C&EN Houston

Corporate management is altering the chemical industry landscape. In the past few years, several major producers have made significant structural and business changes. Some are building on existing, mature business foundations, buttressing them with growth opportunities. Others are creating entire companies from the ground up. The approaches are different and the outcome uncertain, but the bond is through chemistry and biology.

These disciplines are combined in the emphasis toward the life sciences--an often-used descriptor of pharmaceutical, agricultural, and food-related business combinations--and the trend is expanding. In 1993, ICI split off operations to create the life sciences and specialty chemical firm Zeneca. That company is now looking to split off its own specialty chemical operations (C&EN, Nov. 16, page 13), which would leave it with $4.3 billion drug and $2.7 billion agrochemical operations.

A few years after Zeneca was formed, Ciba-Geigy and Sandoz moved chemicals into Ciba Specialty Chemicals and Clariant--now merging themselves (C&EN, Nov. 16, page 8)--and combined remaining operations to form the life sciences giant Novartis.

In the past two years, Monsanto shed its chemicals--spun off as Solutia --while spending about $6.5 billion to access agricultural biotechnology expertise and downstream seed markets. Hoechst has spent about $12 billion to expand its drug and agribusinesses and is splitting off chemical operations in several pieces (see page 10). And Rhône-Poulenc has spent about $7 billion to attempt a similar transformation, putting chemicals into a majority-owned subsidiary, Rhodia.

DuPont has been investing to alter its business mix. It has spent nearly $6 billion on life sciences acquisitions, but nearly the same amount on its chemicals business. Dow Chemical's agricultural purchases have been more modest, and it is keeping chemicals as well. Unlike Hoechst, the other big German producers-- Bayer and BASF --continue to support both chemical and life sciences operations (C&EN, Oct. 12, page 23).

Table: DuPont sheds petroleum to shift business mix

The leaders are willing to make "tremendous investments and commitments in R&D because they recognize that this is a marathon," says Sano Shimoda, president of Biosciences Securities, Orinda, Calif., and a former chemical industry analyst. "They recognize that this is a race that will be defined not in the next one to two or even five years, but in the next 10 to 25 years. Who gets to the end and is the winner is yet to be determined."

Novartis --with a $13 billion health care business, $6 billion agribusiness, and $3 billion nutrition business--is the life sciences leader. Monsanto and DuPont are widely recognized as making up the rest of the top tier.

Whereas some firms are defining themselves as "pure" life sciences companies, an equal number are combining chemicals, materials, agriculture, and pharmaceuticals. Despite the absence of a "one-size-fits-all strategy," says Shimoda, there are common drivers behind the changes. A fundamental one is that mature and cyclical chemical markets just aren't promising the high levels of consistent growth and sustainable returns expected from life sciences businesses.

Pharmaceuticals, although expensive to develop, continue to be a profitable and growing business and are a cornerstone at Hoechst, Rhône-Poulenc, and Novartis. Monsanto and DuPont, with smaller drug operations, are awaiting big returns from new products. Even without pharmaceuticals, which were sold to Hoechst in 1995, Dow says biotechnology will be "a key platform to accelerate growth."

Agricultural biotechnology holds even more promise and complements many firms' existing agrochemicals businesses. Although traditional agrochemical markets are expected to grow slowly, agriculture itself is burgeoning. World population is growing faster than food productivity; dietary habits are changing; the amount of available farmland is shrinking; and the demand for food--and more efficient production of it and with "value-added" qualities--is expected to soar.

About three dozen agbiotech crop and food products are on the market. In six years, that number is expected to double. One producer estimates that a $40 billion market for biotechnology traits should exist by 2010, equal in value to the global pesticide market, but arising from almost nothing five years ago. This "traits" market projection measures only the premium paid--for example, the 3 to 4 cents more per lb for genetically engineered versus unmodified canola oil--and not the price of the entire product.

