Issue Date: April 21, 2008
Stephen F. Kirk, president of Lubrizol Additives, has his mind on his portfolio. It is represented in a chart on the wall in his office. The chart, however, does not include any chemical names or core competencies in chemistry. What Kirk refers to as a portfolio is a collection of methods for expanding the specialties business.
"I have the words ???Additives Growth' written in the middle, and nine boxes going around it," Kirk says, describing the chart. These boxes, he explains, cover new product differentiation initiatives, product performance upgrades, niche product development, product improvement, margin management, expansion into adjacent markets, acquisitions, geographic expansion, and growth with key customers. "We work all nine boxes hard," he says.
Specialty chemicals are, in fact, synonymous with hard work. And also with flux. The sector is perhaps best defined as made up of chemicals purchased for their performance characteristics rather than their molecular specificity. It consists of an ever-shifting array of products ranging from true specialties that command a premium price for the work they do, to others that are almost indistinguishable from commodities.
Keeping its specialty chemicals "true" rather than "commodity-like" is a focal point of working the boxes at Lubrizol, Kirk says. In the chemical industry more broadly, the desire to keep specialties "special" has led in recent years to restructured marketing and research regimes among firms supplying performance ingredients to makers of paint, soap, electronics, sneakers, and other consumer products.
It has also led to confusion, according to Jonathan Goldhill, senior vice president with consulting firm Kline & Co., one of several analysts watching the evolution of specialty chemicals. Although growth in the industry was once linked directly to innovation in research and development, it is now also a matter of downstream product design, application engineering, and marketing—innovation efforts that extend far beyond the laboratory.
At the same time, according to Goldhill, the specialties sector is experiencing an encroaching commoditization—a maturing of markets that has caused the business to behave much like the basic chemicals sector, where growth rates bear little correlation to rates of spending on R&D.
This phenomenon, he notes, is also a reflection of technology maturity among the industry's customers. "We see it with Apple and the iPod," he says, referring to the leading product in the portable MP3 player market. "They spend less on R&D than others in the sector. They have a design and business model advantage." Similarly, differentiation for specialty chemical companies will be achieved largely outside of the basic research laboratory, Goldhill says.
Chris Cardinal, a chemicals consultant at CRA International, sees research as a nuanced proposition. "R&D is a factor in innovation," he says, "but it is not so much a matter of how much you spend. It is a matter of how you spend it." And success in the lab, he says, is largely a matter of how well companies can innovate with products that are already on the shelf. "Think about 3M," Cardinal says. "They do acrylate and polyester material R&D, but they customize. They stack technologies, combining a composite and an adhesive window film to create window layers."
Paul Bjacek, an analyst with Accenture, calls R&D an increasingly sophisticated proposition in which companies need to be on the lookout for opportunities to grab talent globally. He notes that China and India are of growing importance in establishing global research efforts, not only because they are home to more than 2 billion potenial customers but also because they are minting scientists. "There are fewer engineers and scientists in the U.S.," he says, "while India and China are graduating 100,000 a year."
Attractive profit margins are a defining attribute of specialty chemicals. Chemistry alone, however, will not necessarily provide the extra value needed to justify these margins, according to the consultants, and there are fewer true specialty companies as a result. "Are companies making a conscious decision to remain specialty companies?" Cardinal asks. "Will they focus on product differentiation or will they cut research spending in order to maintain margins?" He contends that only 10–20% of some specialty stalwarts' portfolios are truly specialty, while the rest of their businesses center on basic oleochemicals and other commodity-like products that were once specialty but are no longer.
Among the companies the consultants say have committed to cultivating specialty chemical portfolios are Dow Chemical, Ciba Specialty Chemicals, BASF, and Lubrizol, each of which has been "working the boxes" on growth strategies.
"We are specialties top to bottom," Lubrizol's Kirk says, speaking of the lube and fuel additives business he manages; the company also runs a personal care and coating chemicals business, Advanced Materials, which it acquired with the purchase of Noveon in 2004. "We focus on creating technologies that improve the quality and performance of customers' products. We consider ourselves a technology-based company."
