Slowing growth. Shareholder activism. Stalled performance. This is today’s chemical industry reality. While companies want to disintermediate from a commodity chemical mindset to provide specialized products for end markets, the cultural DNA of a chemical company is steeped in a supply paradigm that is inside-out. It is not equal to the challenge.
The traditional definition of supply chain excellence runs deep and is heavily controlled by manufacturing. While traditional economies of scale came from large-scale manufacturing with large volume batches and bulk shipping, the world has changed. The shift to differentiated products requires rethinking batch sizes, shipping modalities and supply chain processes. More importantly, and the top-of-mind question for chemical business leaders is, how do chemical companies translate economies of scale and differentiation into new business models based on the shifts in business market fundamentals?
Table 1. Industry Overview of Trends for the Period of 2010-2016
Stalled on the Supply Chain Metrics That Matter the chemical industry is struggling to redefine process excellence. Traditional process standardization drives improvement in singular area, not a portfolio of metrics. Improvement in a portfolio of metrics improves value. To understand the depth of the issue, take a look at the chemical industry within the value chain as shown in Table 1.
Let’s start by explaining the chart. In Table 1, each industry is represented based on product groupings. We group 495 companies by industry to complete this analysis. >Within an industry, the first number represents the average value for a metric for the period of 2010-2016. The second number represents the percentage change when the 2010 average is compared to that of 2016. For example, while growth in the chemical industry averaged 3% (slightly above GDP) for the period of 2010-2016, growth in 2016 was down 12% on a revenue basis versus 2010. Similarly, while operating margin for 2016 represents a 1% improvement over 2010, the rest of the Supply Chain Metrics That Matter show performance deterioration. Of significant note is the precipitous decline in inventory turns which impacts the Cash-to-Cash cycle.
With the increase in business complexity and globalization, companies struggle with increasing inventories. Few realize that globalization increased in-transit inventories. In addition, port congestion, larger vessels, and slow-steaming by ocean carriers increases in-transit inventories and adversely impacts safety stock due the reliability of supply. Since few chemical companies are good at supply chain planning—with many going backwards versus forwards in capabilities in planning—inventory management remains an opportunity. Few understand how to balance form and function of inventory.
To compensate for the increase in inventories, most companies offset shifts in Days of Inventory by lengthening Days of Payables. This is a short-term gain with long-term impacts. With the lengthening of payables, the supply base is more fragile and the risk to supply increases.
No chemical company has used economies of scale to their benefit in response to the market shifts. As a result, the industry is driven by buy/sell relationships based on price. As growth stalls, and globalization challenges increase, the supply chain leader is struggling to reduce costs.
The business is more complex. Sitting three and four levels back in the value chain, the chemical industry is experiencing the compounding impact of increasing complexity of downstream customers. They are unable to price, to overcome the costs of complexity, through traditional approaches. As a result, the industry is facing the double whammy of price and complexity pressures.
Understanding the Industry
While chemical company leadership wants to drive compliance, i.e. adherence to supply chain best practices and the adoption of standard technology, there is a dilemma. Simply put, they are not able to drive improvement through the adoption of historic practices using traditional IT platforms. There is a need to question if historic practices are equal to the challenge of the global supply chain. Increasingly, supply chain leaders are asking, “Are historic practices best practices?”
The reality is that the traditional focus of creating efficient vertical organizational silos does not deliver an effective supply chain. Instead, there is a need to align the organization to a cross-functional, shared metrics portfolio. Without this alignment, strong manufacturing and transportation organizations within the company become self-serving, throwing the supply chain out of balance.
Few companies are able to drive process improvement. Within today’s company, innovation is focused on new product launch, not process innovation. Few companies have come to grips with the new reality that they must innovate and redefine processes to drive business improvement.
When we examine actual performance, as shown in Figures 2 and 3, a different picture emerges. Companies are struggling. An orbit chart enables a study of year-over-year patterns at the intersection of metrics. The averages for each company is shown in the boxes on the chart.
In Figures 2 and 3, Grace is driving more improvement than BASF, Dow or Solvay. While we picked these chemical companies at random to illustrate the point of stalled metrics performance, if we showed a portfolio of chemical companies the orbit charts would be similar. The patterns show a lack of resiliency (large variation in metrics performance with overlapping patterns).
Figure 2. Orbit Chart of Dow Chemical and BASF at the Intersection of Inventory Turns and Operating Margin
Figure 3. Orbit Chart of Grace and Solvay at the Intersection of Inventory Turns and Operating Margin
As growth slowed, chemical companies focused on cost improvement. When we compare the values of 2004-2006 to the post-recession period of 2010-2016, we see that employee productivity improved 56%, but it did not translate to operating margin due the increase in complexity. Inventory turns decreased, but cash-to-cash improved 50% due to the focus on payables.
Table 2. Company Overview and Performance for Chemical Companies
The shifts in the consumer value chain ups the ante for the supply chain team in the chemical industry. Overall, the performance on the Supply Chain Metrics That Matter is stalled. To reverse this trend, it is time to cast off traditional practices and redesign the supply chain, from the outside-in. This includes better sensing, and translating demand, while building value networks. As a result, in the chemical industry no company rises above and makes the 2017 Supply Chains to Admire list (driving improvement faster than competitors while outperforming the industry).