Businesses are becoming more complex due to increasing merger and acquisition activity, expansion, closer networked operations with suppliers and new product launches. This complexity can often have a negative effect, and is most noticeable in the wide range of products and services offered to an increasing number of customers.
So what is the appropriate level of complexity for such businesses, and how can specialty chemical companies manage complexity for profitable growth? We propose that they should apply some of the lessons learnt in managing complexity from the petrochemicals industry and fast-moving consumer goods (FMCG).
Traditional management techniques are based on a desire to structure and simplify in order to stabilise complex situations. Yet businesses are operating in an increasingly turbulent and competitive global environment. In a recent CEO study by PricewaterhouseCoopers (PwC), respondents reported that over the past three years the level of complexity in their organisations had increased.
While many sources of complexity, such as increasing regulations and competitor actions, are outside the control of business leaders, there are many elements that lie within their reach. The usual approach is to stabilise by simplifying complex situations with a focus on eliminating complexity.
But while some forms of complexity deplete profits, others drive outstanding market returns and prevent entry from competitors. In some cases, inherent complexity in the process or technologies cannot be eliminated and must be handled to drive profitable growth.
Petrochemical firms, for example, are inherently complex and have focused on improving their ability to deal with the complexity involved around production and planning decisions. FMCG companies, on the other hand, have been able to simplify intricate downstream supply chains without adversely affecting consumer value.
Reducing complexity
Specialty chemical companies’ attempts to define an appropriate response can be complicated by what could be seen as an identity crisis; to what extent should they be set up to benefit from economies of scale – similar to commodity chemicals? And to what extent should they differentiate on flexible service, along the lines of FMCG manufacturers?
Are they going to be a cost leader (Dow Chemical’s basic chemicals), a customer leader (JohnsonDiversey) or a technology leader (ICI)?
FMCG companies can provide some applicable insights to reduce complexity and grow profitability. For example, one major consumer product company operates in more than 100 markets, with 150 different brands and more than 6,000 stock-keeping units (SKUs), each having its own case and pack sourced out of multiple factories from just one technology platform.
What do customers value?
While many companies talk about being customer focused, PwC’s survey reveals that only 15% of CEOs believe their company is good at identifying activities that create value. PA Consulting finds that an effective approach is to run workshops involving the total value chain, eg sales and marketing, procurement, supply chain and R&D.
The experience of a major European chemicals manufacturer shows how this approach bears fruit. The company believed it was in a commodity trap, with price being the only customer value driver. By talking to its customers it found that they valued different things and that the company had been applying a vanilla approach to all. For example, some customers valued its technical support, and some found value in joint product development.
Specialty chemical firms can drive profit by segmenting customers based on value-added relationships and by responding with appropriate pricing and processes. For example, online ordering for those looking for a pure commodity buy, with additional charges for those who place a higher value on service. In most cases, a mindset change is needed to focus on profitable products rather than filling capacity.
True cost to serve
FMCGs have achieved significant bottom line benefits by understanding and reducing consumer-neutral complexity. One consumer product company that focused on eliminating non-consumer facing packaging across the value chain reduced SKUs by 20% and achieved savings of around £100m ($195m; E133m) in one region alone.
However, most financial allocations tend to be driven by enterprise resource planning (ERP) standard costing approaches, typically driving costs on a volume basis. Organisations should have a clearer view of the inter-relationships between variables in their business to be able to understand the true cost to serve their customers’ requests.
There are different ways to do this. One approach is to take a snapshot in time on cost to serve. During such an exercise, a global specialty chemical company found that 60–80% of its profit came from 20% of its products. It also found that a subtle balance of customers valued the technical support but had never been asked to pay for it.
Having understood firstly what customers value, and secondly the corresponding cost to serve, companies are now in a better position to make conscious, proactive decisions around customer requirements, pricing and capacity utilisation.
Necessary complexity
Sometimes, complexity is inherent due to a particular technology or product platform. In other cases, the market may simply demand increased variety and service levels. Given the competitiveness of the chemical industry, compounded by high oil and feedstock prices and volatile industry margins, innovation is key to long-term survival – so becoming better at managing those aspects of complexity that cannot be eliminated is critical for specialty chemical companies that want to grow in the future.
Understand cause and effect The petrochemical industry is all too familiar with managing complex operations due to its highly integrated and intricate plant operations, which process large numbers of production combinations. Due to the large number of interdependencies, every decision, however small, can have wide-ranging and difficult to envisage consequences.
Also, seemingly advantageous call-off contracts can force the plant into suboptimal production, making it difficult to react quickly to market changes. When suboptimal production decisions do occur, they have a significant impact as petrochemical companies lack the luxury of turning off or adapting the process quickly to respond to changes in demand or to shifts in prices.
There are many uncertainties inherent with petrochemical production; with feedstock bought at spot prices but products sold at quarterly or monthly prices, leaving margins highly subject to market volatility. Implementing truly joined-up decision-making supported by appropriate tools can deliver direct multi-million pound annual benefits through better planning and production decisions.
Business processes should be designed to support better decision making with the elimination of silo-based planning and implementation of a consistent planning process from strategy to operation. Any optimisation activities need to be done in the context of the overall business, subject to practical or operational constraints of individual silos.
Appropriate tools should be used to support this. These may range from powerful what-if scenario planning and real-time valuation of decisions to relatively simple systems. A specialty chemical company found that by co-locating the key functions of the European supply chain around one desk, the ability to make better operational decisions improved significantly.
Ongoing management
To build a platform for future profitable growth, specialty chemical companies need to eliminate complexity and be better at managing it.
But this is not easy, as fundamental barriers need to be overcome. Leadership understanding and continuity of importance are critical to maintaining the momentum. Most people at the front end of organisations, such as marketing and sales, believe they understand what their customers value. So the people and politics dimension, as well as the ability to work across internal boundaries, is critical.
Innovation plays a key role in this industry. ICI Paints has generated 25% of today’s global paint sales from products launched in the past three years. As such, the new product introduction process becomes a key driver and needs to be adhered to religiously, with coordinated processes between sales, marketing and supply chain functions.
Masters at managing complexity find they need to create a culture and mindset that are fundamentally different from how the business ran before. Customer value-add is the new focus and drives profit contribution in addition to volume. One chemical firm focused on higher customer value-added products rather than sheer volumes, and saw the return on capital employed rise from 7% to 15% in three years. This should be backed with an appropriate reward and recognition system. Decisions and their results should also be analysed with a view to improving the management of necessary complexity. Getting there won’t be easy. While lessons can be learnt from other industries, business leaders need the appetite to start challenging the role their business should play – whether it be cost, customer or technology leadership. Done well, the benefits are there to be had. Without a doubt, proactively managing complexity is a much better place to be in compared to unconsciously seeking a path through complex operations to profiable growth.
