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Volume 85 Issue 6 | pp. 12-15
Issue Date: February 5, 2007

Cover Story

Competitive Intelligence

Chemical firms plan a 7.6% boost in capital spending but forecast an R&D increase of just 5.8%
Department: Business
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Capital Idea
Eastman just completed construction of this polyethylene terephthalate plant in Columbia, S.C., based on new technology.
Credit: Eastman Chemical
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Capital Idea
Eastman just completed construction of this polyethylene terephthalate plant in Columbia, S.C., based on new technology.
Credit: Eastman Chemical

LAST YEAR was a fairly good one for most chemical firms. Energy and raw material costs moderated, sales increased, and profits were decent. But as 2007 gets under way, the economy is showing signs of a slowdown. Many U.S. chemical firms are therefore taking a more cautious approach than they did last year at this time to investments intended to increase their competitive posture.

Sixteen chemical companies that responded to C&EN's annual survey together plan a 7.6% rise in spending for new plants and equipment in 2007 to $6.4 billion. If they follow through on their plans, that increase won't be nearly as great as the 28.1% and 16.5% increases the group reported for 2005 and 2006, respectively. The year 2007 would be only the third time in the past decade that the group increased capital expenditures.

And even though research and development leaders at firms such as Dow Chemical and Rohm and Haas lament that their successes are few and hard-won, a similar group of chemical makers also plans to increase spending on R&D in 2007. The 14 firms in this group budgeted a combined $2.6 billion for research in 2007, up 5.8% over 2006. Their plans mark a slowdown compared with the collective 7.3% and 9.0% boost to research budgets in 2005 and 2006, respectively.

This year, the overall forecast for future-oriented spending is partly sunny. The combined 2007 budget of the 14 firms that supplied both R&D and capital spending data is $8.5 billion. Despite the slowdown in the rates of increase, the figure marks a decade high. Four years ago, in 2003, the group's future-oriented spending hit a decade low of $5.9 billion. A significant run-up in capital expenditures gets most of the credit for the rebound.

But take inflation into account, and the funds destined for future-oriented projects won't buy nearly as much as they did 10 years ago. The $8.5 billion that the group plans to spend this year is only $6.9 billion in 1997 dollars.

Because of the boost in capital spending in recent years, the ratio of investment in new equipment to investment in research has steadily increased. At the decade low in 2004, 65.2% of future-oriented funds were slated for capital improvements. Budgets for 2007 direct 69.7% of funds to capital projects, although that is still not as high as the 72.3% of funds spent on new equipment in 1997.

Funds slated for R&D tend to move in a narrower range than those for capital improvements. So when capital budgets jump, a proportionately smaller share of the budget goes to fund research. This year, the firms in C&EN's survey expect to devote 30.3% of future-oriented funds to research, compared with the decade high of 34.8% in 2004 and the decade low of 27.7% in 1997.

C&EN undertakes its survey in January of each year just as companies are getting ready to announce the previous year's financial results. And it is not unusual for the number of firms willing to reveal their future-oriented spending plans to the press and investment communities to vary from year to year.

Last year, for instance, 18 firms provided forecasts for capital and research spending (C&EN, Feb. 6, 2006, page 12). This year, only 16 firms disclosed their 2007 capital spending budgets for this survey, and just 14 were willing to provide R&D forecasts.

The most prominent absences in this year's survey are DuPont and 3M. DuPont said it spent $1.5 billion on capital improvements and $1.3 billion on research in 2006. The firm would only say it planned moderate increases in both categories for 2007.

3M could not provide 2006 data, nor could it forecast 2007 future-oriented spending. A spokeswoman did suggest that capital spending in 2006 would likely come in at about $1.1 billion.

Companies surveyed in January 2006 expected to increase capital spending by 17.0%, close to the 16.5% increase that firms participating in this year's survey say they in fact made.

For R&D, however, it is a different story, proving that priorities and spending plans can change over the course of a year. Last year's group expected to increase R&D by 4.7% in 2006. This year's group reports that it actually increased R&D by 9.0%.

Of the 16 companies that provided 2007 capital spending plans, 10 expect to increase spending on new plants and equipment compared with 2006, two plan to spend the same, and four have plans to cut back. This compares with 14 that increased spending in 2006 and two that pulled back.

In some cases, firms are spending on new capacity in response to customer demands. For instance, Cytec Industries plans to ramp up capacity to produce carbon fiber used to make lightweight composite materials to build aircraft. The firm expects to choose a site soon for a new $100 million carbon fiber plant set to open by 2009. Thanks in part to this project, the company plans to hike capital spending by 37.3% to $140 million in 2007.

Geared Up
Plant and equipment spending is up and rising as a percent of sales.
Credit: NOTE: Values are for 16 chemical firms listed in the table below. SOURCES: C&EN surveys and estimates

Other firms intend to make capital improvements to enhance efficiency and productivity. Ferro, for instance, says it is increasing spending to fund productivity improvement and also to underwrite restructuring programs in its electronic materials and colors segments. The firm plans to increase capital spending by 36.4% to $75 million in 2007.

