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Mckinsey on Chemicals

Mckinsey on Chemicals

McKinsey on Chemicals

Number 3, 4 22 40 Winter 2011 Chemicals’ changing in Improving pricing competitive landscape chemicals: An interview and sales execution with Dow Corning’s in chemicals Stephanie Burns and Gregg Zank

10 32 46 A capital-markets Capturing the lean Kick-starting organic perspective on energy opportunity growth chemical- in chemical performance McKinsey on Chemicals is written Editorial Board: Florian Budde, Copyright © 2011 McKinsey & Company. by consultants in McKinsey’s global Philip Eykerman, Bob Frei, All rights reserved. chemicals practice together David Hunter, Tomas Koch, John Warner with other McKinsey colleagues. This publication is not intended to be Editor: David Hunter used as the basis for trading in the shares This publication offers readers of any company or for undertaking insights into value-creating strategies Art Direction: Veronica Belsuzarri, any other complex or significant financial and how to translate these Shoili Kanungo transaction without consulting strategies into company performance. Design Direction: Veronica Belsuzarri appropriate professional advisers. Design and Layout: Shoili Kanungo To send comments, request Editorial Production: Elizabeth No part of this publication may be copies, or to request permission to Brown, Heather Byer, Nadia Davis, copied or redistributed in any republish an article, send an Torea Frey, John C. Sanchez, Venetia form without the prior written consent e-mail to McKinsey_on_Chemicals@ Simcock, Sneha Vats of McKinsey & Company. McKinsey.com. McKinsey & Company Industry Publications Editor-in-Chief: Saul Rosenberg Managing Editor: Lucia Rahilly

Illustrations by Jon Krause McKinsey on Chemicals Number 3, Winter 2011

4 10 22 Chemicals’ changing A capital-markets Innovation in competitive perspective on chemicals: An interview landscape chemical-industry with Dow Corning’s performance Stephanie Burns and High energy prices and Gregg Zank the global economy’s Long-term analysis shows eastward shift are that capital markets base Dow Corning’s CEO and creating new chemical- valuations of chemical CTO talk about successful industry leaders who companies above all approaches to new- play by different rules. on past operating product and business- Newcomers must build performance, and that model innovation. capabilities to sustain there is little difference their success, while over time between the incumbents must sharpen specialty, commodity, their value propositions. and diversified segments.

32 40 46 Capturing the lean Improving pricing Kick-starting energy opportunity and sales execution organic growth in chemical in chemicals Even in a recovering manufacturing Some chemical companies economy, many companies Companies can adapt have blind spots when see only limited potential lean tools and approaches it comes to steering sales— in organic growth. But by to improve energy and they pay for it in targeting micromarkets efficiency and capture lost margins and growth. and reorganizing the sales significant savings An approach built force to prioritize growth, in the current environ- around a more granular companies can achieve ment of high energy level of insights makes it growth rates well above prices. possible to improve the overall market. execution and boost returns. 2

Introduction

Florian Budde, Tomas Koch, and John Warner changing competitive landscape” shows how high energy prices and the global economy’s eastward shift are aiding the rise of new leaders, companies playing to different rules than the incumbents that have led the industry for the last several decades. While the incumbents have focused on classic share- holder value, the newcomers are more focused on resource monetization and economic development. If each type of company is to thrive, the newcomers need to build capabilities in management, innovation, and marketing performance to capture their full potential, and incumbents must adapt their strategies and Welcome to the third issue of priorities to this new landscape. McKinsey on Chemicals Our second article takes another longer-term Over the past year, the worldwide chemical perspective on the industry, in this case industry has seen a rebound that has surpassed that of the capital markets. Our analysis of the its most optimistic expectations. Demand period from 1994 to 2009 shows that the remained strong in the major emerging markets, chemical industry has been a strong performer, boosting the growing chemical industries in outpacing most of its major customer in- those countries as well as generating export dustries in recent years. As “A capital-markets demand for established chemical production perspective on chemical-industry perfor- centers in , North America, and Japan. mance” explains, the analysis contradicts one But demand has also proved more resilient in element of conventional wisdom by showing the developed world than had been feared in that there is no empirical basis for the commonly the darkest days of early 2009. US producers in held view that capital markets favor less cy- particular have confounded doomsayers and clical specialty-chemical companies over com- ridden the shale-gas boom that has brought a modity or diversified companies. Instead, the data low-price feedstock bonanza. show that capital markets base their valuations overwhelmingly on past operating performance, Nevertheless, the crisis has certainly affected the regardless of company type. We also analyzed industry significantly. As our first article the capital-markets performance of a sample of shows, it has accelerated shifts in the global companies through the crisis, an exercise that industry’s long-term makeup. “Chemicals’ showed that markets rewarded companies that Article title here 3

took rigorous action—again underlining translation of lean principles to the area of the market’s focus on operating performance. energy consumption.

Proceeding from the general to the parti- Our last two articles focus on marketing and sales cular, our next two articles address themes that topics. With the chemical industry in recovery are consistently high on the priority list for mode and enjoying a volume and margin rebound, senior chemical-industry management—innovation marketing and sales is a particular concern and energy. Innovation remains a major area for senior management. “Improving pricing and of opportunity for chemical companies, and one sales execution in chemicals” describes of the most successful practitioners of inno- an approach that enables companies to achieve vation in the chemical industry is Dow Corning, greater transparency on product and account though it is not necessarily among the profitability and sales-force actions; companies best recognized as such because the company is adopting the approach have improved their privately held. We sat down with Dow Corning return-on-sales performance, in some cases sub- CEO Stephanie Burns and Gregg Zank, its chief stantially. The second article, “Kick-starting technology officer, to talk about their approach to organic growth,” describes how to apply a both new-product innovation and business- more granular lens to discovering new market model innovation—an area in which Dow prospects—micromarkets—and explains how Corning’s Xiameter brand has been a trailblazer. chemical companies can then move to capture these opportunities. Climate change has dropped down many CEOs’ agendas in the year since the Copenhagen In this and future issues of McKinsey on Chemicals, conference, and with it the urgency to reduce we will bring you the best of our thinking in the energy consumption and in that way reduce field. We trust that you will find the publication dioxide emissions. However, energy prices thought provoking, and we welcome your feedback remain at high levels, and energy savings and suggestions for topics to cover in addition continue to present an important area that is to those we are already working on. Please write worthy of focus. In “Capturing the lean to us at [email protected]. energy opportunity in chemical manufacturing,” we describe a new approach to improve energy efficiency based on an adaptation and

Florian Budde ([email protected]) is a director in McKinsey’s Frankfurt office, global chair of the chemicals practice, and leader of its Europe, , and Africa chemicals practice. Tomas Koch ([email protected]) is a director in the Seoul office and leader of the chemicals practice.John Warner ([email protected]) is a director in the Cleveland office and leader of the Americas chemicals practice. 4

Chemicals’ changing competitive landscape

High energy prices and the global economy’s eastward shift are creating new chemical-industry leaders who play by different rules. Newcomers must build capabilities to sustain their success, while incumbents must sharpen their value propositions to compete.

Florian Budde A major shift in the competitive landscape of the in a high--price world, and privileged access to worldwide chemical industry is under way as the most attractive consumer-growth markets. new players from oil- and gas-producing countries and the high-growth developing markets of While newcomers may be better placed than China and join the industry’s top ranks in incumbent chemical companies in Europe, North sales. The new players focus on resource America, and Japan, the shift creates challenges monetization and economic development, in for both groups. If the newcomers want to contrast to the classic shareholder value- establish themselves as industry leaders in the creating goals that have historically informed the coming decades and fully realize the industry’s strategies of top players. wealth-creating and society-supporting potential, they must evolve rapidly. They should move Not only are these newcomers playing by different beyond simply monetizing their cost- and market- rules, but they are also better placed to ben- advantaged positions to build capabilities that efit from two of the key dynamics driving the will put them on more equal footing with incum- industry’s future: control of advantaged feedstocks bents when it comes to management, innovation, 5

and marketing performance. At the same time, Closely related to this is the third major change— to assure continuing success in this new the arrival among the chemical industry’s landscape, incumbents must reconsider their po- leadership ranks of companies based in sition in the industry and adapt their strategies hydrocarbons-producing countries and in large, and priorities accordingly. Newcomers and high-growth developing markets such as incumbents that can take these steps will be well China and India. The simpler value propositions positioned to ride the global chemical industry’s of the new players are in some ways on a continuing profitable growth trajectory. collision course with the value propositions of the traditional players, and the disruptive potential A changed industry of this development is only gradually coming Coming out of the financial crisis and economic into view. slowdown of the past two years, the global chemical industry is seeing major changes. The The industry’s leading incumbents have operated first relates to energy-price dynamics. The for the past two decades with similar goals: chemical industry is confronting unprecedented striving to increase shareholder value based on hydrocarbon price volatility. In addition, energy their technology portfolio and asset base, and prices are significantly higher than they have been making opportunistic excursions from traditional for the past two decades—and they are higher home markets to tap emerging-market growth. than they were coming out of previous recessions. Whether the companies were based in Europe, While there is little progress on climate-change North America, Japan, or South Korea has regulation, which could add carbon tax–related only added nuance to this common approach. costs for chemical companies in certain regions, the industry is nevertheless seeing increasingly In contrast, for governments and their production pronounced divergences in gas and electric power subsidiaries from hydrocarbons-rich countries, prices among regions. Overall, the degrees of chemical manufacturing represents an opportu- cost advantage and disadvantage among regions nity to monetize advantaged feedstock re- have increased. sources and build industries that will provide jobs for their rapidly expanding populations—even Second, the economic downturn has highlighted if it will have a detrimental effect on industry the accelerating shift in the growth of global structure and profitability. chemical demand from developed economies to the developing world. While demand in For leading companies based in fast-growing major Europe and the has not returned emerging markets, chemical production is seen to pre-crisis levels and seems unlikely to do as a necessity to provide the products needed for so until 2012, China’s chemical demand increased continued economic expansion. Lower labor by 6.4 percent in 2009 and by over 15 percent costs in these countries translate into competitive in 2010. Meanwhile, new petrochemical capacity capital-investment and operating costs for in the Middle East continues to expand, while these companies, many of which are owned by plant-closure announcements have multiplied in the state or by families that have close ties to Europe, Japan, and the United States. the government. These companies can establish 6 McKinsey on Chemicals Winter 2011

Building a worldwide market presence will require that newcomers take steps to establish international operations and build up the management skills to run those operations successfully

production to capture local market growth, entry has been built on production, taking and they are little concerned about any resulting advantage of their lower cost base to establish global supply-demand imbalances for the a presence based on price in their export chemicals in question. markets. This is a logical approach and a natural entry point. But it tends to result in the Importantly, both groups of newcomers include commoditization of the market and a strict focus many government-backed companies. As a on the lowest price, and it therefore risks result, these companies can invest on a scale that destroying a lot of the value that exists in the is much greater than even the largest traditional market for the new entrants as well as for chemical-industry players. existing players.