Kirk says Lubrizol spends 5–7% of revenues on R&D, a third of which goes to basic chemical research and the rest to developing new applications for existing chemistry. "It is that basic spending that keeps our technology fresh, our pipeline full, and our platform up to date."
The platform at Lubrizol's additives division is a portfolio of formulated products based on building block chemistries that the company customizes for clients and reformulates as fuel efficiency and environmental standards evolve in the U.S. and Europe. Keeping ahead of the curve on regulatory changes is a means of attaining a competitive advantage, Kirk says.
So is process efficiency—the upgrading of automation systems and streamlining of manufacturing plants, which is funded from the applications development portion of the R&D budget. Lubrizol is also looking for growth by moving into markets adjacent to ones it already serves, according to Kirk, including metalworking additives and synthetic refrigeration lubricants.
Like most specialty chemical companies, Lubrizol has been serving global markets for a long time. "Our customers are oil companies and their lubricant marketing divisions," he says. "They tend to be global. They work closely with car and truck companies and they want global consistency in their products. We are driven by our customer base to think globally. To them it means marketing the same lubricant in China that they do in France." This requires a consistent approach to technology services globally.
"We have historically made technology investments in three continents," Kirk says of the Ohio-based company. "The biggest is the center at our headquarters. And we have been in Europe and Japan a long time." Although Japan is the smallest operation, mostly serving the host country, it is increasingly charged with cultivating business elsewhere in Asia. "Someday," he says, "we will have research centers in China and India." The company recently announced plans to build an additives plant in China's Tianjin Harbor Industrial Park.
Most specialties-oriented chemical companies have a similar mix of growth strategies at work, though the emphases vary.
Developing niche markets is the primary function of Rohm and Haas's process chemicals and new platforms business, which includes biocides, personal care ingredients, and ion-exchange resins. Though grouped aside from the company's primary businesses in coatings and electronics chemicals, many of what the company calls its niche products are sizable. "Some are $400 million businesses," says Guillermo Novo, vice president of the new group.
According to Novo, although the businesses he manages have traditionally grown through the introduction of new chemicals, these chemistries have matured in recent years. Products have come off patent, he says, but many of the company's existing chemistries can be applied to new markets in innovative ways. "Now, for example, instead of developing a new molecule, we look at how we can use material science to improve the performance of existing biocides," Novo says.
Then there is the marketing angle, exemplified by a joint venture Rohm and Haas formed last year with Chemical Specialties Inc., a subsidiary of Rockwood Holdings. Called Viance, the venture will market a new wood preservative that combines Rohm and Haas's 4,5-dichloro-2-n-octyl-4-isothiazolin-3-one (DCOIT) biocide and a stabilizing polymer. The product, EcoVance, allows DCOIT to effectively penetrate pressure-treated wood, Novo says. "We have the technology, they have the route to market," he says of his company and its partner.
Rohm and Haas's $2.2 billion-per-year paint and coatings materials business has spent the past three years establishing a distributed R&D infrastructure. Basic research, which had been conducted entirely in Spring House, Pa., is now also done at the company's new research center in Shanghai and in Hanko, Finland, where Rohm and Haas recently acquired Finndisp, an emulsions manufacturer, according to Luis Fernandez, vice president of paint and coatings materials.
The company is also extending its reach through partnerships with universities, customers, and other suppliers, Fernandez says. For example, the firm recently developed a formaldehyde-absorbing paint with a coatings manufacturer for the Malaysian market. "We work with coproducers with specific knowledge of technologies we don't have," he notes.
According to Fernandez, 30% of the company's R&D budget is spent on basic research, with a comparable amount on developing applications for known chemistry, and the rest on formulation research. The overall objective, he adds, is creating value in maturing markets.
"All industries have an element of commoditization," he says. "You have to continue to develop solutions that no one else can develop." He notes that there is plenty of room for differentiation in application development and formulation. "There is an eight to 20 times price differential between the cheapest and most expensive can of paint in most countries," he says. "People will pay for the differentiated product."
