Chemical Portfolio PlayersBalancing the needs of today and tomorrow in difficult times

IntroductionThe recent recession has been difficult for most businesses, and the chemicals industry is no exception. But the downturn hasn’t affected every chemical company equally. Some have fared significantly better than others—and their experience offers some lessons as the industry moves forward.

From the third quarter of 2008 to the second quarter of 2009, the recession led to a steep decline in chemical companies’ profits. Most companies responded by cutting costs and capital spending sharply and putting mergers and acquisitions (M&As) on hold. But the specifics of how each company took such actions varied, and had a strong bearing on how well each weathered the storm.

Accenture’s industry research has found that as this cycle unfolded, high-performance chemical companies coped with the changing environment quite well, compared to other chemical companies. Accenture defines the high-performance business as one that outperforms its industry peers over the long-term—over economic cycles, industry cycles and generations of leadership. Such chemical companies experienced less of a negative impact during the downturn, and have found themselves to be better prepared to move ahead as the industry recovers.

The question is, what did these high-performance businesses do differently from their peers who did not perform as well? This is not just an academic question; the experience of these companies during the downturn can provide useful, practical guidance for the future.

The industry has come a long way since mid-2008, and chemical companies are once again investing. But the economic recovery has been modest, and the outlook remains uncertain, as companies weigh the debt crisis in Europe, ongoing tax debates in the United States, the real estate bubble in China and other economic factors. Moreover, chemical production appears to have reached a growth plateau, even as the recession has ebbed, and a decline in demand in the near future is not out of the question.

In this environment, chemical companies will need to be exceptionally resilient and cost-effective, and will have to use capital diligently. That is, the practices that have helped high-performing chemical companies through the recession will continue to be important in the coming years. With a clearer understanding of how these companies responded to the recession, chemical companies across the board can be better prepared for the road ahead.

To help foster that understanding, this paper examines high performance among a specific group of chemical companies that Accenture calls “portfolio players,” which are large, diversified companies.

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Global chemical company performance(market basket of 27 companies)

Capital expenditures, avg., rolling 4Q

Cash, avg., rolling 4Q

EBITDA, avg., rolling 4Q

Recession

2002

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2002

-Q4

2003

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2003

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Sources: Accenture Research analysis of INFINANCIALS, based on data for 27 global chemical companies

Figure 1. Global chemical company performance

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Chemicals production

US

EU

Japan

China

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8

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Sources: U.S. Federal Reserve Board; Eurostat; METI: Accenture Research analysis

Figure 2. Chemicals production

Service Providers• End customer /end market facing (branded

products, often assumes customer business processes)

• Faces mainly large and consolidated customers (retailers e.g.)

• Highly individualized services

Scale Operators• Large volume client base• Strong price competitive• Fixed asset intensive• Raw material is a significant part of COGS.

Specialty Balanced• Highly diversified client structure (small, midsize, large

customers)• Many product specifications and formulations• Close collaboration with the client for individualized products

Commodity Balanced • Highly diversified client structure (small, midsize, large

customers)• Strong price competition• Large scale intermediates vs. small volume formulations

SOScale

Operators

SPService

Providers

CBCommodity Balanced

SBSpecialty Balanced

Incr

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Decreasing asset intensity

Chemicals value chainFeedstock End-market

PPPortfolio

Player

The Portfolio Player represents companies diversified within the chemicals industry, crossing two or more of the other business models. They include among the largest chemical companies.

Figure 3. Model chart

To determine which chemical companies are high-performance businesses, it is necessary to view them in peer groups based on their respective business models—essentially, their characteristics related to producing and selling products.

For example, some companies could be categorized as “service providers” that are essentially end-customer/end-market facing. Others could be described as “scale operators”—asset intensive, price competitive and serving a large customer base. (See sidebar, “Industry Business Models and High Performance.”) The proper response to industry challenges varies according to a company’s business model.