These changes have been building for years, but There have been numerous examples of compe- their importance is hard to overstate. In sum- tition from new low-cost producers that has mary, incumbents that have ridden growth in reduced prices well below the level that would developed and developing markets are now assure them a foothold in developed markets, undercut by powerful new rivals with access to in products as varied as terephthalate cheap feedstocks and the most attractive and fluorochemicals. Similarly, Chinese specialty- growth markets. chemical products are often sold in developed markets in North America and Europe on a The new competitive dynamics pose important specification basis through third parties, which questions for both newcomers and incum- means that the Chinese producers are cut off bents about the steps they must take to assure from customers and have limited insights into their continued success. For the newcomers, market dynamics. the choices are arguably more straightforward than for the incumbents, which have large As new players build their presence in the legacy businesses to reposition. industry, they must develop capabilities to sustain their growth and look more ambitiously at the Newcomers must develop world-class kind of profile they want to create. As a first step, capabilities they must establish their own R&D and inno- For new producers—whether based in feedstock- vation capabilities, which will enable them to offer rich countries or high-growth emerging- differentiated products and make them less market countries with low labor costs—market dependent on incumbents for technology. Chemicals’ changing competitive landscape 7

Second, new producers must start to build overseas locations will be a new challenge for marketing capabilities that will enable them to these players’ senior-management teams. move beyond selling simply on low price and reap the full economic benefits from their products. Incumbents must reappraise their They must develop expertise in approaches opportunities and adapt such as differentiated marketing, transactional Established producers in Europe, Japan, pricing and value pricing, and sales-force South Korea, and to an extent North America management. This is a need shared by all new will have to take steps to adapt to lower producers, whether they are manufacturing overall demand-growth rates for chemicals for export or meeting surging demand in in their home markets. Clearly, there are home markets. segments of the industry in mature, developed markets that continue to enjoy good prospects Developing these capabilities will help new and that are relatively safe in the new competitive producers get better returns from their current landscape. These divide into two main areas, product range and avoid leaving money on upmarket and down-market, where there will be the table from selling at unnecessarily low prices. niches that are relatively impregnable. Doing so will become even more pressing as new producers expand their portfolios to include The first area is chemical-industry segments more sophisticated and higher-value-added in markets that require customer intimacy and a products, from which they will want to extract high level of service support. Examples include maximum value. -and-fragrances companies that have de- veloped superior customer insights and ex- Becoming worldwide suppliers will require new clusive manufacturing know-how to support producers to establish marketing and sales customer demands; companies that capabilities in developed markets that are sophis- manage the painting of automobiles within the ticated enough to support this type of product. production line; leather chemicals, where Many of these products will require a completely the producer works closely with luxury-goods different type of sales approach—one that is makers; and -treatment and construc- capable of dealing with product-approval regis- tion chemicals. In all these cases, customer inti- trations, gaining intimacy with customers’ macy makes them less vulnerable to inroads product-development programs, and getting from low-cost offshore competitors. The second products specified for these programs. area is a group of basic chemicals where the low prices mean that importation is not viable; Third, all of the above moves related to building a this includes such products as sulfuric acid, worldwide market presence will require that peroxide, industrial gases, and, to an newcomers take steps to establish international extent, caustic soda. These are, and will continue operations and—most important—build up to be, regional markets. the management skills to run those operations successfully. Whether such operations are Where incumbents must look especially carefully established through acquisitions or built from is at the many market segments between scratch, creating and running subsidiaries in the two poles. In many of these segments, lower 8 McKinsey on Chemicals Winter 2011

demand growth is likely to translate into the cover all domestic demand volumes, and for the consolidation of players in certain sectors surviving incumbents that can manufacture and capacity closures. Producers in Europe, domestically at below the cost of imports, this North America, Japan, and South Korea evolution can be positive if it results in a more have historically been net exporters of chemicals, clearly structured and disciplined market with but for many product areas, their export cost pricing based on import-price parity. position will become less and less competitive. They already face cost disadvantages on raw It is also important to emphasize that across all of materials and must confront disadvantages on their businesses, incumbents must work hard two other scores: incumbents’ domestic plants for functional excellence with regard to low-cost are not only in the wrong place to serve emerging operations and lean and effective marketing growth markets such as China, but they also and sales. In the face of the growing competition tend to be older installations that have intrin- from newcomers, incumbents cannot afford sically higher costs than the new world-scale any slack in their businesses and must make sure production capacity that is being installed in the they are top-class operators in all areas. new growth markets. Riding the new market-growth waves Successfully managing the transition to this Next, incumbent companies must look beyond lower-growth mode will require that their home markets and consider how they incumbents evaluate their product portfolios can ride the dynamics that are transforming the and manufacturing footprints. They must industry—the rise of chemical production in also decide in which sectors they want to be con- feedstock-advantaged countries and the shift in solidators, with an eye to becoming the “last demand growth to emerging markets. Incum- man standing,” and in which sectors it would bents must ask themselves how they can make more sense for them to be among the join up with the new players, whether by estab- companies being consolidated. lishing a presence in a resource-rich country or by building capacity in China and other high- Companies must bear in mind that as the industry growth markets—or by doing both. landscape shifts, the relative attractiveness of products will change, with some more vulnerable They must then consider what they can do to to the trends in the industry than others. They enhance and maintain their attractiveness as a must look at their portfolios accordingly. Estab- partner. Many incumbents operate broad lished markets are becoming net importers of portfolios of businesses; these companies must a growing range of chemicals, as new feedstock- think about how they can clarify and best advantaged producers can profitably serve these articulate the value proposition that they bring markets. While imports frequently lead to lower to their potential partners. High on any list prices and reduced margins in the short term, will be innovation—creating new technologies this is not always the case in the long run, and products—which has always been a route to particularly if incumbents are willing to shut part profitable growth in the chemical industry of their capacity. Imports are rarely able to and remains an area of strength for incumbent Chemicals’ changing competitive landscape 9

chemical companies. Companies that have The global chemical industry has entered a new technology that is needed by oil-producing coun- phase in its evolution, as players from oil- tries to use in their new petrochemical plants producing countries and high-growth developing will be best placed in any contest to participate in markets take their places among the industry’s joint ventures. And companies with know- leaders. These new players are focused on resource how that is much in demand in rapidly growing monetization and economic development—and job emerging markets will be of greater interest creation in particular, in a number of countries— to those countries’ governments; they are thus rather than on traditional shareholder value, and better placed to gain access to such markets. they thus play by a different set of rules than do the industry’s traditional leaders. As a result, the Incumbents must also think about how the market competitive landscape is changing. Incumbents access that they could provide in their home must recognize the shift under way and adapt, market could be valuable to new producers. They while newcomers should build new capabilities to should consider the best way to make this more fully deploy their strengths in the market. available. One possibility is to act as a joint-venture partner with a new producer in a way that As the world economy picks up speed after the would enable the incumbent to gradually ramp crisis, senior managers are understandably down its own production. preoccupied with navigating back to “business as usual.” However, the shifts in the chemical- Finally, incumbents must recognize the strategic industry landscape we have described above have choices that they face. What kind of bar- arguably been accelerated by the crisis, as the gaining chips does the company have, and what major emerging economies have recovered faster types of chips might it want to develop? Is it than the developed ones. As a consequence, the strong enough to stay independent? Should it window of opportunity for incumbents to engage consider partnerships or alliances? Does a with newcomers could close sooner than focus on the Middle East make more sense than a they might expect. The number of exceptionally focus on China? And if a company decides to resource-advantaged countries is finite, and focus on China, should it try to ally with a Chinese major emerging markets such as China may pursue player or to establish a greater direct presence a policy of favoring domestic champions. Incum- in China? Companies must think carefully about bents should use any momentum gained from how to play their bargaining chips for maximum recovery in their traditional businesses to advance value creation—these chips cannot be used their positions in the new industry landscape. multiple times.

Florian Budde ([email protected]) is a director in McKinsey’s Frankfurt office, global chair of the chemicals practice, and leader of its Europe, Middle East, and Africa chemicals practice. 10

A capital-markets perspective on chemical-industry performance

Long-term analysis shows that capital markets base their valuations of chemical companies above all on past operating performance. It also shows there is no basis for the commonly held belief that investors prefer noncyclical specialty stocks.

Florian Budde, The long-running debate continues within the data from 1994 to 2009 for more than 100 Geert Gyselinck, chemical industry over which strategies offer the chemical companies worldwide, accounting for and Christoph Schmitz road to the best shareholder returns. Much approximately 70 percent of the total global senior-management time has been taken up de- chemical-industry market capitalization.1 This ciding whether to focus on a specialty, com- has enabled us to review the performance modity, or diversified portfolio and whether to of individual companies (with figures adjusted take the business closer to the customer, where necessary to make comparisons pos- move upstream, or many other plays; a number sible) and the different chemical sectors, as well of leading chemical players have recently as the performance of the chemical industry made M&A moves to bolster their specialty profiles. relative to other sectors.

But what is the verdict of the capital markets, the The analyses show that capital markets do arbiter of value creation, on these questions? not regard chemical companies’ sector affiliation— Since capital-markets performance provides the specialty or commodity—as an indicator for ultimate test of shareholder value creation, we superior or inferior performance. What does stand compiled 16 years of financial and stock-market out is that capital markets are above all 11

focused on return-on-invested-capital (ROIC) construction, with electronics the only major performance and its development over time, and customer segment to do better. This capital- they base valuations on this performance rather markets performance suggests that the chemical than on expectations of growth—a dimension industry on aggregate occupies a desirable where the markets are seeing little differ- point in the value chains in which it participates, entiation between companies. Consistent across which enables it to capture its fair share—or the period is that capital markets remain even more than its fair share—of value. sensitively attuned to individual companies’ per- formance trajectories. This was demonstrated This performance should ease the concerns of dramatically during the crisis when, as the sidebar chemical-industry management teams that have on p. 18 shows, companies that took aggressive been considering moving their companies closer steps to cope saw their valuations rebound more to end consumers in the hope of gaining valuation quickly than those of more passive competitors. upside in capital markets, since most customer industries have been less successful at creating Capital markets see chemicals as a value than chemicals. The performance should strong performer also be a consolation to senior-management The long-term data show that the often-held teams that have felt on the defensive in the past perception of the chemical industry as few decades because of negative public sluggish and unattractive is largely unjustified. perceptions of the chemical industry due to its From a capital-markets perspective, the chem- environmental impact. These teams have

1 Our analysis covers 100 icals sector is a strong performer: shareholder been wondering how to gain favor from investors chemical companies, returns for chemicals have performed in line and the public by remaking their businesses as each with sales of more than $1 billion per year, with with global markets over most of the past 16 years, something other than chemical companies, at an aggregate market cap- italization of roughly $900 and outperformed the market average since least in name, as evidenced by the lack of newly billion. Based on market 2004. The exception is the period around 2000, spun-off chemical companies with “chemical” in capitalization at the end of March 2010, this accounts when the dot-com bubble inflated technology their names. Capital markets, in contrast, appear for an estimated 70 percent of stocks and the overall market. to have taken an unsentimental view on these the total market cap- italization for chemicals. issues; they are quite happy with the performance In most of our analysis, we The sector has performed particularly of the chemicals sector (Exhibit 1). excluded Saudi Basic Industries Corporation strongly on total return to shareholders (TRS) (SABIC), given that its high since 2006. While overall chemicals, excluding Not a growth play as an industry—but a market capitalization would have introduced a bias. fertilizer, showed a compound annual growth solid earner We gathered various performance metrics (for rate of 5.8 percent per year between 2006 and Capital markets provide a valuable perspective on example, total return to 2010, fertilizer achieved 39.1 percent. This has how the chemical industry should regard shareholders, trading multiples, return on capital, put fertilizer companies among the highest-valued itself—whether it should still look at itself as a cost of capital, and capital chemical companies. growth play or rather as a middle-aged industry efficiency) but hand-adjusted reported numbers to make that is past its best days. For many chemical- possible easier peer Not only have chemicals outperformed the market company top-management teams, it has been comparisons, for example, correcting for nonrecurring in recent years, they have outperformed many somewhat painful to adjust to the reality items, pension adjustments, of their major downstream customer industries, that since at least the mid-1980s, the chemical operating-lease adjustments, and financial activities. such as automotive, consumer goods, and industry has been a mature industry—albeit one 12 McKinsey on Chemicals Winter 2011

McKinsey on Chemicals 2010 Capital Markets Exhibit 1 of 7

Exhibit 1 The chemical industry has outperformed the market and most of its customers in recent years.

Total return to shareholders, $ Indexed, 100 = December 31, 1993

1,000 Oil and gas Electronics Chemicals 800 Chemicals (excluding fertilizer) Global market Consumer goods 600 Construction and building Automotive

400

200

0 1994 1996 1998 2000 2002 2004 2006 2008 2010

Source: Datastream; McKinsey chemicals capital-markets perspective, 2010 update

that is profitable, still growing, and earning its components of capital-markets valuation, ROIC cost of capital—and the mantle of “growth and growth expectations, across all companies industry” has passed to information technology in the analysis set. To do this, we calculated the and other sectors. This has led to much soul- correlation coefficient between valuation (with searching, as companies have attempted to find regard to its enterprise value to invested capital, or the right balance between taking an innovation EV/IC, ratio) and operating profitability (ROIC stance—chemicals’ historic ticket to growth—and before taxes). This calculation showed that in 2009, focusing on squeezing cash out of their busi- the correlation coefficient was at the very high nesses, an exercise further confused by the key level of 0.85, suggesting that the market was enabling role of chemicals in many “hot” basing the largest portion of the valuation of sectors such as solar and electronics. chemical companies on income performance, with only a limited portion of the value attributed to What do the markets say? To get to an answer, we variations in expectations for individual company analyzed the relative size of the two key growth (Exhibit 2). A capital-markets perspective on chemical-industry performance 13

Furthermore, our analysis shows that ROIC per- and diversified. Put another way, it is increasingly formance became the key determinant of hard for chemical companies to make a credible chemical-company valuation in the eyes of capital argument about growth prospects to shareholders. markets over the past decade and that capital markets have observed less differentiation in That does not mean the markets expect the growthMcKinsey expectations on Chemicals for companies 2010 across the industry to stagnate: on the contrary, the markets threeCapital sectors Markets that the chemical industry is expect companies to maintain at least 4 to 5 commonlyExhibit 2 segregated of 7 into: specialty, commodity, percent annual growth in a global market growing

Exhibit 2 Valuation of chemical companies happens on a ‘show me the money’ basis.

