In a recent survey by PA Consulting Groupon how the European chemicals industry is responding to the challenge of the growth of production capabilities in low cost economies, 87% of companies responded that Europe couldn’t compete on cost alone and that future growth depends on innovation, with one individual commenting that, 'only innovators will survive'.
There can be no doubt that innovation protects business. For example, while the sports equipment manufacturer Adidas moved the production of balls for the recent Football World Cup from Germany to South Korea, the raw material for the ball – polyurethane – was still provided by German-based Bayer. Actively seeking to grow the market through new applications, Bayer’s material scientists were integral in solving the design challenge for World Cup 2006 – a ball that remains glossy.
Economists and politicians agree that innovation is vital to ensure that countries with a higher cost base stay competitive. Research confirms the link between innovation and the ability to create shareholder value. Companies that created the highest value were those that developed an innovation strategy focusing on areas that added value as well as variety. Our survey found that they generated 9.9% higher total shareholder return (TSR) than their peers.
The chemical industry knows all too well about the importance of innovation. After years of driving innovation, most chemical companies more recently focused aggressively on cutting costs. Now, business unit managers are being challenged to do both simultaneously. However, short term cost-cutting and performance improvement projects can divert companies from building successful innovation pipelines.
So how can the industry overcome this dilemma? How can it meet its urgent need for short-term cost saving and still make essential long-term investment in innovation programmes?
Cost reduction need not conflict with innovation. On the contrary, the two should run in parallel. Instead of traditional cost reduction from making people redundant or closing plants, successful companies conduct a balanced programme combining creative performance improvement and short- and long-term innovation projects. In its analysis of the return on investment (ROE) and TSR of the largest ten companies by size in a number of manufacturing subsectors including process industries, we found that there are five lessons that can be learnt from these successful companies.
1. Question the value of traditional cost reduction programmes
Although cost-cutting programmes that mainly rely on redundancies and shutting underperforming production units do provide a short-term relief both in operational performance and short-term success in capital markets, they often undermine the longterm competitiveness of a company.
Typically, the stock market’s euphoria at the company’s short-term financial improvement fades, while the costcutting programmes continue to starve innovation – the oxygen of long-term competitiveness.
By the time they reach the middle of their term, traditional cost-cutting measures will usually destroy rather than create value for a company.
Specifically, they prevent employees from taking risks and thinking creatively thinking – both essential success factors for innovation. They also result in company efficiency dropping by up to 15% because they make staff focus on internal issues rather than market-facing activities, and they frequently cause the best people to leave the firm (labour law, particularly in continental Europe, tends to protect low-performing employees rather than the high performers).
The chemical industry has seen significant restructuring over the last few years, with many companies now facing the challenge of building momentum in innovation teams which have been left depleted, dispersed and demoralised after years of focusing solely on cost out.
2. Align innovation initiatives with the company's overall strategic position
Companies have to align their innovation programmes with their strategic positioning in the marketplace. Basically, there are three distinctive positions (based on Porters strategy framework describing cost leadership and differentiation as strategic positions): cost leadership, customer leadership, and technology and quality leadership.
Within each strategic position, exploiting innovation as the main source of value creation clearly requires different mindsets and capabilities (see Table 1 on the PDF version of this article via the link below). However, many companies do not focus and develop their resources sufficiently to achieve strategic innovation and the extra value that goes with it.
Focusing on technology leadership is at the heart of ICI’s strategy. The company spends almost £150m ($283m) a year on R&D. Applying 'joined-up thinking' across the individual businesses has resulted in some winning new products. For example, ICI’s former personal care subsidiary Uniqema (which has since been sold to Croda International) and its adhesives unit National Starch combined technologies to produce a nappy that helps keep babies more comfortable. The result is a patented new nappy to be sold in a $5m market area by Uniqema’s fibre finish unit – and a lot of happy, comfortable babies!
Customer leadership is another proven strategic position which chemical companies such as the cleaning and sanitising specialist Ecolab has pursued successfully. Its innovation is “asset light” and centres around innovating by applying new business models or extending service lines to the business. The Market Guard food retail programme for example offers food retail customers the benefits of one global partner with a full line of outstanding solutions for all their cleaning, sanitation, floor and facility care and pest elimination needs.
In each of these three strategic positions, chemical engineers play a pivotal role – commercial acumen and a process focus can help drive cost leadership, ability to work in multidisciplinary teams across technology areas to provide customer specific solutions (customer leadership) and expertise in research, development and scale-up of new products and processes to secure technological leadership.
3. Introduce creative performance improvement programmes, that contribute to short-term requirements
The most innovative companies all apply distinctive performance improvement measures and initiatives. The difference between these 'smart' initiatives and traditional cost initiatives is that the smart ones draw very much on the involvement of people and on creative approaches for differentiation.
Such initiatives not only improve companies’ performance, but also build the foundation for innovation itself, as they foster creativity, appropriate risk-taking and encourage people to try new ways of thinking.