In the chemicals industry, the right approach to high performance will depend on a company’s business model—how it produces and sells products which, in turn, is also reflected in key financial characteristics as well, such as level of asset intensity versus service and innovation intensity. For example, some chemical companies may focus on high levels of technical support and product innovation, others may focus on the opposite extreme of scale and low cost, and others may have a model that falls somewhere between those two. Most chemical companies can be put into one of five business-model categories:

Service providers—end-customer/end-market facing (typically with branded products, and often taking on customer business processes). Offer highly individualized services and/or high levels of product and service innovation. Examples include Monsanto, Ecolab and Sherwin Williams.

Specialty balanced—highly diversified client structure (small, midsize, large customers); many product specifications and formulations. Often involves close collaboration with customers for individualized products. Examples include Wacker Chemie AG, Evonik, DSM, Albemarle and Kraton Performance Polymers.

Commodity balanced—highly diversified client structure (small, midsize, large customers); price-competitive. Large-scale intermediates dominate this group. Examples include Celanese, Teijin and Mitsui Chemicals.

Scale operators—large client base, price-competitive and asset-intensive. Raw material is a significant part of cost of goods sold. Examples include SABIC, LyondellBasell and Braskem S.A.

Portfolio players—large and diversified, straddling two or more business models. Examples include BASF and Dow.

Industry Business Models and High Performance

Understanding high performance

To identify what “high performance” means in each business model, Accenture assessed long-term and current performance, as well as forward-looking aspects such as growth and innovation. We examined a variety of metrics beyond the basic indicators of return on invested capital and earnings margins. Such basic metrics may reflect short-term phenomena and “luck,” fluctuations in supply or demand for certain products, or even price spikes from plant outages or natural disasters. Therefore, four categories of metrics were used—those covering long-term performance, current flexibility and performance, operational excellence, and growth and innovation. In addition, the ranking process gave long-term metrics twice the weight of current performance indicators. Within those categories, we included factors such as growth in geographic earnings relative to economic growth in the same regions for an indicator of long-term growth, debt ratio for financial flexibility, and inventory measures for operational excellence.

A key feature of our ranking process was the inclusion of innovation measures based on patent applications. While patent applications may not be a measure of innovation in and of themselves (because they may not necessarily be commercialized), cited patent applications (those referenced in other patent applications) are more likely to reflect commercialization feasibility, because they indicate broader interest in the technology. (Figure 4 shows the complete list of metrics used, by category.)

Long term performance (5yr)

Current flexibility & performance

(current)

Operation excellence(current)

Growth & innovation(5yr)

Growth in regional revenue versus regional GDP

EBITDA margin

EBITDA growth

Average ROIC

Market capitalization growth

Net debt ratio (net debt / total assets)

Days of cash

EBITDA margin

ROIC

Market capitalization, annual average - current/prior

EBITDA/S&GA

EBITDA/COGS

EBITDA/PPE

Days payables les days receivables

Days in inventory

Capital expenditures/ sales

Technology importance: # cited applications

Geographic coverage of applications

Number of patent families versus R&D spend

Technology importance: frequency of cited

applications

Figure 4. KPI chart

Using the approach described above, Accenture examined a group of portfolio players—large, diversified companies that straddle two or more business models. We ranked the performance of eight such companies and found that two ranked well above the others. We then identified the practices that contributed to the higher performance of those companies.

Accenture’s ongoing research into high-performance business has identified three building blocks of high performance: market focus and position, distinctive

capability and performance anatomy. (See sidebar, “The Three Building Blocks of High Performance.”) In assessing portfolio players, we looked at practices in several areas that cross all three of those building blocks. These areas are operational excellence, resilience and acquisition proficiency. Of course, these are not the only important factors for high-performance businesses. However, we focused on them because they are directly linked to both short- and medium-term financial performance, and thus especially relevant in times of economic uncertainty.