Commodity Empirical valuation tendency Valuation level Enterprise value/invested capital (EV/IC)1 Diversified Specialty Other Companies linked to Average WACC2 7.0

6.0 Valuation premium

5.0

4.0 Correlation coefficient: 0.85 3.0

2.0

Valuation discount 1.0

0.0 0 10 20 30 40 50 80

Operating profitability Return on invested capital before taxes, 2009E, %

1IC including goodwill, 2009E market data as of February 26, 2010; IC = 2008 adjusted for latest quarter (2009) property, plants, and equipment; 2009 consensus estimate for earnings before interest, taxes, and amortization. Note: EV = market capitalization + debt + minority interest and preferred shares – total cash and cash equivalents. 2Weighted average cost of capital. Source: Bloomberg; Datastream; McKinsey chemicals capital-markets perspective, 2010 update 14 McKinsey on Chemicals Winter 2011

overall at 3 percent. The overall capital-markets In addition, capital markets are attributing growth view is that the industry is mature and that it prospects to Taiwanese companies well-placed is unlikely that many companies will be able to to serve Chinese demand growth, to chemical create outstanding growth stories, but markets companies in the high-growth enzymes sector and certainly like the shareholder returns it provides. in research chemicals for the life-sciences industries, and to chemicals and services for the Rewarding individual growth stories . This observation about the growth profile of the chemical industry in aggregate, however, Thus in the market’s view, the chemicals sector should not obscure the fact that there are some does include areas with growth prospects. growth stories that do impress capital However, to consistently impress markets, top markets. The markets have rewarded such com- management must first make sure that the panies with valuations that exceed their company excels in ROIC performance. performance strictly based on income, which means that value is being attributed to the A dynamic sector, where success gets companies’ growth prospects. rewarded and weakness is punished The capital-markets perspective underlines the As mentioned above, the fertilizer sector has degree to which the chemical sector is dy- recently enjoyed peak valuations and, along with namic. This is shown by the fact that there con- other chemical companies serving the agri- tinues to be significant mobility across all the culture sector, has made up the largest group of industry’s valuation-performance quartiles— “growth” chemical companies in the immediate demonstrating value creation (as well as value pre-crisis period. The agriculture sector received destruction) and making clear the high degree of a certain degree of hype in the late 2000s with sensitivity with which stock markets are fol- the general commodities boom, the biofuels fad lowing the performance of individual companies. and related government subsidies, and food- For example, among top-quartile companies shortage scares. This has resulted in capital- in 2008, fewer than half were in the quartile a markets excitement about fertilizer stocks, decade ago. At the same time, 16 percent of particularly those in the potash sector. Crop- top-quartile companies in 2008 had been bottom- protection-chemicals and seeds companies quartile companies in 1998, while 25 percent also rode the same wave of market enthusiasm. of bottom-quartile companies in 2008 had been

There continues to be significant mobility across all the industry’s valuation-performance quartiles—making clear the high degree of sensitivity with which stock markets are following the performance of individual companies A capital-markets perspective on chemical-industry performance 15

McKinsey on Chemicals 2010 Capital Markets Exhibit 4 of 7

Exhibit 3 Capital markets remain highly alert to changes in performance trajectory.

Distribution of valuations in the chemical industry: changes in one decade

Enterprise value/invested capital1 … and where it came from2 distribution … %, 1998 Median of quartiles, 2008

1st quartile 2nd quartile 16 3rd quartile 1st quartile 2.0 11 41 4th quartile

2nd quartile 1.2 32

3rd quartile 1.0

4th quartile 0.8 26 52 11 11

1 Including goodwill. 2 Excluding new entrants. Source: McKinsey chemicals capital-markets perspective, 2010 update

in the top quartile in 1998. That mobility reflects What strategies best drive chemical the nature of this complex and fragmented stocks’ performance in capital markets? industry, where changes in end-user demands and What guidance does this analysis provide on how raw-material costs give companies opportu- strategy correlates with strong performance? nities to innovate and redefine their products and Since chemical companies’ strategies are hard to services in specific markets and geographies. classify, competing as they do in a range of product and geographic markets, we chose to Thus, even though capital markets are showing an examine performance relative to some easily increasing assumption that growth differentials measurable dimensions of how a company between chemical companies are converging, if a operated—such as scale, product and portfolio company changes its performance trajectory, focus, or geography. That analysis let us test capital markets are perceptive and reflect these a number of hypotheses about what drives value changes in valuations. As a result, some creation, defined as total return to shareholders, companies move up and some drop down. The market-to-book valuation, and ROIC. Using data message from capital markets to senior- from 1994 to 2009, there are a number of management teams: do not rest on your laurels— observations that can be made. and if you are down, do not despair (Exhibit 3). 16 McKinsey on Chemicals Winter 2011

McKinsey on Chemicals 2010 Capital Markets Exhibit 5 of 7

Exhibit 4 Chemical segments perform roughly in line with one another.

Cumulative total return to shareholders1 $, indexed: 100 = December 31, 1993

500 Specialty Diversified Commodity 400 Compound annual growth rate, % 300 Specialty 8.8 Diversified 8.0 200 Commodity 7.8

100

0 1994 1996 1998 2000 2002 2004 2006 2008 2010

1 Sample excludes Saudi Basic Industries Corporation (SABIC) and fertilizer companies. Source: Datastream; McKinsey chemicals capital-markets perspective, 2010 update

Portfolio. Our analysis shows that all the chemical To achieve top-tier performance, portfolio seems segments (specialty, commodity, and diversified) to play a role—but it is not portfolio in the sense performed roughly in line with one another from of specialty versus commodity. Instead, it is more 1994 to 2009. Capital markets have favored nuanced and specific to certain subsectors. It certain segments during certain limited time is impossible to make comparisons at the level of periods. For example, analysis that we undertook companies, as most companies have different of the 1992 to 2003 period2 showed that portfolios, but it is possible to identify the per- 2See Thomas Augat, Eric Bartels, and Florian Budde, diversified companies performed best, followed by formance of individual businesses. “Multiple choice for the specialties; commodities performed worst. chemical industry,” www. mckinseyquarterly.com, However, when we extend the analysis to 2009, it Our return-on-sales (ROS) analysis of individual August 2003, and Thomas becomes difficult to identify a consistent trend businesses shows that while some sectors clearly Augat, Eric Bartels, and Florian Budde, “Structural over time. Put another way, portfolio differences have higher ROS, the spread of performance by drivers of value creation for specialties, commodities, and diversified sector participants is quite large. For example, in the chemical industry,” in Value Creation: Strategies players have not translated into better or worse specialty electronic chemicals achieved higher for the Chemical Industry, performance; all segments are in line with one ROS from 2001 to 2008 than basic electronic Weinheim, Germany: Wiley- VCH Verlag, 2006, pp. 27–39. another (Exhibit 4). chemicals. However, the variations in performance A capital-markets perspective on chemical-industry performance 17

around the average are substantial, and so lackluster sector, or, if the company is determined performance has to be assessed on a company-by- to switch, make sure it can become a top company basis (Exhibit 5). performer in the attractive sector. Presence in an attractive sector is no guarantee of success— This holds a clear message for senior-management and neither does it provide an excuse for poor teams.McKinsey Before on rushing Chemicals to abandon 2010 apparently performance in ROIC. Capitaldowdy sectors Markets and trying to move into supposedly moreExhibit attractive 6 of 7 sectors, management must first Megatrends. One further portfolio-related ensure that it cannot improve performance in the analysis that we undertook focused on whether

Exhibit 5 The average profitability of a business segment is no guarantee of success: participants show wide variations in performance. Performance spread around average

Segment1 Average return on sales in segment, 2001–08, %

–10 0 10 20 30 40

Specialty electronic chemicals Industrial and institutional cleaners Flavors and fragrances Catalysts Cosmetic chemicals Crop-protection chemicals Pigments Specialty additives chemicals Construction chemicals Specialty and Advanced composite materials Water-management chemicals Active pharmaceutical ingredients Basic electronic chemicals Bulk polymers Basic organics/petrochemicals

1Based on SRI segmentation. Source: Bloomberg; Reuters; SRI International; McKinsey analysis 18 McKinsey on Chemicals Winter 2011

Lessons from the crisis: The market rewards tough actions and rigorous management

We analyzed capital-markets performance up of two segments: first, companies that during the financial crisis to understand lessons were recognized as untouched by the crisis on how companies should respond to challenges. (for example, companies making flavors and We examined the total-return-to-shareholders fragrances and serving the (TRS) performance of a representative group of or high-end luxury-goods sector), and second, 22 chemical companies, from an all-time high on companies that visibly reacted to the crisis June 17, 2008, to March 25, 2010. with cost-cutting and restructuring moves, which set them up to come out of the crisis stronger When the economic crisis started in autumn than before. Both these types of companies saw 2008, the initial response from the capital capital markets move their stock prices up, markets was to drastically reduce the value of with top-quartile performers up 72 percent in the chemical sector as a group, just as it did to the period. all other sectors and to the market overall. This phase continued through March 2009, with little At the other extreme were companies that were difference between top-quartile performers hit hard by the crisis, primarily because of the (TRS was down 48 percent) and bottom-quartile weakness of their balance sheets going into the performers (TRS was down 66 percent). But crisis or because the capital markets recognized when the capital markets started to get over their existing strategies would not be successful the initial panic and recover their senses, in the “new normal.” Their valuations remained they revised this initial judgment and showed depressed, recovering only 28 percent. In the appreciation for the differences between middle were companies that did not react individual chemical companies’ performance aggressively to the crisis and were waiting for the and prospects. storm to pass. Many such companies had robust business models, but by failing to make This led to a segmentation of chemical rigorous moves to cut costs and improve companies during the recovery phase from operations, they emerged weaker relative to March 2009 to March 2010 (exhibit). At companies that seized the opportunity for action one extreme was a group of companies made presented by the crisis. A capital-markets perspective on chemical-industry performance 19

These events provide a clear indication that While the crisis was a short period of exceptional McKinseycapital markets on doChemicals respond to 2010individual stress, it confirms the enduring message of the Capitalcompanies’ Markets situations and actions. Management capital markets: chemical companies should Sidebarteams that exhibit reacted decisively and took highly keep their focus on strong ROIC performance. visible actions were rewarded by the markets.

Exhibit Patterns that emerged during the crisis show capital markets favored companies that seized cost-cutting opportunities.

Median annualized total return to shareholders: all-time high to turning point1 %

1st quartile 24 • Companies with rigorous and visible restructuring efforts • High-performing (niche) players that were dragged down with the flow and have now recovered

2nd quartile –1 • Players weathering the storm • Companies with robust business models that continued to operate as usual after the crisis • Companies with limited or moderate restructuring efforts but lasting exposure to the crisis 3rd quartile –16

4th quartile –38 • Companies with tight liquidity and/or refinancing needs • Former growth stocks without a new post-crisis formula; these players have been set back to normal

1From all-time high on June 17, 2008, to March 25, 2010; indexed with starting date of June 30, 2008. Source: Datastream; McKinsey chemicals capital-markets perspective, 2010 update 20 McKinsey on Chemicals Winter 2011

capital markets have favored chemical companies the consistent message from capital markets is that are linked to and riding global megatrends— that any strategic move must focus on gener- trends that are having a broad societal and ating good ROIC performance. Any move related economic impact worldwide. Looking at market to megatrends must also bring strong ROIC performance since 2005, we found that chemical performance with it for it to be viewed favorably companies associated with two megatrends— by the markets (Exhibit 6). population growth and the unconstrained demand for limited resources—have outperformed over- Focus. Focused companies have performed better all chemicals in capital markets. The first group in recent years than unfocused companies. We consists of chemical companies that supply to define focused companies as those with more than the agricultural and food industry (including 80 percent of sales in two businesses; unfocused fertilizer, crop-protection-chemicals, and seeds companies are those with less than 50 percent of companies), and the second group comprises sales in two businesses. The strong performance companies with privileged access to natural of fertilizer companies has helped amplify this resourcesMcKinsey through on Chemicals backward integration. 2010 What trend, but even when fertilizer companies are ex- chemical-industryCapital Markets senior-management teams cluded from the analysis, the superior performance mustExhibit remember, 7 of 7 however, before trying to hitch of focused companies stands out. themselves to one of these megatrends, is that

Exhibit 6 Companies associated with megatrends outperformed the broader market.

