Recalibrating Contract Firms

The nonpharmaceutical contract manufacturing sector has, like its drug-targeting counterpart, fallen on hard times. The economy, energy prices, Asian competition, and the shrinking market for agricultural chemicals in recent years have led to consolidation and a refocusing as companies pursue growth markets such as specialty polymers.

Custom processing of industrial chemicals is a diverse field. It includes small, independent firms such as Dixie Chemical and KMCO, as well as the contract manufacturing units of large, diversified chemical companies such as Dow Chemical, Degussa, and Clariant. Many have operations in major chemical centers such as Houston, while others operate in more remote areas like Galena, Kan.

They all, however, operate in the same economic environment as the customer base they share. For the past three years, that environment has been harsh.

"We are glad that 2003 is in the history books," says Philip A. Johnson, senior vice president and general manager of Dixie, which operates in Pasadena, Texas. Although sales were up more than 6% last year, Johnson says natural gas prices and raw material costs erased this gain from the bottom line. The firm is optimistic about continued growth in revenue this year, and has launched an efficiency campaign to mitigate the rising costs, he says.

Meanwhile, Houston-based KMCO saw a solid recovery in 2003 following unusually tough times beginning in 2001. Richard T. McDill, regional manager of custom processing, credits improvement in the economy and a general movement of the chemical industry out of its slump. KMCO invested in two large reactors last year.

Similar stories can be heard across the sector. Although the timing may differ from company to company, producers uniformly speak of good indications for improvement following a surprisingly severe downturn in business over the past three years. Consolidation, reorganization, and efficiency improvement measures--as well as some investment in capacity expansion--are under way to maximize profitability going forward.

"We didn't meet our targets for growth last year," says Simon Upfill-Brown, business director of Dow Haltermann Custom Processing, Dow's nonpharma contract business. "We were targeting 8% growth, but we achieved only 2%. You can say we were too optimistic. This year, we are targeting 5 to 6% growth."

Upfill-Brown says energy prices, the economy, and Asia factored into last year's performance, but the fate of a handful of important contracts also figured heavily. "We've had one or two projects in the last year in which we were expecting higher volumes and, for whatever reason, it didn't happen."

That phenomenon, according to Edward E. Greene, Dow Haltermann's commercial director, can have a big impact. "It's a project-driven business. The difference between 2% and 8% growth may come down to a couple of projects you thought you would land but you didn't."

TIMING AND SPEED are crucial in nonpharma contract work, Greene explains. "A lot has to come together for our customers ultimately to sell a product that we would make for them," he says. "And the speed with which things develop is very much different than with pharmaceutical work. You have to go from initial trials to 20 million lb in 90 days." Repeat business is also important, he says. It is best for the contractor if customers have several projects in the pipeline, so that there is work coming up behind anything that drops off.

During the past two years, Dow Haltermann has consolidated operations, closing down its phosgene joint venture with SNPE and dismantling the plant. Assets that had been interspersed with Dow's fuel additives business in Houston were consolidated into one area of the facility.

Like many players in the field, Dow is separating pharma and nonpharma custom manufacturing assets. In January, the firm disbanded its custom and fine chemicals division, moving Dow Haltermann into specialty chemicals and Dowpharma into its Dow Ventures group.

Upfill-Brown says he is optimistic about business this year, noting an uptick in large-scale production in Houston and in Antwerp, Belgium, the firm's other large-volume production facility. "We have very rigorous pipeline management, and we are optimistic that a number of things in the pipeline will come through."

At Ruetgers Organics, the nonpharma contract unit of Ruetgers AG, speed and flexibility are highly prized. The company's competence in these areas has recently been put to the test, according to John Wetzel, director of fine chemicals.

As part of a project to cut capacity by 50%, Ruetgers consolidated operations this year at a 20-year-old plant in Augusta, Ga. In doing so, the firm closed its 47-year-old manufacturing operations in State College, Pa., transferring equipment and ongoing projects to the Augusta site, which was originally built to produce 2-chloro-pyridine but was converted to contract work in the 1980s.

"The downcycle of the business certainly figured into the decision to shut down the State College plant," Wetzel says. "We now have a plant in Augusta running at better than 85% capacity."

Wetzel says the company is hoping to limit its exposure to swings in the agchem market by growing other parts of the business, such as high-tech and specialty polymers. In recent years, he says, agricultural chemicals have accounted for as much as 85% of the company's business. They are now down to about 50%.

One of the company's key strengths, Wetzel says, is process development. The firm has landed several contracts because of its ability to design and build processes that cut time and cost out of production or that eliminate dangerous solvents, he says. A key component of Ruetger's processing toolbox is phase-transfer catalysis, Wetzel says. This year, the company added new high-pressure and high-temperature reaction capability with equipment that can handle up to 3,000 gal at a pressure as high as 600 psi.

Last year, the division introduced its first catalog product, polyphosphazene, a temperature-resistant, flexible material with aerospace and military applications. Ruetgers developed the product in partnership with Pennsylvania State University, according to Wetzel.

