Chemical Viewpoint

Capital efficient chemical companies
Outperformers in a changing environment

Cash is king in business, and during a downturn it becomes the main concern of every company. With the credit crunchin full force, a superficial analysis would suggest that capital intensive industries would be hardest hit, and that their
executives cannot avoid having to prepare for very lean times ahead.
However, in the chemical industry, the robust performance of most of the capital intensive industries results in a strategic
advantage in times of economic downturn.

Capital Efficiency: an equally important factor for
Cash Generation1
Arthur D. Little has analyzed the TOP 70 chemical companies
on Capital Intensity2, Capital Efficiency and Cash Generation
to investigate how companies can capitalize on their robust
performances in good times to strategically reposition
themselves in times of economic hardship.

are primarily targets of product management or market driven
business lines, while manufacturing is in charge of asset
management. As a result of it in many cases not all factors thatassure a proper capital management are orchestrated in an
efficient way.

Figure 1: Key requirements for lasting profitability

To increase the profitability of a company, the executives tend
to focus their efforts on the improvement of their margins. Inorder to reach this, company executives rightfully work on thereduction of costs, the optimization of the feedstock use andchanges in product mix. Being agile in jointly managing margins
and capital is however what should be achieved.
Businessmen know well that minimizing use of capital for agiven business level will release well needed cash. Experiencehas taught them, however, that it has to be done in coherencewith the shorter term business optimization which continuously
adapts the product mix in order to optimize the margins (seefigure 1).
While this duality is theoretically obvious, it is not easy inpractice to optimize margins and capital efficiency together.
The reason is that the two processes are generally managed bydifferent entities in the organization: product mix and margins
1 Cash Generation: average Cash Flow from operations over a period of ten years
2 Capital Intensity: average ratio Plant Property and Equipment Gross to Sales

Continuous unit
cost reductionIncrease margins
through product mix

Increase margins
by optimizing feed & utilities

Higher margins
Higher capitalefficiency
Maximize use ofexisting assets

Debottleneckand creep

Maximize use of
integrated sites
Source: Arthur D. Little analysis

Chemical Viewpoint

Additionally, the typical timelines of the two processes arealso different: capital decisions tend to be taken on quarterly or
annual cycle whilst the product mix and margins are adapted inreal time.
Our study shows that the companies who managed to “cooptimize” those two processes are clearly more performing –generate much more cash per unit of Sales – on the long termcompared to others with very similar Capital Intensity.
It also shows that those having high Capital Intensity seem topay more attention to this “co-optimization” and consequently
manage to extract more value.

Some examples of capital efficient companies
When analyzing the Capital Intensity in two different time
periods, companies will strive to improve their performanceby increasing their Return over Invested Capital. If thesecompanies can achieve this goal with equal Capital Intensity,
due to improving margins or product mix are improving theefficient use of capital. Debottlenecking and increasing thecapacities at incremental capital cost (“creep”) reduces theCapital Intensity and thus increases the Capital Efficiency.
Taking the examples in figure 2, we show companies thathave clearly succeeded in improving their Capital Efficiency inthe period 1998 - 2007.

Return Over Invested Capital (in %)Figure 2: Sample of companies with improved capitalefficiency in the period 1998 - 2007
25

Sasol
Akzo

20

WackerPotashSolvay

15

501

1,5Starting point in 1998 of selected companies

2Capital Intensity

End point in 2007 of selected companies
Source: Arthur D. Little analysis, ThomsonONE Banker

Based on industry insights, four major characteristics of highly
capital efficient companies have been identified and should
be considered for a successful capital efficiency improvement
program:

2 Capital efficient chemical companies

Second, the capital efficient companies enjoy either economies
of scale or the right balance between size and flexibility in theirproduction units. The first is more important for capital intensive
industries (e.g. Basic Chemicals), while the latter plays a bigger
role in application driven businesses like Specialty Chemicals.
Third, the well performing companies apply a “no-nonsense”
approach in strategic investments: they do not follow the latest
fashion, but they can be very decisive and action taking whennecessary.
Last but not least the capital efficient companies have clear andtransparent capital management processes in place, enablingthem to review and adapt their businesses and investments at
any given moment in time to manage their Cash Flow. This will
also facilitate the definition and follow-up of any strategic planin the company. A US based Sepcialty Chemicals company has
built up a portfolio of companies since its foundation in 2000 andrestructured the individual businesses accordingly based on aclear capital management process and cash targets.
The above characteristics for Capital Efficiency will not only
improve the cash position of a company, it will also improve thesolidity (Debt/Equity ratio) and the credit rating, it will reduce thedelivery times and the implied discipline will result in many moresecondary benefits.