Cumulative total return to shareholders $, indexed: 100 = December 31, 2004

700 Food-driven Resource access–driven 600 Chemicals overall

500

400 Compound annual growth rate, %

Food-driven 26.2 300 Resource access–driven 14.2 200 Chemicals overall 8.1 100

0 2005 2006 2007 2008 2009 2010

Source: Datastream; McKinsey chemicals capital-markets perspective, 2010 update A capital-markets perspective on chemical-industry performance 21

Size. For specialty chemicals, size clearly matters: believed, for example, that investors prefer larger specialty companies consistently out- noncyclical specialty stocks to commodities, there perform smaller ones on TRS. For commodity is no empirical basis for such a claim. What companies, larger companies outperformed does stand out, however, is that capital markets smaller ones until the crisis, but since then, per- are taking a conservative view of chemical formance has converged. companies’ ability to differentiate themselves with regard to growth and instead are focused on Region. Asian markets (excluding Japan) have companies’ ROIC performance and its develop- done well because of growth in the region; ment over time. Markets are finely tuned to economic growth translates into growth in demand changes in the performance trajectories of indi- for the chemical industry. Europe has also done vidual companies, and winners must therefore well, primarily because the European chemical remain on top of their game. While capital-markets index is largely driven by German companies, performance in the past five years has shown which have increased their productivity and taken chemical companies that ride megatrends have away share from non-German competitors in excelled, experience has shown that capital- the eurozone. Japanese companies continue to markets favorites can quickly change. The message be weak, and North American companies are from the capital markets that endures, however, somewhere in the middle. is that ROIC performance matters above all.

Our analysis of the 16 years of data shows that capital markets do not regard chemical companies’ sector affiliation—specialty or commodity—as an indicator for superior or inferior performance. Put another way, although it is commonly

Florian Budde ([email protected]) is a director in McKinsey’s Frankfurt office, global chair of the chemicals practice, and leader of its Europe, Middle East, and Africa chemicals practice. Geert Gyselinck ([email protected]) is an associate principal in the Antwerp office.Christoph Schmitz (Christoph_ [email protected]) is a principal in the Frankfurt office. 22

Innovation in chemicals: An interview with Dow Corning’s Stephanie Burns and Gregg Zank

Dow Corning’s CEO and CTO talk about successful approaches to new-product and business-model innovation.

Bob Frei Dow Corning’s performance in the past decade is large-scale plant in Zhangjiagang, China and Chris Musso one of the more overlooked success stories (a joint venture with Wacker Chemie), which will of the global chemical industry. Privately held by complement its large-scale plants in the United Dow Chemical and Corning, Dow Corning States and the . Similarly, in is the world’s top silicones producer and, through polysilicon, Hemlock Semiconductor is building its majority stake in Hemlock Semiconductor a new plant in Clarksville, , to main- Group, the leading maker of polycrystalline silicon tain its capacity and cost lead. (polysilicon), the raw material for computer chips and solar cells. Dow Corning has historically What is new is the acceleration of the company’s seen steady growth, but in the past six years, sales and earnings trajectory. Part of this its performance has accelerated dramatically, and is being driven by strong growth in demand in innovation has played a key role in this. developing markets such as China. Dow Corning’s low-cost manufacturing base puts Dow Corning has always grown by combining a it in a strong position to serve this demand, but capability in low-cost bulk silicones with the company is not simply sitting back while leadership in silicon-based specialty chemicals. it rides that wave. Instead, it has made a It continues to follow this approach, with a new significant push in innovation to strengthen its 23

growth momentum. It has drastically redesigned 2010; sales hit $4.4 billion and net income was and reenergized its new-product-development $615 million, putting it on a trajectory for its approach, and at the same time has emerged as best-ever results in 2010. a chemical-industry leader in business- model innovation. Stephanie Burns, a PhD chemist, has been Dow Corning’s CEO since 2004 and has led these In 2002, in the fading days of the dot-com developments. She and Gregg Zank, the company’s boom, Dow Corning took a bold gamble when it chief technology officer and senior vice presi- launched Xiameter, a new business model dent, sat down recently at their Midland, Michigan, comprising an online-managed, low-cost, no-frills headquarters with McKinsey’s Bob Frei and sales channel for its commodity silicones, Chris Musso to discuss their perspectives on suc- offering competitive pricing to customers willing cessful innovation in the chemical industry. to buy in bulk, without research or technical support. Plenty of other chemical companies were McKinsey on Chemicals: Where does dabbling in e-commerce, but none embraced a innovation stand among your priorities? business model that effectively divided the company’s products into two brands, as in this Stephanie Burns: Innovation is definitely one of case, where there was the traditional Dow the very top priorities for the company. It’s our Corning on the one hand, offering customers future—it’s the way we’re going to grow. We divide specialty silicones backed up by technical support the very substantial growth we have achieved and R&D, and Xiameter on the other. over the past nine years into three categories, and there’s been a major innovation component to Dow Corning confirmed the success of the new all of them. The first is momentum growth, which business model in 2009 when it announced is directly linked to GDP expansion around the a fivefold increase in the number of products it world, and Xiameter has brought us a lot of growth offers via Xiameter. Meanwhile, sales growth there. The second is penetrating new geographies based on new-product innovation has continued with our technology, and innovation plays an im- to accelerate. portant role here because we’ll often do for- mulations that are specific for the geography or The financial results bear this out. Dow Corning employ innovative business models that allow us saw sales rise from $2.49 billion in 1995 to $3.37 to expand in a particular region. The third billion in 2004, when it exited from its nine- category is more traditional, “pure” innovation— year Chapter 11 bankruptcy protection linked to new applications and products. All three cate- breast-implant liabilities, a compound annual gories have contributed to growth, with the biggest growth rate of 3 percent. Net income rose from shares driven by the second and third categories. $153 million in 1995 to $289 million in 2004. Its sales then rose 62 percent in the next four years, McKinsey on Chemicals: How has your reaching $5.45 billion in 2008, a compound approach to innovation changed in the annual growth rate of 13 percent, and its net past decade? income increased more than two-and-a-half times to $739 million. After a retreat in 2009, Stephanie Burns: Ten years ago, our innovation results rebounded in the first nine months of approach was mostly the traditional, inside-out 24 McKinsey on Chemicals Winter 2011

materials-innovation approach. But we decided McKinsey on Chemicals: How did you deal that this approach was not working well—we with the challenges and cultural issues within the really needed to deliver greater returns from our company when making this change? strategic R&D investments. Reevaluating our approach to innovation has been part of a complete Stephanie Burns: I think we have been suc- rethink of Dow Corning’s business. Dow Corning cessful in this because we defined a really clear has always enjoyed respectable growth rates business model—Xiameter—for our undiffer- across most of its businesses, and for better or entiated business. We have been very clear on what worse this led to an attitude in the company that brand represents and what its goals are for that every business is a growth business, and an cash generation and contribution to the earnings attitude to R&D spending where everyone gets of the company. That business model is all about the same level of investment, and people across efficiency and quality of supply to our customers the company felt almost entitled to a certain at a price point that allows them to really be com- level of investment. petitive. Customers are not asking for a lot of product innovation in that space, so that would be But in the early 2000s, we could see that parts of an area where we are not going to put research our portfolio were maturing and becoming less dollars, except toward process improvements. differentiated, and the service-intensive specialty- chemical approach to doing business was no At the same time, we have been very clear on the longer wanted by parts of our customer base. Those differentiated side of the company about which customers were mainly interested in the most areas we wish to invest in and what our customer competitive prices for undifferentiated products, acceptance and financial expectations are, and we backed by reliable supply. Seeing this and have shifted resources to priority areas. recognizing that there was going to be more of this trend coming was a major driver for us We had to communicate clearly that it’s just as im- in our design of the Xiameter business model. We portant to work in area A as area B, and that couldn’t treat those more price-sensitive and both are critical to serve our customers. We’re innovation-insensitive customers the same as our going to create growth in each unit, but they specialty customers. And so we separated our have different mandates and deliverables. It has product offering into two brands: the Xiameter taken time to get the teams comfortable with brand and the Dow Corning brand. this, but now people see the success and so they are buying into it with great commitment. Gregg Zank: And at the same time, we recognized that we needed to rethink our approach to I think that one advantage we have culturally is new-product innovation across all our businesses. that we have employees who are extremely creative To get better returns, we saw that we couldn’t and willing to try new things, and who do not invest in every market the same, but we needed to resist change the way that perhaps they do in some be selective and choose those innovation areas other companies. We’ve worked hard on encourag- where we’re going to get the biggest returns and ing the dynamic that it’s healthy to embrace change. have the biggest impact on the company. It comes down to leadership and clarity of purpose. Innovation in chemicals: An interview with Dow Corning’s Stephanie Burns and Gregg Zank 25

Stephanie Burns Vital statistics (2003–2010) Fast facts Born 1955 President Incoming chairman of the Married, with 1 child American Chemistry (2000–2003) Council Executive vice president Graduated with a PhD for global operations Member of the board of in , GlaxoSmithKline and of with a specialty in (1997–2000) the Society for Women’s organosilicons, in 1982 Director of the electronics Health Research from Iowa State University and life-sciences businesses and of science Appointed to the Pursued postdoctoral and technology for Europe President’s Export Council studies at Université in 2010 Montpellier 2 Sciences et (1994–1997) Techniques, France Director of Named to Forbes.com’s women’s health list of the world’s 100 Career highlights most powerful women Dow Corning (1983–1994) (1983–present) Positions in laboratory research, product (2006–present) development, science and Chairman technology, and business and (2004–present) management chief executive

This certainly has required changes in behavior. Dow Corning—and add more clarity. We still Take the salespeople in our specialty-chemical had some undifferentiated products managed by business: their job out in the field is to do new- our specialty business, and by moving them to business development and work with cus- Xiameter, we have been able to serve our cus- tomers on new areas of growth—it’s not to go in tomers with more clarity. and sell existing products to existing cus- tomers with the same application that they’ve We will do that kind of fine-tuning constantly sold for the past five years. So they’ve had a real in the future. A product may currently be man- change in their mandate. aged by our life-sciences business or industrial- intermediates business, but as the products ma- With our relaunch of Xiameter in 2009, not ture, we’re going to challenge the business every only did we put more products into Xiameter but year: should that be a Dow Corning–branded we also continued to fine-tune these two busi- product or should it be managed by Xiameter? ness models—Xiameter and specialty-oriented And we’ll move products over as appropriate. 26 McKinsey on Chemicals Winter 2011

Gregg Zank Vital statistics (2002–03) Reviewer with the National Born 1958 Program leader for new- Science Foundation Married, with 2 children business development Member of the board of Education (1985–2002) directors of the Michigan Graduated with a PhD Positions in research, Molecular Institute in inorganic chemistry in product development, 1985 from the University and new-business Member of Michigan’s of Illinois at Urbana- management Climate Action Council Champaign Fast facts Recipient of the American Career highlights Holds 30 patents for Chemical Society’s Earle Dow Corning including B. Barnes Award in 2009 (1985–present) those related to advanced composites, rechargeable (2009–present) batteries, and high- Senior vice president temperature thermosetting polymers (2003–present) Chief technology officer and executive director for specialties and technology

Meanwhile, we are getting new specialty products the undifferentiated area. For instance, do we have from our innovation efforts to expand our intellectual property protecting our product, Dow Corning portfolio that more than offset what or are there a lot of similar products on offer from is moved to Xiameter. the competition? And when we go to visit the customer, are we meeting with the new-business McKinsey on Chemicals: How do you know developer or only with the procurement team? when a product should move to Xiameter, and That’s a pretty strong signal right there. what are the challenges and opportunities? Stephanie Burns: But it’s important to rec- Gregg Zank: It’s not by our definition that a ognize that there is a huge opportunity in the product is no longer differentiated—it’s our Xiameter model, not only in providing customers customers’ and the marketplace’s. That in turn with reliable supply at a certain price point but reinforces the message within the company also for the company overall as the low-cost, that we have to embrace this new business model. highly efficient supplier. We are winning at that There are clear signals when a product is in low-cost game, and we’re going to continue to Innovation in chemicals: An interview with Dow Corning’s Stephanie Burns and Gregg Zank 27

win. We’ve got fully utilized assets and efficiencies the same time, there may be a need to explore a in our manufacturing operations that we believe new business model, packaging, or delivery are the most competitive in the industry. method, for example, to successfully deploy a product line in a certain region. The offtake of the large, low-cost plants also goes into our specialty business, where we develop Stephanie Burns: In business-model innovation, finished, formulated products, and we get a lot our big “aha” came with Xiameter. That really more value than just selling the basic inter- opened the door for us to think differently, mediates. So the innovation that goes on in our and we’ve realized that new business models are specialty plants that leverages this low-cost just as critical for new-product development as position is a wonderful synergy. they are in the more mature parts of our business. We deployed new ways of working with our And at the same time, there are a lot of innovation partners: for instance, faster prototyping or finding challenges posed by the Xiameter side of the different ways to more quickly establish business. For instance, how do we get a product profitability. And in our polysilicon business, we line’s cost down to stay competitive and make have implemented new business models the right level of return? There’s a lot of energy designed to ensure that we meet our needs and and excitement going into improving manu- our customers’ needs. facturing and process efficiency, as well as on the business and commercial side. It can be just McKinsey on Chemicals: How do you steer as exciting as new-product innovation. your new-product innovation approach?