Balance, Alignment and Renewal: as the world changes business environments, high performers proactively manage their building blocks and transform or ‘change ahead of the curve’

Distinctive Capabilities

Market Focus and Position

Maximizing business results by targeting the right place at the right time

Being customer focused to create a unique business

Out-executing through consistent, competitive mindsets

Performance Anatomy

The Dynamic Nature of the Building Blocks of High Performance

Accenture’s three building blocks of high performance are:

Market focus and position

High-performance businesses maximize growth opportunities and economic structural advantage by striving for optimal scale within their industries. They understand the dynamics of their industries and successfully manage the creation of value through appropriate market strategies. Acquisition proficiency links to this building block in the strategic selection phases. Financial resilience is also linked to this, based on the speed and appropriateness of business decisions.

Distinctive capabilities

High performance businesses create and exploit distinctive, hard-to-replicate capabilities that deliver the promised customer experience, while simultaneously driving the most efficient

utilization of assets. They master technical capabilities to maximize differentiation and at the same time extend their mastery across their business models. Operational excellence and resilience fall within this building block, as does the integration phase of acquisition proficiency.

Performance anatomy

This focuses on creating cultural and organizational characteristics that power companies toward their goal of out-executing the competition. Performance anatomy comprises a set of organizational “mindsets” that enable companies to out-execute the competition, and are measurable and immediately actionable by the organizational leadership. Operational excellence, resilience and acquisition proficiency all depend on this building block, with its characteristic unified goals and objectives for rapid and successful decision-making and implementation.

The Three Building Blocks of High Performance

Figure 5. Building block graph

Assessing the industry’s portfolio players

The research found that high-performance portfolio players did indeed apply leading practices in these areas. As a result, these companies managed the economic downturn better than their peers. Conversely, those companies that did not apply leading practices in these areas did not maneuver well through the economic crisis, and recovered at a slower pace.

The practices of high-performance portfolio players are examined in more detail below.

Operational excellence

High-performance portfolio players are noted for their innovative approaches to improving business processes and the vigorous execution of those improvements. They appear to operate under several key principles; these may not be explicitly stated, but they nevertheless guide these companies’ approaches to operations, These principles include:

Simplification—eliminate duplication and low-value activities; maintain a clearly defined decision-making hierarchy.

Speed—work to reduce cycle times, waiting times and process errors; eliminate waste; standardize and harmonize processes; and drive collaboration.

Discipline—rely on fact-based decision making, and use results management, performance measurement and incentivization.

Resilience

Unlike many companies, high-performing portfolio players kept relatively high and stable operating margins during the recession. They accomplished this by making immediate, tough cost and production cuts early on in the downturn, while at the same time making “real-time” investment decisions that boosted operating performance in support of long-term ambitions. That is, they struck an effective balance between the needs of today and tomorrow. These investments included strategic capacity increases, asset additions in better-performing emerging regions, and undertaking well-positioned acquisitions and/or joint ventures. Overall, these companies continued to drive improvements during the difficult times, rather than delaying plans and “hunkering down” until the crisis had passed.

Meanwhile, companies that did not rank among the high performers registered lower and more volatile margins during the recession. In the earlier stages of the crisis, they tended to delay capacity closures and layoffs of workers for some time, which ultimately ended up hurting morale and business continuity. They also tended to be overly focused on production consolidation. Some did continue long-term investments, but too often, they did so without adjusting them to also target shorter-term benefits that would help weather the economic crisis. Finally, these companies typically waited longer than high performers to resume M&A and capacity-enhancement efforts, doing so only near the end of the crisis.

Figure 6. EBIT/deviation chart

Standard Deviation 5y average EBITDA margin

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In the M&A area, high-performing portfolio players managed a balanced blend of strategic acumen and execution. For example, their business portfolios were aligned with global societal megatrends, such as emerging market growth, electronics proliferation, energy reduction, pollution control, food/agricultural development and scarce water. These companies typically had clearly defined M&A strategies that were well-communicated to investors, employees and customers. Our research showed that these leaders managed numerous acquisitions while maintaining low gearing ratios, with a low proportion of debt to equity, and healthy profit margins.

