Only a few industries have undergone as great a change over the last two decades as the European chemical industry. The latest chapter came last month from none other than Marijn Dekkers, chief executive of Bayer and the new president of the chemical industry association. With his plan to spin off Bayer’s plastics division, he is shifting the 151-year-old business to a pure life-science company – and setting the stage for new transformation in the closely-linked pharmaceutical and chemical industries.
Tearing down old business models in the tradition-rich chemical industry has had widely varying results. On the pharmaceutical side, there are now a half-dozen strong European players, including Bayer. On the chemical side, only one large European company of global significance remains, the industry leader BASF. After that there’s a fragmented host of small and mid-sized companies.
So the most crucial question raised by Mr. Dekkers’ restructuring plans has less to do with the future of Bayer as a life-science company and more with how things develop in the classic chemical industry.
The chemical industry is not only threatened by reduced competitiveness because of high prices for energy and raw materials; there are also worries about the extreme gap between giant BASF and the rest of the industry. BASF is more than four times as large as its next-sized competitor, if the private and deeply indebted petrochemical company Ineos isn’t included. BASF – headquartered in Ludwigshafen, on the Rhine across from Mannheim – makes as much in operating profits as all other market-listed chemical firms in Europe do. It has nearly double as much cash flow. And in stock-price performance over the last 15 years, scarcely any of its smaller competitors can compare to BASF.
This leads to only one conclusion: The fragmented industry today is not convincingly superior to the old model of the large, integrated company. It has its own inherent weaknesses.
This might have to do with a basic principle of the chemical industry: Value is added when by-products from one process serve as the basic material for other processes. So there is a natural tendency toward many production processes in closely-knit networks at large sites.
Those established physical networks were not destroyed by early restructuring in the chemical industry. Instead, the networks grew overloaded, through new legal structures, with greater costs and complexity. While a huge company like BASF could take its time in optimizing its vast networks, the rest of the industry had to sort them out under new conditions. Companies had to set up new administrative organizations and engage in many complicated negotiations: For instance, who pays how much for shared fire safety service at a jointly operated plant?
Despite the advantage of closely linked processes, weaknesses can arise from the variety of products. Only some of the mid-sized firms can position themselves as pure specialists such as Merck, Symrise or Altana. In reality, many mid-sized players are specialized chemical companies only on paper. Many of their products are standardized, which means prices are subject to global competition. A little excess capacity or a slight slowdown in demand can put pressure on profit margins. That’s been the case in recent years not only with Lanxess, but also at such firms as Evonik, Solvay and Bayer.
The fragmented industry today is not convincingly superior to the old model of the large, integrated company. It has its own inherent weaknesses.
The problem for the companies is they have to meet the same widely divergent challenges that once confronted the chemical-pharmaceutical giants. Although parts of their business are fueled by research and development, other parts are concerned exclusively with efficiency and low costs. Chemical giants such as BASF and Dow may manage to be halfway successful in pursuing both business models in parallel. But this is apparently quite difficult for mid-sized companies.
The current situation serves as a driving force for more efficiency and new partnering connections that ideally would run right through today’s firms and not stop at European borders. With its new Bayer MaterialScience company, Bayer is introducing a new player on the field, one that could be a catalyst for rebuilding the European chemical industry.
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