McKinsey on Chemicals: What are your Gregg Zank: We want to focus on areas that are thoughts on new-product versus business-model driven by large societal trends and needs in innovation? the world—megatrends—because we know those trends are going to drive discontinuities in Gregg Zank: It’s not black-and-white. The days the marketplace. There are a number of areas we are gone when you could just make a new are particularly interested in. These include product and customers would beat a path to your health care and personal care, renewable energy, door. To be successful in the marketplace construction, and electronics—where we are and establish a sustainable competitive advantage looking at the ever-expanding demand for devices requires a combination of approaches. The key and the merger of electronics with other areas for us is customer intimacy, which guides us as to such as photonics and biotechnology. And we are which levers of innovation we should employ— watching how megatrends—such as energy scarcity, how much new product and new technology, how urbanization, and others—interact with these. much new solutions, and how much business- model innovation. It’s also important to consider When you’re tied into those discontinuities, it just regional differences: mature products in one means the market opportunity is big. You’re region may be innovative products in another. At not in there fighting tooth and nail using price and 28 McKinsey on Chemicals Winter 2011

other levers for a piece of a limited-size market— that. We’re not just saying there’s a wonderful instead you’re in a market that is expanding megatrend out there in the demographic of an rapidly. Light-emitting diodes (LEDs) are a great aging population and we’re going to invest all our example—they’re now showing up in flashlights, projects against it, but instead, we’re defining displays, traffic lights, and in automobile exteriors where the opportunities are for Dow Corning. and interiors, and they have the potential to We’ve been improving that process and have keep growing into areas of commercial and started to integrate it across the company. residential construction. McKinsey on Chemicals: How does the Encapsulants for LEDs have been a great success process work? story for us. We started the work in the late 1990s, and it became a new-business program in the Gregg Zank: Our underlying challenge was to early 2000s that was sheltered even though it was improve the way we develop a raw idea into not making any money. We backed it because something tangible. The approach we now use is we knew it was going to be a hit. We had key intel- to work very intensively for a highly com- lectual property; it’s a very enabling tech- pressed period of time—10 to 12 weeks. We will nology; and we were ready to go when the market take something as large as the societal impact was ready. Our encapsulant business has of an aging population and distill that down with grown dramatically over the past five years. numerous interviews outside the company. We dedicate a group of employees around the world to We are on the lookout for developments that are undertake a lot of strategic marketing—both truly going to be disruptive and try to tie technical people, who are in my opinion very good ourselves to them. We constantly challenge our- early-stage strategic marketers because they selves and refresh that list of the large trends ask a lot of difficult questions, and commercial that we should be looking at, and then we ask, how folks. Then we have weekly meetings to say, what can silicon-based materials provide a solution? have we learned about this area? It’s got to be a large opportunity, it’s got to get marketplace Stephanie Burns: What we’ve been doing over acceptance within a certain time frame, and it’s the past four years is to take these megatrends got to be something that is not incremental to and apply filters that narrow them down to what what we are already doing. We assess the really could be the opportunity, and identify applicability of our scientific tool kit against the how best our technology and competencies match opportunity and create an early proposal.

There’s a level of research expenditure that must be maintained even in tough times—it’s not discretionary spending; it’s required Innovation in chemicals: An interview with Dow Corning’s Stephanie Burns and Gregg Zank 29

We pressure-test the proposals from the points of associated with them to represent a large area of view of technology, the market, the supply chain, growth for a significant amount of time? and whether it will still be a good opportunity if some other external factors change. It is a difficult Stephanie Burns: We also have to take some thing for the team to go through because they care managing the filtering part of the want to chase five things and they only have time process—this is the painful part, where you have to get two worked up as full business proposals. to let go of ideas early on that you don’t think But I’m insistent that as we go through this, we are a hit and stay focused on the ones that look capture and document all the things that we leave promising. When we started this process, on the side as well, because they may be relevant our people got so enthused by innovation and for some of our other existing businesses. In sustainability and improving our planet, and they addition, the process can help us identify markets were buying in fast and looking at things that that are starting to move and make us check if we we knew were not going to fly. But you’ve got to let are in tune with them. Are they on our radar them expand the lists of ideas, so that they say, screen, and how are we interacting in the value this is new and exciting, and to make sure they’re chain of those markets? going along the path with you. You can’t shut it off prematurely; you have to let it run its course. We undertake this process twice a year. In ad- dition to identifying opportunities, it completely McKinsey on Chemicals: What are examples of energizes the entire company, because there is megatrend-linked work? not only a core team but also a broader team that gets involved because there are Web calls for Gregg Zank: One of the problems with the aging information, where people can contribute, so population is diseases that make bones brittle. everybody is a part of it. We end up with a pretty So you can look at ways to protect the human robust portfolio of initiatives as the process body from falls or ways to better enhance bone cycle proceeds. growth in aging people. Since there is research relating bone strength to silica intake, we said, McKinsey on Chemicals: Have any cultural is there a way to help uptake of silicic acid or silica issues emerged with the adoption of the into the body to help bones be less brittle? An- megatrends approach? other is enhancing aging bodies’ efficiency in ab- sorbing medicinal drugs, and so, is there some Gregg Zank: The danger we have run into is not way to use silicones to help the uptake of drugs? so much resistance as that everyone reframes what was already going on to be part of a mega- Stephanie Burns: We also see megatrends trend, and everything becomes a green-energy intersect. For example, one of the trends project or an aging-population project. That’s why with an aging population is that baby boomers we have these filters and say, OK, within the want to live in their own homes rather than aging population, what are the big things that we in a nursing home. To take care of them and make think we can have an impact on and that have sure they’re safe, third parties observe them enough discontinuities and opportunities in their homes, and so there are new electronics 30 McKinsey on Chemicals Winter 2011

applications, as you get to surveillance Stephanie Burns: I’d argue our chemistry cameras and sensors. In other words, the elec- set is probably more complex than most tronics megatrend intersects with the aging- companies’, and our expertise in that chemistry population megatrend. set allows us to do so many more things. I am constantly amazed at the potential of silicon McKinsey on Chemicals: Dow Corning technology to meet the needs of current and seems to have shifted its R&D talent strategy to future advanced applications. include more than just silicone chemists, hiring physicists, materials scientists, and even I think we are able to build closer and stronger industrial designers. How has this new relationships with customers because our combination changed the innovation problem- silicon-based expertise can be so enabling for solving dynamic? them. Take skin-care product makers: they use thousands of different ingredients to make Gregg Zank: It’s a great new dynamic. When you formulations, but the silicone ingredient combine a silicone chemist with a material enables that formulation to perform, and that scientist, a ceramist, and a metallurgist, you get gives us privileged access to their research some very robust technology debates, and you department. And we’ve deliberately built up get to a good answer—not yet necessarily the right a capability we call “application expertise,” where answer—but one you have a lot more confidence we have scientists who are world-renowned in, because you did not just charge down one path. experts in many of our customers’ applications. In hair care, for example, we have globally Stephanie Burns: Here’s an example. We know a respected experts on how to test products on lot of our customers buy our materials for the hair, and our personal-care customers rec- aesthetic properties—the feel, or “hand,” as it’s ognize and respect these experts’ work. called, the silky touch, the visual appearance. But we realized that there’s a whole element in how McKinsey on Chemicals: How much time do customers make buying decisions that we did not you as CEO spend on innovation? fully understand. When silicone ends up in a piece of furniture or cookware, we don’t know who Stephanie Burns: As CEO, I would say around these people are who are selecting the product. 15 percent on a pure innovation basis, but When a maker of handheld electronic devices looks innovation is part of everything we do, so it is at silicones, they are looking for the customer difficult to estimate. I do have a very full experience as well as the electronic-circuitry per- understanding of the innovation portfolio, which formance, which we always focused on. So we is on all our major executive-meeting agendas. brought in an industrial-design engineer who thinks completely differently from a chemist or McKinsey on Chemicals: What does it mean to physicist, and this brings a totally different have a scientist as CEO? dynamic to the team’s interactions. Stephanie Burns: When I am out with R&D McKinsey on Chemicals: Is being just in silicon folks and teams that are bringing projects chemistry a limitation? forward, there’s probably an ease of discussion Innovation in chemicals: An interview with Dow Corning’s Stephanie Burns and Gregg Zank 31

and a connectivity that takes place. The last Some of our big successes today had their time I was with our compound semiconductor genesis back in the late 1990s. In tough economic research team, for instance, I understood times, you’re looking to squeeze anything exactly what they were doing and the progress you can, and innovation is not immune to that, but they have made in advancing silicon carbide there’s a level of research expenditure that must wafer-production technology. be maintained—it’s not discretionary expenditure. It’s required. Most important, I think I probably have, com- pared with a nonscientist, a better understanding that this innovation stuff takes time to come to fruition, and that you’ve got to keep these investments consistent and you cannot flip-flop.

Bob Frei ([email protected]) is a director in McKinsey’s Chicago office, andChris Musso ([email protected]) is an expert principal in the Cleveland office. 32

Capturing the lean energy opportunity in chemical manufacturing

High energy prices and climate-change concerns are driving new interest in energy efficiency. Companies can adapt their lean tools and approaches to capture significant energy savings.

Frank Plasschaert, Between 1990 and 2009, chemical companies the industry over the past decade. European Ken Somers, were among the many industrial and man- chemical companies, for example, have and Gautam Swaroop ufacturing companies that boosted corporate seen energy costs increase from 5 percent of total performance by adopting lean production costs in 2002 to about 12 percent in 2009, methods to optimize material and labor pro- driven primarily by rising oil prices, which have

1 The study, conducted from ductivity. Indeed, a multiyear study of how remained relatively high despite the 2005 to 2008 by McKinsey well thousands of manufacturing companies in economic slowdown. and the London School of Economics, looked closely at North America, Europe, and Asia adopted how well manufacturing companies adopted proven management best practices (including lean) Most companies have taken steps to lower their best practices, such as highlighted just how important these practices energy intensity (the amount of energy lean, and at the relationship 1 between these efforts are to a company’s economic success (Exhibit 1). consumed per unit produced). The return on and financial results. An efforts to optimize energy usage was gen- early view on the research, published in 2006, is de- However, most chemical companies that have erally three times greater in 2009 than in the scribed in “The link between adopted lean techniques have not incorporated, 1990s, and one major focus has been large management and produc- tivity,” by Stephen J. Dorgan, or have only partly incorporated, lean techniques capital-investment projects to capture energy John J. Dowdy, and Thomas for increasing energy efficiency, even though savings, such as combined heat and power M. Rippin, available at www.mckinseyquarterly.com. energy costs have reemerged as a major issue for (CHP) plants. Energy-efficiency initiatives also 33

enable companies to cut carbon dioxide emissions, efforts first to holistically map out energy thus providing companies with the means consumption at each step in their operating both to do the right thing and to save money. processes or to identify specific energy waste in their production systems, and then to Traditional lean programs typically identify use lean techniques to focus on opportunities savings that can be gained by improving every to reduce waste. aspect of a manufacturing step, and this can include energy savings. But in our experience, We have found that most chemical companies can traditional lean programs enable companies substantially improve the overall energy effi- toMcKinsey realize only on about Chemicals one-sixth of2010 their potential ciency of their operations when they apply lean energyLean energysavings—leaving efficiency the rest on the table. tools and approaches that have been trans- Why?Exhibit Few 1 companies of 3 are making systematic lated and adapted to cover energy use (Exhibit 2).

Exhibit 1 An analysis of the development of energy productivity over time suggests substantial improvement potential.

Current Historical productivity New requirements capabilities improvements to increase energy productivity

• Optimizing lead Factor input per unit of value added, indexed • Including energy efficiency and cycle times in optimization levers and preventing 350 Labor • Making energy waste productivity consumption transparent • Managing • Making waste detection organization using 300 systematic key performance • Developing methods to indicators (KPIs) 250 reduce waste for quality and • Incorporating energy lead and cycle KPIs in management/ Material times 200 productivity governance systems • Training and • Building capabilities for leading employees Energy continual energy- in shortening lead 150 productivity efficiency improvement and cycle times and improving 100 quality

50

0 1960 1970 1980 1990 2000

Source: Bundesministerium für Umwelt, Naturschutz, und Reaktorsicherheit (BMU) 2007; McKinsey analysis 34 McKinsey on Chemicals Winter 2011

McKinsey on Chemicals 2010 Lean energy efficiency Exhibit 2 of 3

Exhibit 2 Incorporating energy efficiency into lean methodology: there are eight kinds of waste for energy.

