The United States chemical industry is characterized by process-based manufacturing, high capital intensity and long investment cycles. Over the longer term, capital was deployed for R&D or capacity expansion while, over the shorter term, resources were targeted to increase productivity and reduce costs. The timing of these investments was typically at the top of the business cycle (i.e., “when times are good!”). This playbook served to keep the industry stable and profitable across the cycle for about a hundred years – primarily because things outside of a chemical company’s control didn’t really change all that fast back then. The industry’s typically conservative response to change was sufficient.
Over the last several decades, however, the pace of change outside the firm’s sphere of control has been unprecedented. Changes in regulation, competition, supply, demand, and technology pose greater chances for disruption in ever shorter periods of time. As SAP CEO Bill McDermott said recently at this year’s Sapphire Conference, “the pace of change has never been faster—and it will never be this slow again.”
At some point, a company’s inability to respond within an acceptable window to the pace of change of external factors will begin to exponentially add risk. Currently, there are several new quickening factors looming for the industry that can rapidly shake up the order. These include the following: the acceleration of the downstream commoditization cycle, a growing skill gap for STEM and trade skills and the blurring of industry lines—mostly initiated by the advancement and adoption of digital technologies in other industries.
The Impact of Commoditization
Commoditization is the process by which competitive advantage erodes as competitors—both direct and indirect—look to nullify it. The impact of commoditization results in lower margins and switching costs. Although the industry has struggled against the direct commoditization of their products for decades (more a factor of oversupply), there has been a profound impact from commoditization and disruption in industries downstream from the chemical industry. This is causing the product lifecycles in those industries to compress—much of that triggered by digital disruption. Commoditization and disruption downstream from the industry tends to weigh down the ROI of capacity investments as the probability rises that the assumptions made in the original investment thesis could potentially no longer be valid when the assets come onstream—especially given the long investment cycles.
A prime example of this was the sharp decline in demand of polycarbonate about a decade ago due to the rapid rise of streaming services, like Spotify and Netflix, that replaced CDs and DVDs. The precipitous decline in demand had a major adverse impact on that market for the next several years. An investment decision in 2007 to expand polycarbonate capacity, backed by what may have appeared to be a solid business case at the time, would have likely ended the career of the executive who approved it.
As a more recent example, digital advances in agriculture have enabled the precise application of chemical inputs for crop protection that could significantly weigh on demand. Now you can begin to get a picture of the scale of the problem when pretty much all your target markets are being impacted by digital disruption. In fact, the commoditization cycle for most industries has been compressing exponentially over the last several decades as the pace of change quickens.
Unfortunately, the industry is currently not well prepared to address it as internal cycles (such as strategic planning, product innovation and development, demand forecasting) have not accelerated at nearly the same pace while executive focus has largely remained quarter to quarter.
Impact of Skills Gap
There has been much said about the growing skills gap and the impact it is expected to have for manufacturing. A Deloitte study published in 2015 in conjunction with The Manufacturing Institute projects that, of the 3.4 million new manufacturing jobs that will be needed in the US between now and 2025, roughly two million of them will remain unfilled. What are the factors contributing to this projection? For starters, the Deloitte report highlights three causes: the impending retirement of Baby Boomers from the workforce, skill shortages among the up and coming generations, and a general lack of interest in the industry due to misperceptions.
With regards to the first point, the table below from the study shows that the chemical industry is skewed toward the baby boomer generation. Per the study, the average age of the chemical employee currently sits around 45.3 years old—older than all other industries except agriculture, transportation and utilities, and public administration. The industry is currently grappling with knowledge loss as sizable portions of this population begin to retire in the coming few years.
With regards skill shortages among newer workers, much has been made of the declining rate of participation in STEM curriculum by younger generations. Deloitte’s survey of manufacturing underscores this by highlighting fundamental skill shortages in the chart below. This issue should worsen as the immigration policies of the current administration make it harder to find this talent abroad.
In terms of a general lack of millennial interest, available graduates from STEM careers just don’t view manufacturing jobs, particularly in the chemical industry, as appealing. Jobs in this sector are viewed as “dirty,” dangerous and inflexible. The table below from the Deloitte study shows how this perception is most dramatic for Gen Y.
The skills gap is particularly unsettling for the industry as it raises concerns as to who will build, run, and maintain the infrastructure needed produce and distribute product in the near future.
Blurring of Industry Lines
Digital technology has reached a tipping point causing industry lines to blur and boundaries between participants begin to shift or break down. When this happens, constraints that once defined the value chain are removed creating new possibilities and opportunities for innovation. New entrants are, almost by definition, seeking to disrupt. However, incumbents that are not able to benefit from the new opportunities this creates will be increasingly in threat of being disrupted as the old rules no longer apply.
In an article published in a 2015 Deloitte Insights, “Blurring Boundaries, Uncharted Frontiers,” author Eamon Kelly points out that “historically, when boundaries have moved—geographic, scientific, technological, institutional, or cultural—the results have been momentous. When multiple boundaries shift simultaneously—as happened during the Enlightenment and the Industrial Revolution—truly extraordinary breakthroughs and great strides in human progress occur, through the creation of new connections, possibilities, and ideas.” He goes on to speak of the current impact of technology on the human-machine, producer-consumer, and physical-digital boundaries in both society and for business.
This is what is happening now in the manufacturing space as digitization, hyper-connectivity, and the accelerated growth of several technologies like big data processing, advanced analytics, machine learning, artificial intelligence, and blockchain are leading to the blurring of industry lines in almost every industry precipitating the emergence of new business models and disruption of existing ones.
Examples include manufacturing companies trying to reach customers directly using web based digital channels (P&G) while distributers and retailers are trying to move from two-day to two-hour deliveries (Alibaba). Some are shifting from physical inventory to digital inventory where they store detailed design specifications for critical parts that are 3D printed on demand (UPS). Traditional business models of selling products is shifting to consumption-based services like equipment uptime that will directly impact the top line and bottom line of customers (Kaeser Compressor).
IT Emerges as the Key Enabler for Meeting New Challenges
In light of these pressing challenges, executives in the chemical industry have come to terms with the new realities and now understand that better use of information across the value chain is the key enabler. They seek answers to questions like: how can we stay ahead of the commoditization curve? How can we derive higher return from our assets and resources? How can we proactively meet emerging demand? How can we transform our business to better meet our customers’ (and their customers’) needs? How can we better attract and retain talent while curating and sharing specialized knowledge and skills to enable us to execute on our plans? And finally, how can we disrupt our current business model before someone else does?
The adoption of digital technologies is now viewed as the means forward. At the recent SAP Sapphire event in Orlando this past June, Accenture underscored this fact while revealing their research indicating that roughly 83 percent of current IT projects in the industry are business as opposed to IT driven. This is a major turn from even a year ago when projects were mostly IT led. Their research also revealed that the majority of mid to large chemical companies (> $1B in revenue) in the U.S. are presently along the continuum of planning and deploying a digital platform as the first step to gaining these capabilities—giving credence to the notion that the “dawn of digital” has finally arrived for the chemical industry.
About the Author
Mike Laprocido is the strategic industry advisor, Chemicals, at SAP.