a more significant revenue percentage. For conventional B2B players, omnichannel models have become a necessity. Several online marketplaces (or digital platforms) were launched last year, creating new opportunities.
Digital has become a mainstream marketing strategy for legacy players and industry incumbents. McKinsey research found that a leading fertilizer and agricultural inputs company faced competition by setting up its direct-to-consumer digital channel. More than 60 percent of its customers switched to the platform within 12 months. The platform generated more than $1 billion in sales in 18 months, accounting for 10 percent of the company’s revenue. A third of the churn rate was reduced through the digital channel, increasing the customer’s share of the wallet by around 25 percent.
Once revenue growth is addressed, it makes sense to focus on profitability. There are wide variations in the weighted average cost of capital (EBITDA) margins within the specialty and diversified chemicals sector, ranging from less than zero to about 60 percent. Growth champions in diverse segments offer exciting opportunities for value accretion. It is possible to win in non-obvious areas like construction chemicals, and growth champions must seek multiple opportunities to drive profits.
Using Data and Analytics
Companies must transition from intuition-based decisions to analytics-driven strategies, especially in pricing and management. In the pandemic’s wake, fast-growing B2B companies have developed capabilities to use customer data and generate actionable insights to improve customer experiences.
Advanced analytics can enhance various sales functions, including customer acquisition, cross-selling, upselling, dynamic pricing, and customer retention. Analytics is used beyond sales planning, account management, and pricing to gather more granular information on account-level and deal-level insights and assess opportunities and threats.
According to research, the analytics-led approach has resulted in at least a 20 percent productivity increase for growth champions.
Evaluation of contracts
Contracts must include selective negotiations for long-term agreements wherever possible when supply and production constraints exist.
Companies initially doubled down on shorter-term sources of value capture in the current environment with disrupted supply chains, raw-materials shortages, and labor constraints. However, cost optimization projects will no longer bring results as price levers are now critical, and inflationary pressures dominate. In this environment, leading organizations are reevaluating their contracting strategies.
Here are some powerful approaches:
- Signing long-term contracts with higher-margin customers.
- Adding new contract clauses, such as minimum order quantities and service fees.
- Protecting pricing from market volatility by implementing shock-absorbing clauses.
High growth and high return are every company’s dream scenario, but they can be made a reality through suitable approaches, particularly in the chemical manufacturing sector. It will take a sophisticated strategy to outpace competitors in the chemicals sector. Market momentum is slowing, so companies should focus on previously neglected areas such as omnichannel traction, investing in digital-and-analytics capabilities, and reexamining commercial constructs.