Kind of waste Definition Example

Overproduction Producing excess energy (input Venting excess steam energy that is unused)

Waiting Consuming energy while production Keeping stirrers at full speed in reactor is stopped while production batch is analyzed

Transportation Inefficient transportation of energy Leaks and heat radiation in steam network

Overspecification Process energy consumption Standardized reflux rates in (deliberately) higher than necessary columns for all product specifications

Inventory Stored goods use/lose energy Using uninsulated tanks in tank farms where product must be kept heated

Rework/scrap Insufficient reintegration in upstream Redrying fines process when quality is inadequate that did not get coagulated in drying process

Motion Energy-inefficient processes Excess in steam boiler (inefficient processes)

Employee Failure to use people’s potential Employees not involved in developing potential/intellect to identify and prevent energy waste energy-saving initiatives

Savings vary by sector, but typical savings for Taking the lean path to improving chemical companies can be 10 to 20 percent—and energy efficiency in some cases, substantially higher. Importantly, Companies can realize these gains by incor- all these savings can be achieved with limited porating energy-efficiency analyses and investment and payback periods of three techniques into their existing lean approaches in years or less. Energy consumption has tradi- four ways. First, they can focus specifically on tionally been managed more carefully in energy consumption and then system- the chemical industry’s most energy-intensive atically identify waste as they would in any other processes, such as steam or ammo- lean program (Exhibit 3). Translating the lean nia and chlor-alkali production, where energy is value-add identification methodology to the energy a major cost element. Nevertheless, we have context, the approach here is to map energy seen savings of up to 5 percent achievable in consumption at every step of a company’s such cases—important gains on such large operating processes. The next step is to calculate energy volumes. the thermodynamically minimum energy Capturing the lean energy opportunity in chemical manufacturing 35 McKinsey on Chemicals 2010 Lean energy efficiency Exhibit 3 of 3

Exhibit 3 Building the theoretical limit for heat consumption creates clarity on losses while identifying potential key performance indicators.

Description Heat consumed by plants 1 and 2 100

Transportation Heat in steam is lost during transportation, 1 ie, through piping

Vented Steam vented because of plant steam 6 imbalance for flash steam reuse

• Modular Heat Heat-exchanger insulation losses approach Incidental exchangers 1 makes technical limit Exhaust Heat content of air entering scrubber work for both complex and gases 13 simple sites • Offers potential Radiation Radiation and air leaks of dryer shell to track and air leaks 5 progress through update at regular Availability Heat consumed by dryer when not running intervals after 1 standardization • Signals key Performance Difference between actual performance and performance indicators to 8 best performance; no load losses present, as line runs almost 100% variable optimize at frontline level OEE EE1 Input/output Variation in moisture input and output quality 1

Rework Heat necessary to reheat recirculated 2 fines in dryers

Theoretical limit for plants 1 and 2 62 –38%

1Energy efficiency (EE) linked to overall-equipment-efficiency (OEE) levers. 36 McKinsey on Chemicals Winter 2011

required for each process (its “theoretical limit”) remainder for 90 percent of the time, eliminating and evaluate actual consumption against this the need to keep them heated when they were theoretical limit. This analysis reveals where not being used. energy is being wasted and how loss can be avoided, and it also provides a powerful A second way companies can extend their lean motivating tool for site personnel to push for programs to improve energy efficiency is by new ideas. optimizing energy integration in heating and cooling operations, moving beyond pinch One US maker, for example, undertook analysis. A chemical company changed its process a heat value-add analysis and found that only to release heat more quickly during polymer- 10 percent of the steam heat inputs were actually ization, allowing evaporation to start sooner and thermodynamically required to make its products; saving energy on the subsequent drying stage. 90 percent were wasted. Once the causes of the The total savings from both steps amounted to 10 waste were identified, more than 20 measures percent and brought the production line close to were planned to address the problem. These the industry cost benchmark. In another example, measures would allow the company to capture a chlor-alkali maker undertook a number of steam savings worth $600,000 per year, and the measures to avoid heat loss and to capture waste investment would be paid back within three heat via heat exchangers that enabled it to years. Loss of steam as it was piped around the raise the temperature of the brine solution so that plant represented one of the largest sources of the electrolysis could attain a higher efficiency waste, and it was addressed by insulating lines, level. The investment paid for itself in a year and repairing steam traps, and simply repairing leaks. lowered energy consumption by 2 percent—a The measures also included writing a new significant reduction, given the size of the chlor- algorithm for the software steering the company’s alkali producer’s power bill. heating and cooling control loop, making possible 5 percent savings on total steam consumption. A third way that companies can use lean ap- This initiative alone resulted in $75,000 per year proaches is to identify process-design and equip- of savings for just two days of the company’s ment changes that can deliver greater energy software engineer’s time. efficiency. As already mentioned, chemical com- panies have responded to higher energy prices In another example, a chemical producer was able with substantial capital expenditures to capture to reduce the energy bill on its storage operation energy savings. Complementing this, lean by 50 percent by reorganizing its tank-storage methodology makes an important contribution strategy. Previously, it had operated multiple by helping to identify numerous smaller invest- storage tanks, all of which had to be kept heated. ments that can add up to major energy savings. By changing its storage procedure—following lean thinking on optimizing inventory to minimize One chemical producer replaced traditional fixed- waste, here with an energy focus—it consolidated speed air compressors with high-efficiency on a limited number of tanks and closed the variable-speed compressors, which led to savings Capturing the lean energy opportunity in chemical manufacturing 37

of up to 40 percent of electricity consumed to $2 million in additional boiler capacity. By power its compressors—paying back the €200,000 improving consumption planning, it was possible investment in less than two years. Another to make sure that demand would not pass the company installed a blower-dryer combination to threshold that triggered pressure drops, and so avoid using compressed air as a dry air source, the company was able to avoid making the and it saved €30,000 a year for an investment of boiler investment. At another site, a company €50,000. And at another site, a company in- captured substantial savings when it was able to stalled a new heat sensor that enabled it to better get an accurate demand forecast from a third-party manage its energy output—again having iden- user it supplied. Previously, the producer had tified energy waste through the lean approach— maintained steam production at the ready to meet and achieved savings of €64,000 per year unpredictable demand from its third-party user, for an investment of just €1,000. but once it knew the demand timetable, it was able to put its boiler in power-saving mode A fourth area where lean energy approaches can during downtime. eliminate waste and capture savings is opti- mizing the interface between producers—steam- To ensure that the gains are sustainable, companies boiler operators, cooling-water-unit operators, must put into place a performance-management and power suppliers—and consumers. One system for energy efficiency that will provide an was reaching its boiler capacity objective basis for discussion. One company, and experiencing pressure drops at demand for instance, spent about $300 million on energy spikes, and it was therefore getting ready to invest a year, but it was having difficulties estab- 38 McKinsey on Chemicals Winter 2011

Focusing on theoretical limits stretches the organization’s aspirations for energy savings that can be achieved with the existing asset configuration and product requirements

lishing appropriate key performance indicators will quickly devolve into an analysis of variance (KPIs) for energy because it had little sense that leads only to incremental changes. Focusing of how KPIs would change in response to oper- instead on theoretically achievable energy ating decisions. As a result, it did not change efficiencies and on the identification of specific its KPIs for two years. Once the company under- types of losses between actual and theoretical stood how it should correct for factors that positions enables a far more fruitful discussion play a part in energy consumption—such as price on potential improvement levers. Such a conver- fluctuations, product mix, and throughput— sation will generate strong insights into the type the company was able to install meaningful KPIs. and size of losses, and it forms a clearly quantified With these in place, the company was then basis for relentlessly focusing on loss reduction. able to make appropriate decisions and raise its energy efficiency. Set up the right metrics. Frequently, the chal- lenge for low-cost improvement starts with Lean energy: The priority list insufficient energy-consumption metering and for management energy-generation cost allocation. Improving Implementing these lean energy-efficiency tools these enables companies to identify operating and approaches will require some new manage- changes that lower energy usage, such as reducing ment approaches. Senior management at chem- standby times. Better information about con- ical companies will need to take several steps: sumption and cost allocation also helps in devel- oping meaningful KPIs. With a combination of Focus attention on operational improvements energy-efficiency planning and employee training, versus the theoretical limit. In our experience, low-cost, sustainable savings can be achieved. the most successful companies have moved their Relevant metrics would then include a clear cor- managers from a benchmarking mind-set to rection for product mix, quality losses, and one focused instead on opportunities and closing throughput variation. gaps to theoretical limits for energy savings. This stretches the organization’s aspirations for Set targets for developing ideas. Companies the energy savings that can be achieved with must signal the importance of energy-cost the existing asset configuration and product re- reduction to employees and communicate this quirements. Given the product mix and site opportunity in the existing language of lean, specificity of energy production, transport, and and they should set targets to develop break- consumption, the benchmarking discussion through energy-efficiency ideas. For instance, Capturing the lean energy opportunity in chemical manufacturing 39

they should emphasize the importance of Put teams of experts in place. Many of the ideas that involve little or no capital expenditure leading players in energy efficiency have invested and that are generated through frontline in developing coaches trained in the discovery engagement with plant workers, cross-functional of energy waste, which is often invisible and tends problem solving, and changes in mind-sets to be spread across an entire plant. Identifying and behaviors. In addition, senior managers should that waste requires specific technical knowledge, arm themselves with examples of what can be for example, steam production network achieved—borrowing ideas from industry peers economics or pinch analysis. In addition to if necessary. technical knowledge, coaches must possess the ability to tap into frontline knowledge in order to identify solutions and mobilize personnel to capture savings in a manner similar to typical lean programs.

Frank Plasschaert ([email protected]) is a principal in McKinsey’s Antwerp office, where Ken Somers ([email protected]) is a consultant. Gautam Swaroop ([email protected]) is an associate principal in the Delhi office. 40

Improving pricing and sales execution in chemicals

Some chemical companies have blind spots when it comes to steering sales—and they pay a high price in lost margins and growth. A sales-management approach built around a more granular level of insights makes it possible to improve sales execution and boost returns.

Joel Claret, It is well recognized that improving companies’ four main hurdles. First, although it is well Dieter Kiewell, pricing and sales execution can have a significant established that sales profitability rather than Soenke Lehmitz, impact on profitability. Our data, covering more sales volume is key to a company’s performance, and Prashant Vaze than 1,000 commercial performance-improvement some chemical companies still do not have initiatives in a range of industries, show that a clear understanding of the profitability of when they are successful, such initiatives typically geographical regions, product lines, and in- translate into an improvement in return on dividual customers or transactions, which can sales (ROS) of between 2 and 7 percent and lead guide pricing and sales decisions. This is not to additional sales growth as well. In the chemical for lack of data: most companies have copious industry, successful pricing and sales-execution sales information available through their initiatives have mirrored these results in a variety enterprise-resource-planning (ERP) systems. of portfolios that encompass both specialty But many companies are not able to orga- chemicals and commodities. nize or interpret the data appropriately to pro- vide transparency on profitability, and so their What is specific to chemicals? Initiatives to im- sales representatives lack the right data to guide prove pricing and sales execution must overcome them when they are agreeing on sales contracts. 41

Next, the chemical industry’s asset intensity individual salespeople with only simple metrics, encourages plants to be run flat out, generating which limits their ability to steer their sales production surpluses, and companies fre- force’s actions in the most effective way and quently suffer “leakage” from their official pricing improve performance. structure, as production surpluses must be placed. If sales representatives are given incen- Boosting sales and pricing performance tives based on volume or revenue, they are based on detailed and real-time market likely to award ad hoc discounts and make other and customer insights accommodations, such as offering free services, These hurdles represent substantial and inter- to win sales. Sales management, meanwhile, has connected challenges that hold back many difficulty precisely assessing the impact this chemical companies’ ROS performance. We has on margins and enforcing behavior that will have found that the four-step approach described maintain profitability. below can help companies tackle them and improve performance. Third, the chemical sector has had to confront extreme volatility in raw-materials prices in Chemical companies that have adopted this ap- the past several years, creating serious challenges proach have achieved substantial improvements for products that are sold on longer-term con- in ROS, with the degree of improvement depend- tract periods than the company’s raw-materials ing on their starting point and on the type of purchase contracts. Many companies do not business they are in. Companies mainly selling have a clear understanding of which selling prices commodities in the spot market have seen ROS should rise and by how much—or, importantly, improvements of 2 to 4 percent, while companies how quickly—to pass along the cost increases and that sell primarily through individual customer maintain profitability. Lacking this information, negotiations have captured improvements of 3 to companies may find it difficult to provide appro- 6 percentage points of margin; companies that priate and timely guidance to their sales forces on sell customized products and solutions have the price levels needed to maintain profitability. achieved ROS improvements of between 5 and 8 percentage points of margin. In some very Finally, some chemical companies have a sales- selective special-product and service cases, ROS force skills gap. Their salespeople are good improvements of as much as 20 percentage points at the traditional job of placing volume that keeps of margin have been captured, but this requires their production plants loaded, but many sales a granular approach that allows players to identify people have limited abilities to analyze sales data niche products and services where they have a and limited negotiating skills to act on what true competitive advantage and where they can the data show. This imposes a serious handicap on implement value-pricing approaches to capture companies that want to move beyond simply the full potential value of their offering. These ROS recouping their costs to capturing pricing that re- improvements have typically been achieved flects the distinctiveness of their product and within two years—and in some cases as quickly as its value to different customer segments. At the within nine months. same time, some companies are monitoring 42 McKinsey on Chemicals Winter 2011

1. Discovering the sales portfolio’s true profitability Factors that should be examined include the more The first step that enables chemical companies obvious, such as sales prices, and the less to make improvements in pricing and sales apparent, such as “cost to serve”—in other words, execution is to establish full transparency into companies should make a full assessment of the factors that drive the profitability and all the costs associated with supplying a customer. growth of geographic regions, product lines, and Many of these costs are not immediately visible. individual customers and transactions. The It is important to identify customer behaviors analyses that must be carried out include the pro- that impose additional costs but that are not fitability of customers by volume and segment, captured in ERP-based information. For example, price performance and profitability across micro- a customer might make last-minute changes markets,McKinsey and onchanges Chemicals over time 2010 with regard to an order that result in the chemical company toPeriscope margin, volume, and churn by customers and incurring additional but hidden handling and segmentsExhibit 1(exhibit). of 1 logistical costs. Similarly, some customers make

Exhibit Achieving transparency into the drivers of profitability opens the way for performance improvements.