What is the strategy to survive and even benefit fromthe current downturn?

100,5First, they improve their plants and processes over years in avery professional way. Continuous improvement programs, focusing on the efficiency of the assets, result in lean production
processes and higher quality. Therefore, these companies
possess high performing technology and engineering teams. One
example is a European Multichemical company. They focusedvery early on their key portfolio, sold non core business and substantially improved their quality, process and engineering skills.

Each of these Capital Efficiency elements will, next to theproduct mix and margins, improve the company’s Cash
Generation. Companies that have performed well in the past ten
years will enjoy an interesting cash position which is a weapon
for strategic implementation: it permits the right move at theright time. Fortunately, even a global downturn is not all gloom
and doom for every player as these downturns, beside theirpainful effect on the sales capacity utilizations, are also unique
opportunities for acquisitions or expansions.

Chemical Viewpoint

In our analysis we have divided the companies into four clusters.
A first group of companies should focus on expansion andstrengthen their market position, especially in a capital intensive
environment. After all, a downturn is a perfect time to invest infuture growth. The value for acquisition targets are dwindling,resulting in lower multiples to be paid. Next, the order books ofengineering and construction companies are deflating, leading
to a reduced cost of plant construction and an excellent service
offering. On top of that, newly acquired or built capacities areready for the take off by the end of the crisis.

windfall profit and further strengthen their business. For theseproducts the management should focus on strategic pricing,
dedicated service offerings and innovations driven by the market
and thus get paid by the customer industries.

The second group of companies is called “the optimizers”
and include companies that have performed very well over theprevious ten years. They need to continue the optimizationof their business: the improvements of the variable margins
should be combined with a reduction of the fixed costs and acontinuous attention need to be paid to the improvement of theefficient use of capital (see figure 3).

Unfortunately, not all companies were able to generate a decent
cash flow and some will be forced to fix their profitability whileworking on both product mix and margins and an increasein Capital Efficiency. In order to secure their existence, theirmanagement should take stringent actions like:nn

Redefining their strategies and focusing on their corestrengths, with aggressive business portfolio management

The application driven companies which are less capital intensive
but with a rather healthy cash flow, will have to focus on “marginoptimization”. By optimizing their margins, companies will makemoney available which will enable them to take advantage fromthe down cycle and expand or strengthen their market position.
Fortunately, the application driven companies will be favoredby the burst of the raw material bubble, which will lead to a
substantial decrease of their raw material cost.

nnDifferentiating of their process chains and services according
to innovative specialties and commoditized productsnnCreating a sustainable complexity management with holistic
process chain optimizations

nn

Implementing a stringent operations management withproduction network and cost optimizations

nnFocusing on feedstock and raw material management
including backward integration

nnAdopting straight forward business models, organizations,services and overhead costs to a differentiated environment

However, to make such a margin management program
really successful and differentiate themselves from the closecompetitors, they need to segment their offering between
innovative specialties and more commoditized products.
For the first type of products, which are sold on performance,companies should take benefit from this burst, enjoying its

For the commoditized products, the companies will have tofocus on the contribution margin in order to manage the cash
flow including a differentiated pricing along the line of reduced
services, especially in the area of technical marketing and thesupply of products.

By taking these rigorous actions, the top management will beable to fight the current downturn, avoid the life-threatening
dangers and become stronger!

Average Cash Flow over Sales 1998 - 2007 (in %)Figure 3: Recipes for success for executives in both capital intensive and application driven chemical companies
35%
30%

Expand out of available cash
25%
20%

Optimizers

15%

Margin optimizers

10%Fix profitability while
decreasing capital intensity

5%0%00,51

1,522,5Average Capital Intensity 1998 - 2007
Source: Arthur D. Little analysis, ThomsonONE Banker

3 Capital efficient chemical companies

Chemical Viewpoint

Contact
Frederik van Oene
vanoene.frederik@adlittle.com

Authors
Edouard Croufer, Dr. Uwe Nickel and Lode Van Laere

Arthur D. Little
Arthur D. Little, founded in 1886, is a global leader inmanagement consultancy; linking strategy, innovationand technology with deep industry knowledge. We offer
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