At Dow Chemical, specialties growth is managed in major end use markets through networks of related businesses called "market-facing" groups. "Our programs play a critical role in our long-term profitability outlook," says Carol Dudley, vice president of market-facing business development and licensing. "When you connect markets to research—when you target unmet product needs—it does make a difference."
Dow established market-facing groups for the agricultural, automotive, and building industries several years ago. Last year, the firm added market-facing coatings, fabric and surface care, and footwear groups.
Today, about two-thirds of Dow's $1.3 billion in annual spending on R&D goes toward growth—basic research and application development. The rest is spent on product support—research associated with maintaining product portfolios. "In the past, it was the other way around," Dudley says. She attributes the shift to the connection made between marketing and R&D under Dow's new chief technology officer, William F. Banholzer, former vice president of global technology at General Electric. "Now, one-third of our revenue comes from products introduced in the last five years."
Under the market-facing model, Dow has shifted its focus from selling specific products to marketing formulation and application expertise. "When we supplied the coatings industry, we used to offer solvents, latexes, and polyurethanes," she says. "Coating customers had to come to Dow. Today, we go to the market and we are product-agnostic. We change products to meet customer needs. We address the market as the market, not as an individual purchaser of epoxy or polyurethane. We go as Dow to the auto industry and look for supplier relationships."
Recently, Dow's automotive unit agreed to manufacture a finished car filter for a customer. "It includes a specialized soot-control catalyst that goes on the kind of diesel engines that will be used in 50% of the vehicles in Europe," Dudley says. "We are not afraid to move into making a part if it is the right thing for Dow."
Dow has several specialty chemical businesses outside the market-facing regimen, each with particular growth challenges. Mark Henning, general manager of Dow's biocides business, sees a renewed interest in chemical production done in the U.S. "Over the last several years, there has been a lot of excitement and movement and scrambling to find low-cost specialty production sites," he says. This has led to a rush on India and China. "We have spent an inordinate amount of time focusing on that," he adds, "and I see an inflection point starting last year."
In 2007, he notes, the Chinese government made significant reductions in value-added tax rebates for most specialty and fine chemicals exports, a move that increased the cost of exporting from China by 10???15%. Energy costs and fluctuating currency exchange rates also crimped the country's competitiveness.
Henning says Dow's biocides division is based on 18 active chemistries that go into industrial applications including pulp and paper, water treatment, paint, and oil and gas. He says his division has also taken a market focus, carving out new uses and geographies through formulation and application research. "Biocides are a clear example of an area where we will have no new chemistries," says Henning, noting the regulatory challenges in the U.S. and Europe to bringing new molecules to the market. "We will take existing chemicals and apply them where biocides are needed and value can be delivered."
For its part, Ciba has undertaken a reorganization of R&D in an effort to centralize research in each of its six main product areas: protection and stabilizing chemistries, color components, polymerization and curing chemicals, interface and rheology additives, paper strength and coating chemicals, and solid/liquid separations. The program will establish centralized research laboratories and management for global R&D in each area.
"We are doing this now, really, to sustain our competence in each of these areas," says Martin Riediker, Ciba's chief innovation officer. "Over time, they have been dispersed. We want to bundle them again."
Like Dudley at Dow, Riediker speaks of the importance of linking the lab to the market. Implementing top-down management of resources will help focus the businesses on the core elements of innovation at Ciba—process improvement, application development, and development of new technologies. "We want to make sure we allocate funds to the products with the highest potential for success," he says.
New products at Ciba include a nanoencapsulization technology that allows light stabilizers to be applied in water-based coatings, as well as lubricant additives formulated to meet European eco-labeling standards.
At Clariant, which recently divested its life sciences businesses, the specialties operations have been going through a reordering to better align research and marketing resources to customer needs, according to Monika Riese-Martin, head of corporate development. "In the last two years, we have identified which of the businesses are more product-oriented and which are more application-oriented," she says.