€ per kilogram Contribution margin per unit, Q3 2009—Q4 2009

12.44 –1.25 0 –0.10 –10.43

61.60 0.18 61.78 0 –1.21 61.23 0.71 61.94

Average Lost Con- Volume Portfolio- Pricing Pricing Ex- Effects of Increase Con- New Average margin business tinued effect mix effect up down change- dis- in tinued business margin in Q3 business rate counting variable business acquired for Q4 in Q3, impact costs in Q4, overall average average margin margin

Source: McKinsey Periscope Platform Improving pricing and sales execution in chemicals 43

extensive use of companies’ laboratory ser- that reflects the cost to serve, customer price sen- vices and technical support, but these additional sitivity, and its competitive positioning. New costs are often not reflected in the prices pricing guidelines, as well as go-to-market and charged to them. service-level guidelines, should also be established to reflect these profitability targets. It is also important for senior sales management to enforce a standardized approach to measuring Companies can also use guidelines to steer account profitability across geographies. Fre- the sales force to capture premium pricing on quently, different national sales organizations products if it is merited. For example, one apply different metrics. These national differ- specialty-chemical company had a product with ences make it difficult to effectively manage distinctive characteristics that provided benefits performance across regional or global markets. in certain end-use markets that the company knew gave it the opportunity to charge a higher Building on this, companies can conduct further premium in those markets than in others. The analyses on price performance and profitability company created guidelines for the sales force to for individual customers compared with the capture that premium on the product in the total portfolio, examine price leakages from gross particular application, backed up by differentiated price to net price and then to contribution mar- branding of the product. It also started to gin, and look at cost to serve and leakage for educate its salespeople about where to look for different customers. These analyses provide a this type of value-pricing opportunity. wealth of insights on the true levels of pro- fitability of the company’s businesses, and they When setting such guidelines, we have observed can inform targeted pricing actions to capture that one effective approach is for companies to the profitability improvement potential. simulate the impact of their price-setting actions. This allows the company to model changes 2. Pricing to maximize value capture on in raw-materials and other costs and then enter each transaction prices for a region, country, customer group, Once the company has gained insights into pro- or product line. In this way, it can see the impact fitability, it can start to address its sales per- on ROS coming from each change. A company formance, and here pricing is a top priority. The that produces , which found that its first area on which to focus is setting pricing costs were increasing, was able guidelines. These guidelines are created by de- to model how much it would need to increase vising action plans for certain customer or pro- prices to maintain its margins and then set duct groups; such action plans include deciding pricing guidelines accordingly for its sales force. on target profitability levels and price points. 3. Steering the sales force to get the best For example, if a company identifies that pro- possible deal fitability at its small customers is too low because The third step focuses on sales execution. This is of the additional complexity entailed in appro- an area where some chemical companies need to priately serving this segment, it should reset its improve, particularly when preparing their sales profitability targets for the segment in a way representatives for negotiations with customers. 44 McKinsey on Chemicals Winter 2011

We have observed that while chemicals sales focus on, for example, directing a salesperson to representatives are good at the traditional skill of push volume sales in an area where price securing sales volumes, many cannot negotiate increases have been going through easily. confidently with their customers’ procurement departments to secure price increases. Many reps 4. Establishing an integrated performance- also lack the analytical skills to deal with sales management system across the sales process, data. Given that chemical companies are selling to from the CEO to the salesperson in the field many industries that have taken steps in recent Many chemical companies steer their sales efforts years to strengthen their procurement depart- based on volume and on a superficial view of ments, this puts chemical suppliers at a dis- the contribution margins that they earn, but this advantage. Sales representatives must be trained represents a relatively crude instrument for to look for ways that they can work with col- steering the sales organization. Once the steps leagues in their operations, freight, and finance outlined above have been taken, best-practice departments to fine-tune the offering that can be companies put in place performance-management provided to the customer, closing leakages and systems that establish consistent key performance tying up loose ends to improve service. indicators (KPIs) for all their commercial activities. Such systems go into a high level of detail, An effective approach used by some best-practice and the results are then consolidated into a single companies is to provide the sales force with a reporting system. While companies often have tool for quoting prices in real time, which arms different KPIs covered in different reports, an the salesperson to get the best possible deal integrated system makes it possible to track from the customer. The tool’s algorithm incor- everything in one consistent way. Management porates pricing guidelines and supports the can monitor overall pricing performance and salesperson in finding the deal terms that capture individual customers’ performance against tar- the maximum value based on the supplier’s gets, identifying the best- and worst-performing distinctive position; it also includes the surcharges accounts and products—the information is all at needed to cover specific delivery and product- their fingertips in one system. quality requirements for the customer. Addi- tionally, the tool gives the salesperson infor- This kind of performance-management system mation—for example, on different price, volume, also transforms sales-force mind-sets. Tradi- and delivery-term packages, and on margin—to tionally, performance dialogues with sales- be able to propose deal alternatives. All of this people have focused on activities and volumes. puts the salesperson in a position to negotiate With the new system, KPIs are aligned with the confidently with procurement departments. goals of the sales organization and the sales staff, and it becomes possible, for example, to At the same time, sales management can use the monitor whether a salesperson captured the tool to monitor sales reps in the field and maintain target price set for an account. This more compre- an ongoing dialogue on sales performance, hensive system with new KPIs can provide regu- reinforcing its intended messages. The historical lar feedback to support more effective data that the tool collects can also show sales performance dialogues with the sales team— management which customers and salespeople to discussions that are focused on issue resolution. Improving pricing and sales execution in chemicals 45

Beyond performance dialogues, the management Our experience has shown that when applying system provides a generally more effective way for this four-step approach, the greatest benefit to the company to steer the efforts of its sales force. senior sales management comes from the analysis of a limited number of key indicators that have Moving to higher ROS performance: the highest impact on ROS performance. We have Success stories developed Periscope, a platform that provides Once these four steps have been taken, we have tools and this type of focused information to observed that companies are able to make support pricing and sales execution. Additional substantial improvements in ROS performance. information is available at https://solutions. Consider the initiatives taken by two chemical mckinsey.com/catalog/periscope.html and from companies. The first, a diversified global chemical the authors. company with a 500-person sales force, had been contending with declining ROS performance Companies should also look at the potential that for several years. This could be partly attributed can be achieved by integrating this pricing and to increasing competition from new suppliers in sales-execution approach with a broader set low-cost countries, but business segments not of improvement initiatives that cover all the affected by such competition were also in decline. important dimensions of the commercial process. The company embraced the approaches outlined These initiatives include attending to organiza- and applied them to its commercial operations; tional setup and pricing processes, as well as within 24 months, each of its business units looking at how the company works across its experienced improvements in ROS of 2 to 5 different functions to resolve pricing and margin- percentage points. management issues. The initiatives also cover capability building for sales management and In the second case, a European petrochemical frontline sales staff. This is a multiyear process, company lacked full transparency on profitability but it can allow a company to capture significant levels in certain customer segments and channels. additional margin independent of the chemical- The transparency that was achieved using the industry business cycle, as well as to make approach we have described showed the company silo-breaking, cross-functional improvements that it could earn better returns by selling that can carry company performance to a directly rather than through distributors for parts higher level. of its business, and demonstrated that it should enforce new price guidelines for selected customer segments. Within six months, ROS had improved by more than 5 percentage points in the targeted segments and channels.

Joel Claret ([email protected]) is a director in McKinsey’s Geneva office,Dieter Kiewell (Dieter_Kiewell @McKinsey.com) is a director in the London office,Soenke Lehmitz ([email protected]) is a principal in the office, andPrashant Vaze ([email protected]) is a principal in the Antwerp office. 46

Kick-starting organic growth

Even in a recovering economy, many companies see only limited potential to boost revenues and profits through organic growth. But there is a larger opportunity to capture: by targeting micromarkets and reorganizing the sales force to prioritize growth, companies can achieve growth rates well above the overall market.

Maximilian Coqui, Chemical companies face two challenges when opportunities that are hidden when a more Manish Goyal, seeking to grow organically in seemingly generalized or average view is taken of the larger Jason Grapski, saturated and highly competitive markets. First, market.1 This is as true for the chemical and Soenke Lehmitz many companies have trouble finding oppor- industry as it is for other industries and markets. tunities. Second, even if they identify new areas to pursue, they find it difficult to motivate their Why do chemical companies frequently fail to sales forces to break old habits and take initiative. see these potential growth markets and But while it is not easy to find growth oppor- translate them into new sales? One part of the tunities in such markets and transform the sales problem is that some companies do not do 1 See Mehrdad Baghai, Sven Smit, and force, companies should not give up. enough homework on market prospects and Patrick Viguerie, The are not keeping up-to-date on the shifting Granularity of Growth, Hoboken: John Wiley & Extensive McKinsey research shows that re- customer base, notably when selling into Sons, 2008, and Baghai, examining markets at a more detailed or granular fragmented and changing markets. As a result, Smit, and Viguerie, “The granularity level reveals large numbers of micromarkets that companies lack insights, in any particular of growth,” McKinsey present substantial organic-growth opportunities geography, into where the fastest-growing and Quarterly, May 2007, www.mckinseyquarterly.com. well in excess of overall market-growth rates— most profitable customers might be. 47

The second and related part of the problem stems The approach, Micromarket Management (M3), from how companies handle their sales forces. has two main components. First, it adopts a In the mature markets in which most chemical granular lens to target micromarkets and pinpoint companies in developed countries operate, growth opportunities. Second, it focuses on salespeople tend to have routine ways of looking actionable steps at the sales-force level: at and dealing with their customers. Directives building strategies to pursue micromarket from the top to prioritize new market segments growth, boosting sales-force effectiveness and often get lost in middle management and providing incentives for the sales force to are not transmitted to the sales force, and when pursue growth, and strengthening underlying they are, salespeople do not know how to commercial capabilities. follow through. Defining and grouping micromarkets The result is sales-force-led prioritization For many senior managers in chemical of customer development based on the companies—in particular, those that serve a ease of winning the customer, rather than an market sector growing in line with GDP in approach built on prioritizing customers which multiple competitors are entrenched—the based on their potential contribution to profit- key question is where to find areas of growth. ability. Making matters worse, many companies Getting to the right answer can be a major chal- do not use an incentive system that rewards lenge for companies with hundreds or thou- sales staff for seeking new growth accounts. sands of customers. For companies that have suc- ceeded with this approach, the first step is to Not surprisingly, senior-management teams at break the market down into manageable sub- many chemical companies in developed groups—or micromarkets—where the prospects economies view grappling with these challenges can be reviewed in detail. Such subgroups can be as offering little growth. They see rallying based on shared characteristics—notably, scale, their sales forces once again to fight for gains in type of industry, or degree of service intensity—or this familiar territory as unrewarding trench simply on geography. One specialty-chemical warfare. Instead, many senior teams prefer to company, for example, sorted its markets into geo- focus on the seemingly more exciting prospects in graphical regions and then grouped customers M&A and on investments in fast-growing and potential customers within each region by emerging economies. industry type.

