Issue Date: February 18, 2008
LAST YEAR was a good one for many U.S. chemical companies. Though energy and raw material prices reached all-time highs, firms were able to pass along price increases to customers in most product lines and turn respectable profits. And while the domestic housing and automotive sectors slowed, overseas demand for the products of the U.S. chemical industry was strong.
These trends are likely to continue through 2008. Most firms are factoring in a brief slowdown in the U.S. in their 2008 plans, but they expect to take advantage of continued growth in demand for chemical products from the rapidly developing economies of Asia. And so, with some caution, they are attempting to tailor their 2008 capital and research expenditures to the times.
Together, the 17 chemical companies that responded to C&EN's annual survey aim to increase spending on new plants and equipment by an average of 8.6% in 2008 to nearly $8.8 billion. If they follow through on their plans, it will be the fifth time in the last decade that the group increased capital expenditures. The largest increase in that period was in 2006, when the group boosted its investments in new assets by a whopping 20.7%. And though the group's 2008 plans mark a significant increase, it is the second year in a row in which investment growth has slowed.
A subgroup of the companies that also provided R&D budget data is likely to increase spending at a slower pace. The 14 firms that responded to this year's survey say they budgeted a combined $2.8 billion for research in 2008, up 6.0% from last year. The good news is that the rise will cover increases in the projected rate of inflation and then some. However, this year's increase marks a slowdown compared with the collective 8.2% and 6.7% budget enhancements in 2007 and 2006, respectively.
Assessed in meteorological terms, the overall forecast for future-oriented spending would be partly sunny. The combined 2008 budget of the 14 firms that supplied both R&D and capital spending data is $9.9 billion. Storm clouds may be off in the distance, especially if a U.S. slowdown spreads to the rest of the world, but for now, most companies remain optimistic. Although the pace of the industry's spending growth has slowed, the 2008 figure marks a collective high. The group's future-oriented spending hit a decade low of $5.8 billion five years ago. Capital spending gets most of the credit for the rebound.
However, if you take inflation into account, the funds headed for future-oriented projects will not buy nearly as much today as they did 10 years ago. In 1998 dollars, the $9.9 billion that the group plans to spend this year would be worth only $7.8 billion.
Because of the faster pace of capital spending in recent years, the ratio of investment in new equipment to investment in research has increased steadily. At the decade low in 2004, 64.7% of future-oriented funds were directed toward capital improvements. Budgets for 2008 direct 71.5% of funds to capital projects, although that is not as high as the 72.3% of funds spent on new equipment in 1998.
Funding devoted to R&D does not fluctuate as dramatically. So when the economic outlook is good, a proportionately smaller share of budgets tends to go to R&D. This year, 28.5% of future-oriented spending will likely go to research, compared with the 10-year high of 35.3% in 2004.
THIS YEAR, C&EN conducted its survey in early February as companies were releasing 2007 financial results. Last year, C&EN conducted its survey in late January (C&EN, Feb. 5, 2007, page 12). As a result, the 2007 data in this year's survey more closely reflect the R&D and capital spending numbers companies reported in their year-end statements.
The number of firms willing to reveal their future-oriented spending plans to the press and investors varies from year to year. Last year, for instance, 16 firms provided forecasts for capital expenditures and 14 provided the numbers for R&D. This year, 17 firms revealed their 2008 capital spending budgets and just 14 were willing to give out R&D forecasts.
Appearing in last year's survey but absent this year is Chemtura. The firm spent $116 million on new equipment and $62 million on R&D in 2007, but declined to forecast 2008 budgets. The firm recently hired a financial adviser and said it is considering "strategic alternatives," including a sale of the firm.
Back on the capital spending table after a year's absence is 3M. However, unlike in prior years, the firm could not provide a forecast for R&D spending and so is missing again from that survey. In 2007, 3M spent $1.4 billion on its research efforts, down 10.0% from 2006.
Budgets are not set in stone and unforeseen circumstances often force managers to adjust their priorities. Companies surveyed in January 2007 expected to increase 2007 capital spending by 7.6%. However, firms participating in this year's survey say they actually increased spending by 13.2%. Even without 3M, whose budget is so large it can have a significant effect on the collective data, spending rose 11.5%, in part due to rising costs for construction materials.