Jürgen Dormann, Hoechst's chairman, has explained to shareholders that concentrating on life sciences means a "shift from cyclical, high-volume, low-margin products to stable, low-volume, high-margin products [and] from a high asset base and low R&D investment to a small asset base and high R&D investment." In other words, he says, "from bricks to brains."

"The globalization of the industrial chemicals businesses and the biotech revolution require different strategies, resources, knowledge, and competencies," says Dormann, who, finding chemicals and life sciences incompatible, believes in separation. "Focusing on the life sciences businesses while exiting from industrial chemicals is necessary in order to ensure our long-term competitiveness, to create and safeguard jobs, and to increase the value of the company. Success through diversity and size is no longer our success formula."

Managing diverse businesses "presents challenges," admits Gary M. Pfeiffer, senior vice president and chief financial officer at DuPont. "But before the industry developed the phrase 'life sciences,' DuPont was already in a diverse mix of businesses and continually learning how to manage those in a differential manner." Life sciences "is much more intensive on the research end and the intellectual capital side."

DuPont's management is calling biotechnology and life sciences a "cornerstone" and "growth engine" that will coexist with chemicals. The company has stated that by 2002 life sciences would be roughly a third of the company's sales and earnings.

"The crux of DuPont's strategy is to run in parallel paths down our materials business and our life sciences business because we think it's prudent for our shareholders to have the diversification and insurance that brings," Pfeiffer says. Yet articulating complex business approaches and performance to shareholders and analysts "has always been a challenge, more so as other companies have chosen to move to what Wall Street calls 'pure plays,' " he comments.

Chemical companies shifting completely to life sciences also may have to help shareholders adjust their thinking. "Monsanto much more resembles a Silicon Valley company than one like a Solutia," says a company spokesman. "After the spin-off of the chemicals unit, there was a very pronounced shift in our shareowner base. Monsanto investors [now] are more apt to be interested in higher risk and higher return, like those holding a small biotech company."

That financial return has yet to come, and shareholders may have to be patient through a few more years of spending money before making it. For example, Monsanto's earnings for the first nine months of this year, excluding extraordinary charges, were $553 million, down 20% from the same period in 1997. With acquisition-related charges included, earnings were down further to $353 million. At its old chemicals business, Solutia, earnings rose 31% to $194 million.

A few years ago, Monsanto saw that the "science and business goals of three of its four businesses matched up pretty closely," says its spokesman, with the exception being chemicals. Integrating its agriculture, nutrition, and drug businesses--for instance, creating crops with added nutrients, producing or delivering drugs in plants, and driving that from an understanding of human health--is "the core of executing a life sciences strategy."

The possibilities for integration and synergies between discovery, development, research, and products in drugs, agriculture, and nutrition aren't lost on any of these companies. They can apply very similar tools--genomics, informatics, biotechnology, combinatorial chemistry, and rapid screening--across life sciences areas, they hope, to rapidly discover and commercialize new products. To do it well or quickly may be extremely expensive, with R&D spending averaging about 10 to 15% of sales, instead of the chemical industry's more usual 3%.

"The test of companies is going to be balancing cash-flow generation in the near to intermediate term to fund the 'hungry monster' [of these growth businesses]," Shimoda says. "At Monsanto, that funding mechanism is its Roundup herbicide and Roundup Ready [herbicide resistance] trait technology." Roundup sales volumes continue to grow more than 20% annually, despite being a 22-year-old product and in part because of new uses on herbicide-resistant crops.

However, Monsanto's now-defunct merger plans with American Home Products hurt its stock value and have left the company strapped for cash, although determined to remain independent. Earlier this month, it announced attempts to raise $5 billion by selling $1 billion worth of "noncore assets," offering $1 billion in stock, and taking on $3 billion in debt C&EN, Nov. 16, page 12). By 2000, the company anticipates showing a healthy return from new drug and agricultural products.