Still others are taking advantage of recently acquired assets. Like Ferro, adhesives maker H.B. Fuller plans a 36.4% increase in plant and equipment spending this year. Part of the $30 million Fuller is budgeting will go to opportunities in recently acquired grouts and insulating glass sealants businesses.

C&EN predicts that the group's capital spending as a percentage of sales will be 4.8%, up from 4.6% in 2006. The estimate assumes a 3% increase in sales in 2007. That ratio hit a 10-year high in 1998 when spending on capital projects reached 9.0% of sales. The decade low was in 2004 and 2005 when the group spent only 4.3% of sales.

Of the 14 firms surveyed on R&D spending plans, nine plan to increase spending in 2007, three plan spending cuts, and two anticipate no change from 2006. This compares with 11 that increased expenditures in 2006, two that made no change, and one that cut its budget.

In 2007, C&EN estimates, R&D as a percent of sales for the group will be 2.4%, just a tad above the decade low of 2.3% last year and in 2005. The decade high was 3.6% in 1998 and 1999.

Inevitably, inflation whittles away at the buying power of dollars devoted to research. The $2.6 billion devoted to R&D by this year's group of 14 companies represents only $2.1 billion based on a constant 1997 dollar. However, that $2.1 billion also marks the inflation-adjusted decade high.

A recently released survey of U.S.-based companies, conducted in the summer of 2006, finds that many firms with U.S. research facilities anticipate a "significant increase in overall spending and a strong focus on new business development." The Industrial Research Institute's "R&D Trends Forecast for 2007" notes that despite a slowing housing market and wavering consumer confidence, many companies will commit significantly more money to R&D in 2007 with an emphasis on new business projects.

Of the 99 respondents representing a broad array of industrial businesses that sponsor research, 58% expect to increase R&D spending by more than 2.5% and only 14% plan to hold spending at the same level as in 2006 or reduce it.

Another recent survey of U.S. firms projects that they will collectively spend $219 billion on R&D in 2007, up 3.4% from 2006. The survey, conducted by Battelle Memorial Institute and R&D Magazine, predicts that R&D growth will be stronger than the average in fields such as electronics, biotechnology, pharmaceuticals, and software development.

Despite the large investment that industry puts into R&D, commercialization rates for new technology proven at the bench level tend to be low. And the time it takes to bring a new technology from the bench to market can be as short as six months or as long as seven years, industry R&D experts say.

"We are pleased if 1% of what we see at the bench makes it in the real world," says Daniel R. Kittle, vice president of R&D at Dow AgroSciences. New agricultural chemicals have a rate of success similar to that of pharmaceuticals because scientists have to take into account the effects of a new molecule on people, crops, and the environment.

"Few actually make it," admits Yakov Kutsovsky, global R&D director for Cabot. "Maybe 20 to 30% are commercialized if we are rigorous about selecting projects at an early stage." But even if research selection teams do a good job of assessing technical, manufacturing, and marketing risks early on, "there are just some things you can't know," Kutsovsky adds.

At Rohm and Haas, the success rate for commercialization of new products from the bench is less than 50%, according to Gary S. Calabrese, chief technology officer.

Lines of Inquiry
R&D spending is on the rise and increasing as a percent of sales.
Credit: NOTE: Values are for 14 chemical firms listed in the table below. SOURCES: C&EN surveys and estimates, White House Office of Management & Budget

"New products at the bench need to be tested early and often with the customer," Calabrese says. With computer-chip makers in particular, "you know what targets you have to meet, so you can have a higher rate of success." Although new products can be introduced in the electronics sector in as little as six months, in mature markets such as the automotive industry, new product introductions can take three to four years, he says.

"THE TRUE TEST of innovation is how long it takes for something to cover its cost and contribute earnings to the company," points out William F. Banholzer, Dow Chemical's chief technology officer. "The more profound the product or process, the longer it takes." Taking into account the wide number of markets the chemical industry serves, "I'd give a range of two to seven years depending upon whether we have a market position with the product, we can use existing assets, and the market is already developed."

Dow's Kittle agrees with his boss, noting that satisfying regulatory requirements for new agricultural products accounts for some of the time to market. And profits don't come naturally just because a product has successfully passed all hurdles to commercialization, he emphasizes. Unlike pharmaceuticals with their high profit margins, a new agricultural product "has to be a great active, cheaper than dirt to make, and safe all around," he says.

"The path to commercialization is strewn with lots of hurdles," says David A. Hurwitz, managing partner of Garnett Consulting. A veteran of Union Carbide, coatings firm DeSoto, and consultants Arthur D. Little, Hurwitz says some companies do a better job of precommercialization studies than others.

Industries have widely varying risk profiles, he emphasizes. In the semiconductor industry, if new circuitry technology works, it can go to market in a matter of months. Automakers won't put a new technology into the market so quickly, and paint makers are so risk-averse that, even after years of testing, a supplier has no guarantee that paint makers will adopt a new ingredient.

"There are no hard-and-fast rules about how long it takes to commercialize new technology," Hurwitz says. But that doesn't mean chemical firms will stop taking investment risks in pursuit of increased earnings.

 
Chemical & Engineering News
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