For R&D, it is a similar story. Last year's group planned to increase R&D spending by 5.8% while this year's group reports that it actually increased R&D outlays by 8.2%.
Of the 17 companies surveyed for their 2008 capital spending plans, 15 plan to increase spending on new plants and equipment and two plan to keep it level with 2007. This compares with 13 that increased spending in 2007 and four that reduced it.
In some instances, firms are continuing projects to satisfy customer demands. Last year, Cytec Industries said it planned to ramp up capacity to produce carbon fiber used to make lightweight composite materials. Those expansion efforts continue this year, says a company spokeswoman, along with projects to increase capacity for waterborne and radiation-curable coatings materials. Due largely to these projects, the company says it will hike capital expenditures in 2008 by a hefty 65.2% to $190 million.
Others are pursuing projects to expand their global footprint. Cabot, for instance, plans to give a significant lift to its capital budget with an expansion of its carbon black and specialties facilities in China as well as a series of global projects aimed at making its plants more energy efficient. The firm plans to increase capital spending by 54.1% to $225 million.
Arch Chemicals plans a more modest 26.2% boost in new plant spending to $53 million. The most significant project for the firm will be the completion of a plant in Suzhou, China, that makes a zinc-based antidandruff compound. Other projects, according to a company spokesman, include the expansion of its water treatment chemicals business in Brazil.
C&EN predicts that the group's capital spending as a percentage of sales will be 6.0%, up from 5.7% in 2007. The estimate assumes a 2.5% increase in sales in 2008. That ratio hit a 10-year high in 1998 when spending on capital projects reached 9.3% of sales. The decade low occurred in 2004 when the group spent only 4.6% of sales.
Of the 14 firms surveyed for their R&D spending plans, nine plan to increase spending in 2008 and five plan no change from 2007. This compares with 11 that increased expenditures in 2007, one that made no change, and two that cut their budgets from 2006.
W.R. Grace plans an 18.9% boost in its research budget to $88 million as the company increases its competitive posture and gets closer to emerging from bankruptcy. Rohm and Haas plans a 13.2% boost in R&D spending to $335 million. A spokeswoman says that the increase "supports an additional focus on product development for rapidly developing economies."
In 2008, C&EN estimates, R&D spending as a percentage of sales for the group will be 2.5%, just a notch above the decade low of 2.4% during the years 2005 to 2007. The decade high was 3.7% in 1998.
Inevitably, inflation wears away at the purchasing power of cash devoted to research. The $2.8 billion committed to R&D by this year's group of 14 companies represents just $2.2 billion on a constant 1998-dollar basis. But that $2.2 billion also sets the inflation-adjusted high for the last 10 years.
OTHER SURVEYS of spending plans find many chemical companies continuing to ramp up investments in new plants and equipment. According to the American Chemistry Council's economics and statistics department, improvements in industry profit margins since 2003 have set the stage for increases in capital spending.
On the basis of a fall 2007 survey of its members, ACC anticipates that 2008 capital spending for basic and specialty chemical companies will increase by 6.3%-somewhat less than the 8.6% increase that C&EN's February survey found. Looking ahead, ACC expects chemical firms will lower the bar somewhat in 2009 and fund a 6.0% increase.
Over the long-term, U.S. chemical firms are shifting expenditures overseas both to follow customers and to invest in regions offering lower feedstock costs than in the U.S. ACC says its members expect to reduce the U.S. share of their total capital spending budgets from 62% in 2006 to 48% in 2011. Benefiting in particular from the shift abroad are Africa and the Middle East, which together will garner 15% of ACC member budgets in 2011, up from 2% in 2006.
ACC's survey also predicts a 4.4% gain in 2008 R&D spending by chemical firms-less than the 6.0% rise that C&EN's survey projects. ACC predicts an additional 4.9% rise in 2009.
A subset of the chemical industry, represented by the Synthetic Organic Chemical Manufacturers Association (SOCMA), is eager to expand and invest in R&D. A late-2007 survey of members, who are mainly small and midsized custom and fine chemical makers, pointed out that members plan increases in 2008 expenditures in both new equipment and R&D.