However, in the chemical industry—as in a Once the micromarket segments are defined, number of other industries—some companies are these companies evaluate the growth potential of starting to show impressive results from a new each micromarket—both with regard to the level approach that turns these shortcomings around. of penetration the company has already achieved In chemicals, companies that operate in highly and the additional share that it can aspire to fragmented specialty markets comprising large capture—and of the market’s underlying growth numbers of customer niches have been or lack thereof. This can provide surprises. For particularly successful using this approach. example, one chemical and services company with 48 McKinsey on Chemicals Winter 2011

a 20 percent share of the overall market dis- continent. To avoid becoming bogged down covered it had share as high as 60 percent in some in the complexity of handling numerous micro- markets, while in others, including the fastest- markets, successful companies combine micro- growing market, its share was as low as 10 percent. markets with similar characteristics (including Companies also assess the competitive dynamics growth opportunities) into a much reduced in the micromarket, such as the number of and manageable number of “peer groups,” and competitors and whether pricing in the then define a strategy for each peer group. In market tends toward value-based practices or is most chemical sectors, that number is no more just aggressively cost-based (Exhibit 1). than 8 to 10 peer groups in each of a company’s main regions. AMcKinsey typical micromarket-definition on Chemicals 2010 exercise M3can generate dozens of micromarkets—or even For example, a company specializing in inputs hundredsExhibit 1 if ofthe 3 company considers an entire for the agricultural sector (including crop-

Exhibit 1 Companies can use internal and external customer data to assess current performance and identify attractive micromarkets.

The attractiveness of growth areas becomes more nuanced when examined at the level of micromarket data

Market size Market penetration $ million % 40 50 35 40 20 20 22 10 15 5

Growth Competitive-intensity index % 100 = bad 7 6 73 52 3 36 2 2 22 28

A B C D E A B C D E Micromarkets Micromarkets

Source: Disguised client data; McKinsey analysis Kick-starting organic growth 49

McKinsey on Chemicals 2010 M3 Exhibit 2 of 3

Exhibit 2 Define peer groups and assign strategies for the micromarkets making up each peer group.

Gross margin relative to operating expenditure, $

Micromarket 5.0 Approach 2. Maintain 1. Invest to grow Peer-group strategy: 4.5 • Set micromarket 1. Invest Invest in sales growth productivity goals 4.0 based on 2. Maintain peer-group 3.5 Improve productivity average 3. Monitor investment • Reallocate Ensure payoff in capturing 3.0 investment to new business focus on 3. Monitor 2.5 4. Overstaffed 4. Overstaffed markets with investment Reduce expenses to meet high potential 2.0 average peer-group productivity 1.5 0 5 10 15 20

New-account opportunity, $ million

protection chemicals, fertilizers, and seeds) micromarkets exercise can be translated into aggregated its 200 micromarkets in the United an actionable sales-development plan for the States to 10 peer groups. These peer groups company. As will be explained in more detail, the were built based on the characteristics of the peer groups can also be used to share best farms that they were serving. Factors that practices across the sales force and to compare were taken into account while building these different sales representatives’ performance. peer groups included the size of the farms, the relative density of the farms in a geographic Building strategies area (for example, farms in the west were larger The next step is for the company to develop and more spaced out than those in the strategies for its peer groups, which can then east), and the type of product ordered by each be tailored for each micromarket. In one of the farms. example, a chemical company grouped its 18 micromarkets into four peer groups and out- This aggregation to a limited number of peer lined four related strategies, including “invest,” groups is an essential step in ensuring that the in which the company sought to capture an 50 McKinsey on Chemicals Winter 2011

outsize share of growth, and “maintain,” in external resources and tap into information which the company’s strategy was to hold on to gathered by the sales force in the field. This keeps its market share while maximizing operating the company’s information on growth prospects efficiencies (Exhibit 2). fresh—and hopefully ahead of its competitors’ insights. With this enhanced resource in hand, Developing the strategic plan involves taking the company made a scan of potential hospital into account which micromarkets to focus on based client prospects, analyzing details down to the on growth potential and defining how to capture number of beds in every hospital across a the potential and to meet or exceed market country market. growth. This results in a detailed plan that covers sales-force allocation and in-market capabilities, Adding the sales-force-effectiveness performance goals related to capturing new dimension business and retaining old business, briefings to The next step is to ensure that the sales force the sales force on how to approach new types of is allocated and provided with incentives clients, pricing, and an implementation program. in ways that are aligned with the strategies developed for the micromarkets. Having an District managers translate the strategy into accurate view of the performance and capabilities specific tactics for sales reps to use: for instance, of the sales force enables the company to act identifying which accounts to pursue and how effectively on the leads created by the new much time should be allocated to each. A com- micromarket data, so that it can match the best pany’s pricing policy should reflect micro- salespeople with the best opportunities. market opportunities, as well as the customer life-cycle stage and purchase histories that Some best-practice companies monitor how much predominate in the micromarket. In addition, time each salesperson has been spending with marketing strategies should be sufficiently each account and conduct a “skill/will” assess- tailored to provide a distinctive product or service ment of all sales and service reps, including their suited to the traits of a given micromarket. For account conversion and retention performance. In one chemical company, adopting this peer-group one company, district managers completed and micromarket-strategy approach resulted in evaluations to assess each rep’s skill and will for a tenfold increase in prospects—identified po- new-business sales. Coupled with prior perform- tential opportunities—in some micromarkets and ance data (including new-account growth, a narrowing down of realistic prospects in retention rates, and so on), this evaluation was others (Exhibit 3). used to identify the role on the sales force that each sales rep should be assigned to. The chemical A key piece of the strategy is undertaking company evaluated each of its 3,000 sales and detailed research on the best prospects in the service reps worldwide. prioritized sectors. One specialty-chemical company redeployed some sales-force resources Companies can then use the new understanding to create positions for market-prospect re- of each micromarket’s relative opportunity searchers. These individuals scan data from in combination with each rep’s skill set to re- Kick-starting organic growth 51

McKinsey on Chemicals 2010 M3 Exhibit 3 of 3

Exhibit 3 Companies should develop a comprehensive view of tangible customer opportunities within each micromarket.

Apply a robust process to identify and prioritize … and significantly increase the world of opportunities in each micromarket … opportunities for reps to pursue

In current client database Newly identified opportunities

• Investigate any account site that Total identified purchases the client's products Target Current market • Search more than 50 global and Industry opportunities sales local databases $ million $ million • Identify more than 5,000 accounts per microdistrict across 65 industries A 0.64 0.02 • Identify exact locations and B 0.62 0.27 calculate value per account C 0.60 0.00

D 0.33 0.00 • Examine opportunities the Relevant client is interested in E 0.27 0.15 opportunities approaching in the midterm but currently lacks the F 0.27 0.00 capabilities to address G 0.20 0.02

H 0.15 0.00

I 0.14 0.00

J 0.12 0.03 • Identify opportunities where the K 0.11 0.04 Accessible client has the right offering but opportunities economics do not justify L 0.10 0.13 immediate pursuit (eg, small accounts, low-margin accounts) M 0.07 0.01

N 0.02 0.00

Total Current sales: 0.67 • Target opportunities that are an Target Opportunities in database: 0.88 immediate priority and will be opportunities assigned to specific sales reps Newly identified opportunities: 2.76

Source: Client financials; external trade publications 52 McKinsey on Chemicals Winter 2011

One company not only doubled its rate of growth over an 18-month period but also reduced costs 5 percent, since it was able to deploy its sales force more efficiently

allocate sales resources. This should result in reps levels (or “bands”) and calculate average market skilled at gaining new accounts (“hunters”) share to understand the point of diminishing spending their time aligned with the opportunity returns. These data were then used to set as- for generating new business, while reps skilled pirations. For each micromarket, the client made at maintaining existing business (“farmers”) an explicit decision on whether it wanted to get concentrate on those accounts. This approach the most possible share points from added improves sales growth and reduces waste of coverage or only increase coverage where “bang sales resources. At one company, the analysis for the buck” was the largest. showed a top-performing “hunter” was traveling 200 miles and spending 55 percent of his time Successful companies have also established in an area where it now appeared that only improved performance-management systems. 25 percent of the opportunity existed. His work- These include defining new pricing and plan was reorganized and his home base was service guidelines across accounts to ensure that moved so that he was traveling only 50 miles and all accounts are held to a minimum level spending 75 percent of his time in an area where of profitability. With regard to sales-force per- 75 percent of the opportunity existed. formance, best-practice companies have created incentives for the sales force to pursue The company also developed customized pricing the newly identified growth opportunities and sales tools that could be adjusted depending and to look out for new growth opportunities. on strategy. As a result, new customers in an They do this by evaluating the sales reps on “aggressive growth” micromarket received lower leading indicators, such as how often they call prices than customers targeted for service prospective customers and top-performing renewals in “moderate growth” micromarkets. “hunter” reps’ increases in sales time, and on lagging indicators, such as new-account In another example, the agricultural-chemical generation and sales growth. company conducted a detailed analysis that plotted market share against sales coverage. This Again, the peer-group structure can play a valu- analysis helped the company identify coverage able role here. Companies can measure per- Kick-starting organic growth 53

formance within peer groups of similar micro- reps to accounts in close proximity, as well as markets, replacing the typical practice of changing time allocations to focus on more simply evaluating an individual market’s and profitable accounts and more sales (rather than salesperson’s performance against a set of key service) activities. performance indicators. This approach makes it easier to spot major performance gaps and to Impact validate hypotheses about the effectiveness Using this approach, one chemical company of micromarket strategies and changing market doubled its rate of growth over an 18-month conditions. In addition, the peer-group perspec- period while maintaining upward price momen- tive can be used to share best practices across tum. It did this primarily by identifying its largest the sales force and to compare different sales opportunities and then assigning sales reps to representatives’ performance. capture them. The growth rate achieved was three times higher than that of the underlying Building the supporting organization to market, which mirrored the region’s GDP growth. drive and sustain the change The company also reduced costs by 5 percent, In the third phase, successful companies build up since it was able to deploy its sales force more the commercial capabilities required to execute efficiently, giving top sales reps more time for their micromarket strategies. When assigning roles face-to-face selling instead of servicing accounts. and responsibilities, we have observed that companies tend to standardize some duties but Another chemical company turned around a also allow for a degree of modification across decade of market-share losses after implementing micromarkets. this approach. The client had lost a point or more of market share for 10 successive years and In addition, the need to build up certain capa- failed to capitalize on a booming market. bilities to be able to pursue micromarket After launching this effort, the client was able to opportunities is often recognized when pursuing hold market share steady for the first year; this approach. Rather than adding overhead it has increased share by two to three points to build capabilities, best-practice companies re- annually for each of the past three years. allocate resources. One specialty-chemical company shifted staffing allocations from lower- This approach has had significant impact in priority sales territories to set up a new sales- industries beyond chemicals as well. A large operations group to monitor its progress in each air- operator was able to double the share of of its regions (Americas, Europe/Africa/the wallet from key strategic customers along Middle East, and Asia-Pacific). It also put in targeted trade lanes by following this approach. place a marketing analyst to identify and track Similarly, a logistics player was able to grow opportunities across one region and added a volume and price simultaneously, increasing second analyst to prepare financial tools for revenues by 3 percent. In another case, a leading real-time decision making in each micromarket. Asian mobile operator whose annual revenue This included building maps and assigning growth had declined by 50 percent over two years 54 McKinsey on Chemicals Winter 2011

used the approach and is now on track to realize The approach outlined in this article makes it revenue growth of 5 percent. possible for companies to generate new market insights by combining granular micromarket To support companies in the initiatives described data on growth prospects with specific and above, we have developed a framework and a actionable steps that the sales force must follow. number of tools, which are available as the M3 Chemical companies that have adopted the approach. The M3 offering includes templates that approach have seen impressive organic-growth can be used in micromarket analyses, frameworks improvements. Consider the alternatives: M&A for aggregating micromarkets into peer groups, has a high failure rate. Expanding in emerging and a number of sales-support tools. markets is expensive and requires extensive new skills, while innovation—though a well-tested route to growth in chemicals—takes time and luck. Given all that, chemical-industry senior- management teams should look carefully at organic growth as a route to building their busi- nesses and improving returns to shareholders. They should also bear in mind that if they are not paying sufficient attention to and defending their core business, they may well lose it to a competitor—one that is willing to invest the time and effort necessary to build it up.

Maximilian Coqui ([email protected]) is an associate principal in McKinsey’s Munich office, Manish Goyal ([email protected]) is an associate principal in the Dallas office,Jason Grapski (Jason_ [email protected]) is a principal in the Southern California office, andSoenke Lehmitz (Soenke_Lehmitz@ McKinsey.com) is a principal in the Berlin office. February 2011 Designed by McKinsey Publishing Copyright © McKinsey & Company