Chemical engineers can lead the way in this area, bringing years of experience in safety, health and environment and responsible care programmes. These initiatives have delivered reduced energy, emissions and operational costs but more importantly have done so through the involvement of people in a sustainable manner and in many ways resulting in innovative new products or business models.
Solvay’s new Vinyloop process for recycling PVC began as a quest to solve a problem encountered by a customer, Ferrari Textiles Techniques. By dissolving PVC and any additives it contains (but leaving other plastics behind) a much wider range of products containing PVC in among a variety of plastics can now be recycled. Also, the process produces PVC that is much purer than that obtained through other PVC recycling techniques, Solvay says. This novel process is now a source of competitive advantage for Solvay and has attracted considerable interest across the industry.
Similarly, Dow Chemical launched an innovative business model based upon the principles of responsible care. Called 'Safechem', the project offers Dow’s partners and customers a system of patented containers for the safe delivery and take-back of chlorinated solvents in a closed-loop delivery system, backed up with help and advice from waste management experts and a service alliance with over 50 chemical distributors. The system has around 3500 customers in Europe and has been credited with contributing to the automotive industry reducing solvent emissions from metal cleaning applications by over 60%.
Even thinking about a cost reduction problem in a different way can have startling results, as demonstrated by Baxenden Chemicals in the UK. The company looked to biomimicry and the application of industrial biotechnology in order to achieve a step change in environmental and economic performance. Applying an enzymebased bioprocess eliminated the need for expensive catalysts and enabled the process to operate at lower temperatures, meaning lower energy and operating costs. In addition, the polymer produced was of improved product quality and uniformity, which gave them competitive advantage in a number of specialised markets.
4. Implement short-term innovation initiatives balanced by longer-term programmes Innovation programmes for the short term usually focus on process issues, either to stimulate innovation or to build competencies for new products and services to grow the top line. Typical short-term initiatives include streamlining new product development and commercialisation processes, proactively using customers and suppliers to stimulate short-term innovation, and upgrading existing products and services to grow the top line.
Although short-term innovation initiatives create short-term benefits, which justify further investments, companies must simultaneously embark on more long-term programmes in order to stay ahead in the innovation race.
Bayer has had considerable success in delivering both short- and long-term innovation. For example Makrolon, a polycarbonate plastic patented by Bayer over 50 years ago, is still a dynamic product. Now contributing 25% of the material science division sales, Makrolon is used in applications such the roofing for the Athens Olympic stadium, Daimler Chrysler's Smart car, and the medical industry, to name but a few. In parallel, Bayer has launched a strategic innovation initiative called 'Triple I' focused on white spaces not yet covered by the current business units.
Another tactic that companies can successfully employ is to drive networked innovations or new business structures delivering longer term, highrisk innovations. Examples include BASF's investment in the European nanomaterials group Oxonica, Du Pont and DSM's corporate venture arms and Degussa's 'project house' system, which brings together experts from across the company’s businesses to work on specific innovation projects such as nanotechnology, process intensification, biotechnology and catalysis. With each project house limited to a three-year period, the aim of the €15m ($19m) initiative is to develop products or new technologies for Degussa's future business, which are then realised either in the company’s existing units or via specially-established new business development structures such as internal start-ups. An important feature of the project houses is the collaboration of chemists, chemical engineers, material scientists and physicists in interdisciplinary teams.
As networked innovation becomes more common, chemical engineers with strong interdisciplinary skills will continue to be highly sought after to provide the much needed end-to-end view to turn good ideas into great commercial propositions.
5. Allocate financial resources to businesses with major value
Another key finding of PA’s growth survey was that successful companies invest more in healthy performers than in loss-making businesses. They apply the same principles in allocating resources – manpower and financial – to innovation projects: they invest only in projects with value potential. At a corporate level, managers have to consider the performance and core activities of the business. This means:
- investing in performing businesses with the biggest value potential;
- diversified chemicals companies having the ability to leverage cost out in basics/commodity businesses and use that to continue to invest in innovation in higher margin areas such as specialty or performance chemicals;
- fixing a loss-making business first, before agreeing further investments;
- avoiding investment in businesses where products or services have become commoditised for customers, unless they can prove that these investments will lead to a step change in competitiveness (ie 'decommoditisation').
- using cost savings to reinvest in innovation. Food multinational Cadbury-Schweppes for example has earmarked a third of the €600m ($789m) savings it expects to make through an ongoing cost cutting and performance improvement programme to accelerate innovation and marketing.
Conclusion
There is no contradiction between cost cutting, performance improvement, and innovating products, services or even entire businesses. Companies that thrive have proven that the route to success is the exploitation of both sources of value-creation. The answer to the apparent contradiction is a strategy-led programme, which combines creative and smart performance improvement measurements with focused innovation initiatives. With chemical engineers playing a leading role of innovating under real world constraints, it is entirely possible to save money on today's operations and invest prudently in tomorrow.
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First published in tce www.tcetoday.com News & views from the process industries, published monthly by the Institution of Chemical Engineers