DESPITE RISING competition from India and China, 75% of 41 SOCMA member companies say they will boost their investment in R&D by 2-10%. The mean investment planned is 8.6% of sales. The 2006 survey found that only 68% of respondents said they would boost R&D by 2-10%, with the mean spending level at 8.0% of sales.
In addition, 38% of respondents to the SOCMA survey say they are very likely or somewhat likely to invest in new equipment in 2008. The mean investment planned for new equipment is 10.8% of sales. The 2006 survey found that 41% of respondents were very or somewhat likely to make investments in new equipment in 2007, with the mean spending level at 8.8% of sales.
A survey of a broad range of U.S.-based industrial companies conducted in the summer of 2007 finds that respondents are planning "a significantly higher level of R&D spending" in 2008. Even though the Industrial Research Institute's (IRI) report, "R&D Trends Forecast for 2008," cites high energy prices and a weak dollar as reasons for concern, it says companies feel compelled to respond to societal and environmental needs with greater investments in new technology.
Of 80 respondents, 54% plan a 2.5%-or-greater increase in 2008 R&D spending and only 11% plan to hold spending at the same level as it was in 2007 or to reduce it. The results were comparable with last year's IRI survey, for which 58% of 99 respondents expected an increase in R&D spending of more than 2.5%; 14% planned to hold spending at the 2006 level or reduce it.
IRI also asked the firms responding to its survey this year whether their spending in 2007 matched earlier budget projections. About 37% said their actual investments differed from their initial projections for a variety of reasons, including lack of personnel, increased emphasis on growth in new products, and strategy changes.
Because the millions of dollars spent on R&D do not always lead to successful new products and processes, R&D leaders are constantly looking for ways to boost their successes and minimize failures. Most, if not all, have adopted the stage-gate management methodology developed by Product Development Institute cofounder Robert G. Cooper. The method, intended to rapidly move ideas from conception, through feasibility studies, to development, and on to product launches, is designed to discard notions that can't make the cut at increasingly rigorous decision gates.
HOWEVER, Gary R. Traylor, executive vice president of consulting firm Celerant, says most chemical firms don't use the stage-gate process effectively. Instead, he says, most firms use it "to funnel only the most risk-averse and financially viable risk-weighted ideas to fruition." What is missing, he says, is an outsider's view of where customer needs and trends are headed.
One trend that is having an impact on chemical companies is the movement to make products and processes green. Peter Nieuwenhuizen, a senior manager at consulting firm Arthur D. Little, says definitions of what makes a product or process green can vary but that most involve the reduction or elimination of waste and the more efficient use of energy.
Nieuwenhuizen suggests that chemical firms could look at the green policies of government entities, such as the European Union's Registration, Evaluation & Authorization of Chemicals program, and the initiatives of nongovernmental organizations such as Greenpeace as opportunities and not just threats. He encourages chemical companies to use their R&D apparatus to develop products and processes that will give them an edge in an increasingly regulated market.
Hercules, for instance, has taken green chemistry seriously and last year won a government endorsement for its efforts, says Richard Royce, the company's director of technology. The firm helped to develop a plywood adhesive made from soy flour as an environmentally friendly replacement for conventional formaldehyde-based adhesives. Together with partners from Oregon State University and Columbia Forest Products, the company received a Presidential Green Chemistry Challenge Award.
For Cabot, green chemistry means developing less energy-intensive processes to make the company's core product, carbon black. Besides enjoying cost savings that result from using less energy, the company will also reduce carbon dioxide released into the atmosphere, says Yakov Kutsovsky, vice president of R&D. Green chemistry also means developing energy-conserving materials such as Cabot's Nanogel aerogel, which can be used to insulate homes or refrigerators, he adds.
Taking calculated risks, whether to develop greener products or processes or to otherwise advance the business of chemistry, is what R&D managers do best. As long as corporate earnings continue to be strong, most chemical firms will plow dollars back into research and new equipment in the hopes that new business will sprout in the future.
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