Georg Weichselbaumer, general manager of Clariant's nonpharma custom synthesis unit in Germany, says contract business has been stagnant if not declining in recent years. But things are picking up. And despite the fact that Clariant, like Ruetgers, is working to decrease its dependence on agricultural chemicals, part of the uptick is in agchem, Weichselbaumer says.

Still, agchem is a difficult business to rely on. "There are only three innovators left in Germany," he says, "Syngenta, Bayer, and BASF." Customers are also beginning to "in-source," according to Weichselbaumer. And while business is up this year--part of the "good news" is an outbreak of Asian rust fungus in South America--pricing is under constant pressure.

Clariant has also downsized, closing a facility in Rock Hill, S.C., and mothballing operations in Elgin, S.C. The company also consolidated its plants in Griesheim, Germany. Overall, Clariant cut staff in this area by 200 in 2003, a 20% reduction.

All of this has taken place as Clariant took on the task of integrating the contract manufacturing assets of British fine chemicals producer BTP, most of which are in the pharmaceutical arena. Clariant's custom synthesis business currently consists of three units--pharmaceutical, nonpharma custom synthesis, and specialty fine chemicals.

Weichselbaumer says the company contemplated setting up an operation in China as a means of competing against low-cost Asian suppliers. "We decided we were too late to establish something new there," he says. "There is enough steel in the ground in China."

Instead, India is Clariant's primary front line in dealing with Asia, and the company is planning to nearly double the size of its plant in Roha. Although the Indian plant is run to Clariant standards, Weichselbaumer acknowledges that customers concerned with "intellectual property, reliability, and cooperation" tend to prefer to work with the firm in the U.S. and Germany.

Cooperation is extremely important in nonpharmaceutical contract manufacturing, Weichselbaumer says. "Agchem is an especially cost-driven business. There is a huge effort on the part of the customer and supplier to jointly identify the potential for savings. Pharmaceutical customers are more focused on regulatory issues, and don't work as closely on the cost factor of the final molecule."

DEGUSSA ESTABLISHED separate businesses for pharma and nonpharma contract work last year. According to Michael Korell, business development manager for the company's new Building Blocks business unit, the move can be viewed in the context of integrating Hüls, SKW Trostberg, and Laporte--all major acquisitions of the past four years, each with a contract manufacturing component. But ultimately, he says, splitting pharma and nonpharma contract work was a conscious decision on the part of Degussa to break up two businesses that had been managed as one.

In November, the firm announced the formation of the $1 billion nonpharma Building Blocks unit and a pharmaceutical contract chemical division half the size called Exclusive Synthesis & Catalysts. The new structure will allow the nonpharma group to concentrate on a business operation that is ultimately quite different from pharma contract work, Korell says.

"There are very few pharmaceutical products that reach a scale of 1,000 tons or more. This is not uncommon in the industrial field," he says. Speed to commercialization is also a major difference--drug products can take six to eight years to reach the market, while in the industrial area many products are commercialized in two to three years. "As a supplier to the industrial market, you have to be able to keep up with the pace of your customers," Korell says.

Agility must be matched with comprehensive reaction expertise, Korell adds, "but you also have to be selective. You have to decide which technologies make sense from an economic perspective. Not every technology that looks attractive from a scientific perspective will be suitable because of the costs associated with it."

Korell says Degussa focuses on areas where technological strength is matched with back integration and secure raw materials supply. These include malonates, cyanoacetates, orthoesters, cyanamids, and downstream derivatives.

Agricultural chemicals make up a small part of the Building Blocks portfolio, and Korell does not expect significant growth. Major markets are polymers and polymer additives for adhesives and coatings, textile chemicals, and flavor and fragrance ingredients. Electronic chemicals are also a growing part of the portfolio. "But the growth push is in materials--polymers and modification of polymers," Korell says. "That is where most of the growth in the industrial market will be in the future."

Degussa's Building Blocks division manufactures in Germany, the U.K., Spain, Belgium, and the U.S. Although Exclusive Synthesis shuttered a plant in Germany over the past year, Korell says Building Blocks has not had to close any facilities. There is, however, a steady process of consolidation within the plants, whereby the company evaluates the relative benefits of filling idle capacity or shutting it down and pushing for efficiency improvements to accommodate new work.

Korell says results fell below expectations in 2003, largely because of energy and related raw materials costs. On the other hand, the recent slump has had a positive effect because of its impact on customers. "There is steady business from companies that are having a tough time getting the funding to start new [manufacturing] projects," he says. "Some of the projects we are currently discussing with people are driven by the intention to consolidate and shut down facilities, to hold tight, or by the lack of funds for investment in new capabilities."

Ultimately, sources agree that the business of contract manufacturing is fraught with this kind of contradiction. Although fortunes are to some extent tied to the economy, project management and sheer chance can pull business in the opposite direction. "One thing in our business that I am absolutely sure about is that what we think is going to happen won't," Dow Haltermann's Upfill-Brown says. "Then something else comes through. That's very much the nature of the business. You have to be extremely flexible."