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When Bad Things Happen to Good Chemicals

Posted on August 4th, 2016 by in Chemical R&D

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Chemical producers often refer to products as becoming “commoditized” as the market becomes more competitive resulting in a drop in profitability.  This is a fair characterization for commodity chemicals such as ethylene or methanol that by definition cannot be differentiated.  But is this a fair way to describe specialty chemicals that once enjoyed a profitable differentiated past but have fallen on hard times?  Is commoditization inevitable or is it an excuse for managers who have mismanaged product lines by not keeping the technology fresh and supported by strong marketing?

Let’s take a look at the cause of commoditization and ways to mitigate it.

How Did This Happen to Me?

Let’s start first with a definition of commoditization.  Investopedia defines commoditization as:

A process in which goods or services become relatively indistinguishable from competing offerings over time. Generally speaking, commoditized products within specific categories are so similar to one another that the only distinguishing feature is pricing.

Commoditization can be inherent to a chemical.  For instance, methanol, by definition, cannot be differentiated as it must contain one carbon, one oxygen and four hydrogen atoms in order to be called methanol.  All producers have to produce the exact same molecule and methanol is clearly an undifferentiated commodity.

Specialty chemicals are another matter as the molecules are usually much more complex and can be highly differentiated.  But even specialty chemicals can show commodity-like characteristics as the products mature.  A typical scenario is a new-to-the-world specialty chemical that is introduced to the market at very high price and margins.  Customers initially don’t mind the premium price because the new chemical does something they have never seen before and they make money off the uniqueness brought to their products.  Management and shareholders are happy because the new product brings nice margins and returns on the investment in capital and R&D.  But slowly over years or decades prices and margins erode and management throws up their hands to the inevitable “commoditization”.

So why does this happen?

Typical causes include:

“Agglomeration” – A common cause of commoditization of specialty chemicals is all customers gravitating over time to buying a small number of common grades of a particular product line.  As the product line “agglomerates”, the volume for each grade grows and all producers eventually match each other in performance for that grade.  This makes the products much less differentiated and customers can more easily switch from one producer to another.

Contributing to agglomeration are deliberate actions by customers to create increased competition through industry standards and specifications.  Specifications and standards are technical documents intended to “standardize” certain products by describing the physical property requirements that must be met in order to sell in to the market.  Specifications essentially drive producers to converge on products having the same properties and that become undifferentiated even though the molecule may be quite different from one producer to the next (e.g. complex polymers and resins).  Other contributors to agglomeration are very large end-uses that dominate a market and drive use of a common product (e.g. emulsion resins used in house paint) and “optimized” products that have a nearly perfect cost/performance ratio (e.g. 33% glass-reinforced nylon resin used under-hood in automotive).

Increasing competition – A second cause of commoditization is new producers entering a market and increasing the likelihood that any one grade has multiple producers.  Even the most specialty chemical market can fall prey as patents, which had previously limited the competitive field expire, and new competitors are attracted to the high margins.  Increased competition usually occurs simultaneously with agglomeration to create a commoditization “perfect stor.”

Old Age – Lastly, products grow old and are obsoleted by newer products with better performance and economics.  The older products deliver less value and producers drop prices as an enticement for customers to keep using them in face of the newer alternatives.

Fortunately, commoditization is not always inevitable and can sometimes be reversed with a bit of proactive care and nurturing.

Turn Back the Hands of Time

Once a product is commoditized it is difficult to recover the prior glory days of high margins.  Fortunately it is possible to improve the market dynamics enough to make margins acceptable by finding ways to increase differentiation, limit the competitive field, regain pricing power and lower costs.

Some ways that commoditized products can be improved include:

  • Innovate– Develop new and differentiated versions of the commoditized products that deliver enhanced performance and/or lower customer cost-to-use. Market these products in a way that entices the customers to use them in place of the industry standard/specified products.  An example is new plastic resins that improve the line speed of a blown film customer.
  • Customize – Offer to enhance the value (and price!) of the commoditized product by delivering it in:
    • New product forms – an example is liquid colorants used in place of commoditized solid masterbatch for coloring and tinting plastics.
    • Moving down the value chain – an example is an epoxy resin producer moving down the value chain to produce higher-value semi-finished preforms from commodity resin for use in aerospace and wind energy composites.
    • Combining a commodity with a service offering – an example is the for-fee technical services offerings in water treatment and metalworking fluids markets.
  • Segment and economize– Sometimes it is wise to accept that certain products are commoditized and cannot be reversed. That does not mean the entire product line should be castigated as lost to commoditization.  Instead, segment out the customers and products that show commoditization and manage them accordingly by reducing manufacturing and support costs.  An excellent example is Dow Corning creating a new business platform in the early 2000’s when parts of its silicone business commoditized.  This new platform shed sales, marketing and supply chain costs by moving customers of the commoditized products to a self-serve e-commerce platform.

Survive – If all else fails, look at your cost position and determine if you can survive long enough to be the “Last Man Standing.”  Even old mature products have a long tail of customers unwilling or unable to easily switch to newer products.  While these customers will likely switch to the newer products over long periods of time, a producer can still quite profitable as long as the cost structure and pricing is managed accordingly.


 

All opinions shared in this post are the author’s own.

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