Clariant is now organized into four divisions: textile, leather, and paper chemicals; pigments and additives; functional chemicals; and color and color additives masterbatches. Clariant is managing the 40% of its businesses that are product-oriented with "an intense focus on efficiency" and the 60% of its businesses that are service-oriented with a combination of cost leadership and application and service know-how.
Most specialty chemical development work is being done within the context of a strategic push called Clariant 2010. "We are going to focus on operational excellence, somewhat on portfolio management, and really try to be more stringent in implementation and paying attention to the consequences of how we manage our businesses," Riese-Martin says. "Some of our businesses are more knowledge intensive, more on the specialty side of the scale. What we want to do when we focus on operational excellence is make sure these businesses have what they need."
At FMC, specialty chemical managers are trying to expand both mature businesses serving food and pharmaceutical markets and newer businesses such as a just-formed health care ventures unit, which is moving natural products and biopolymers into wound care and other novel applications. The company's lithium division is also looking for new applications in energy, electronics, and other industrial markets.
According to Theodore H. Butz, vice president of the firm's specialty chemical division, growth comes down to innovation, and innovation often comes from no-nonsense applications development work.
"There is a rejuvenation in the lab," Butz says. "If you look at trends in the specialty chemical industry 12 years ago, all anyone talked about was the ultimate highest value-added ingredient. Foo-foo dust. And somebody would be willing to pay for it." But competition had a commoditizing effect, he says. "We needed to rethink how to grow, especially in the U.S., Europe, and Japan. We needed to innovate out of low growth."
In FMC's lithium division, some of that growth is coming from new product development. "There are a million and two uses," Butz says. "The trick is to know when to go on to something else when you go down a dead alley." He notes that FMC cut short a foray into lithium-cobalt batteries. "It is very competitive, and cobalt is very volatile in price," he says.
Butz assesses FMC's specialties portfolio as 35% high-value specialties and 20% cyclical, commodity-like materials. The rest of it falls somewhere in the middle. Product life-cycle management is an important concern at FMC, Butz says, where some businesses in the health care area are experiencing "embryonic" growth while others, such as the food ingredients business, seek to rise above price competition and create value through applications work with customers.
At Chemtura's performance specialties division, which manufactures urethanes and petroleum additives and fluids, technical service and application research has driven growth to some extent. Still, there are limits to what can be achieved merely with new formulas of old chemicals, according to David J. Sikora, vice president of chemical technology for the division.
"In some of the areas we know best, the industry has hit the wall on formulation to a certain degree," Sikora says. "There is a need for new molecules to make step changes." In polymer and petroleum additives, he adds, Chemtura is actively filing patent applications for plastic and lubricant antioxidants.
During the past year, Sikora's division introduced four new products: Barinate B-70, a barium sulfate-based corrosion inhibitor for industrial lubricating oils; Naugalube 810, a nonphosphorus, nonsulfur antiwear additive for engine oil; Naugard 431 Plus, a liquid phenolic antioxidant additive for polyolefins that replaces solid antioxidants; and Weston NPF705, a phosphite-based plastics antioxidant that replaces nonylphenol-containing phosphites.
"It isn't typical for us to introduce four products in one year," Sikora says. "But the company is seeing years of work coming to fruition at this point; we are harvesting fruit of seeds planted five or six years ago." Much of the product development of recent years is aimed at keeping ahead of environmental regulations. "The dial is turned up for greener materials and low pollution. And we are not going to reach the point of regulations being relaxed. Products are being introduced as new things come up on the radar screen. It's a great marketing driver for us."
Environmentally friendly products are just one of many drivers at work in specialties research, where the diversity of chemistries and end markets are reflected in the diversity of growth strategies. The one constant is that chemistry alone cannot guarantee the growth that companies are looking for, be the market a fast-growing one like health care or a mature one like paint.
"It's a diverse area, with a lot of unique chemicals," Accenture's Bjacek says. "But paint is dog-eat-dog. There is no way you are going to avoid a down cycle."
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