High-performance chemical companies managed a large number of acquisitions in the past five years, while keeping their debt low. Besides diligent market focus and positioning, high performers also excelled in rapidly achieving synergies from mergers. Other attributes of high-performance acquirers in the chemicals industry include:

•Having strategic focus/purpose for M&A. As simple as it sounds, distinctive strategies are pervasive among leaders.

•Being unafraid to acquire vertically. They sell higher value products and more products to the same customers.

•Establishing value targets based on the implementation of their own best practices, processes and systems.

•Having strong integration engines. They are able to quickly implement processes and systems.

•Ensuring a good fit regarding products and culture; a strong emphasis on communicating to employees, customers and suppliers.

Meanwhile, characteristics of lower-performance companies in this area include a failure to implement common platforms and slow integration, which often entails drawn-out plant shutdowns, staff reductions, organizational changes, and so forth.

Figure 7. Gearing chart

Bubble size ref lects number of acquisitions (acting as buyer 2006-2011)

*Gearing = Total Debt/Total Assets

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Acquisition proficiency

ConclusionLooking at the last few years, it is clear that high-performance portfolio players use leading practices to excel during uncertain times. They have in place a clear understanding of where they want to be, and the processes and systems to get there. And as the recent downturn illustrated, they benefit from a focus on operational excellence, resilience and an effective M&A capability.

However, not all leading practices are used uniformly among high performers, and there is always room for improvement—for any company in the industry. Indeed, a focus on ongoing improvement is fundamental to the high-performance business—and a sound practice in both bad and good economic times.

About the AuthorsPaul Bjacek, a senior manager in Accenture Research, leads global chemicals and natural resources research. He is based in Houston.paul.bjacek@accenture.com

Karin Walczyk, a manager in Accenture Research, leads resources innovation research. She is based in Dusseldorf.karin.walczyk@accenture.com

Special thanks to Patricia Faust, Segran Pillay, Gaurav Sharma, Manish Sharma and Mandisa Sizane.

Operational Excellence

• Is your business structured to be efficient?

• How efficient are your reporting structures?

• How efficient are your supporting services?

• How effective are your productivity enhancements?

• How standardized are your processes on a global basis?

• How harmonized is your IT on a global basis?

• How collaborative is your information sharing system?

• How consistent is your R&D focus?

High Resiliency

• How flexible and fast can your company react to unstable economic situations?

• How flexible and cost competitive are your production facilities?

• How resilient is your long term strategy? Your long term investment allocation?

• How strategically aligned is your product portfolio?

• What is the share of cyclical products in your total product portfolio?

• How diversified is your local footprint?

• To which extent do you participate in the growth of emerging regions?

Successful M&A

• How are your M&A activities aligned to your company strategy?

• Do you have clear measures and principles defining a strategically successful acquisition?

• Does your organization support effective and efficient integration of new businesses?

• How high is your success in reaching planned synergies for an acquisition?

• How embedded is your internal and external communication strategy before, during and after the takeover?

• What support do you offer your employees to make the acquisition successful?

In a changing economic environment, chemical companies need to pay special attention to operational excellence, resilience, and merger and acquisition acumen. Some key questions relating to these areas are below.

High Performance Business Scorecard: Where do you stand relative to High Performers?

About AccentureAccenture is a global management consulting, technology services and outsourcing company, with more than 246,000 people serving clients in more than 120 countries. Combining unparalleled experience, comprehensive capabilities across all industries and business functions, and extensive research on the world’s most successful companies, Accenture collaborates with clients to help them become high-performance businesses and governments. The company generated net revenues of US$25.5 billion for the fiscal year ended Aug. 31, 2011. Its home page is www.accenture.com.

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