DuPont's funding mechanism, says Shimoda, comes from a "recognition that it [must] solidify its market position in its areas of strength." This may mean adding assets--such as the plan to acquire Hoechst's coatings business--to increase its critical mass, improve its competitive position, and dominate more traditional markets, he explains. DuPont (through the Conoco stock offering), Hoechst, Rhône-Poulenc, and others are monetizing assets as well.

Dow sees its existing agrochemicals business as a foundation for growth. "The goal is to grow Dow AgroSciences to become a $5 billion business" by 2005, says Nickolas D. Hein, vice president and global leader for plant genetics and biotechnology at Dow AgroSciences. He expects sales of traditional agrochemicals to increase from about $2.1 billion today to about $3 billion in 2005, whereas much of the remaining growth will come from new biotech-based business creation.

Table: Dow Chemical buys and sells assets across the board

Last month, Alain Godard, chairman of Rhône-Poulenc's plant and animal health sector, told analysts that "the crop protection market will see revolutionary change in the coming years, dominated by the introduction of new products supplemented with biotechnology." The company believes that "a balanced product portfolio focusing on innovation in both chemistry and biotechnology is the best way to serve customers and lay a foundation for future growth."

Bayer is expanding its life sciences operations (C&EN, Sept. 21, page 18; (Sept. 28, page 14), which include about $2.3 billion in crop protection and $8 billion in health care sales annually. Like others, it is selling a chemicals business--up to 75% of shares in its Agfa photographic products subsidiary.

When announcing the stock offering in September, Bayer Chief Executive Manfred Schneider said, "While concentrating on the health care, agriculture, polymers, and specialty businesses, our strategy is to focus more strongly on our core competencies, with the stress on our life sciences operations."

As in choosing whether to focus entirely on life sciences, investment strategies vary. Some companies have gone on spending sprees to ensure they own businesses to stake claims and guarantee market share, whereas others are taking more conservative partnership routes. Either way, acquisitions and alliances have similar purposes--building or leveraging a technology base, acquiring new products and research, and reaching markets and expertise--and are being widely used in both drug discovery and agbiotech.

Although many alliances have been set up with small drug discovery firms, most small agbiotech firms have been bought. A few select major companies "control access to emerging enabling technologies," which has created a "vacuum in the technology pipeline," according to San Francisco-based investment firm Burrill & Co. Start-ups form a "crucial link in the technology pipeline," providing basic research and innovations to large companies with late-stage research and product development capabilities, marketing infrastructure, and financial resources.

"Large agribusiness companies compete for limited supply, driving up the cost of acquiring new technology," says Burrill & Co., which along with Bayer, AgrEvo (a 60-40 joint venture between Hoechst and Schering A.G.), and other investors created a $100 million venture-capital fund to address the shortage of small innovative agbiotech firms. Dow also has set up a $40 million investment fund.

Limited supply in the face of tremendous demand has also confronted companies trying to buy seed producers. Seed companies are the delivery mechanisms for newly developed genetic traits and thus a means for technology developers to get a return on their R&D. Many companies have paid tremendous premiums to buy seed companies for strategic reasons.

Rhône-Poulenc has taken a contrary view, according to Godard. "If you feel that biotechnology will enable your company to offer something genuinely different with innovations of potential interest to several seed companies, then you will invest in R&D rather than having to make very costly investments acquiring seed companies.

Table: Rhône-Poulenc makes chemicals a subsidiary

"Our strategy is to focus on innovation and invest in the development of genes that offer a distinct competitive advantage," he explained. "At the same time, we have expanded our partnerships and alliances to a number of key global players in the food industry."

Monsanto and DuPont have spent the most to integrate their operations vertically from R&D through seeds to food processing. Novartis already has a seed business and baby food business. However, it is spending $1.2 billion to set up and fund neighboring research institutes in functional genomics and agbiotech. DuPont also has a $400 million-per-year research collaboration with Des Moines-based seed producer Pioneer Hi-Bred.

Table: Monsanto boosts agriculture after chemicals go

"We certainly question pouring billions into this," says Fernand J. Kaufmann, Dow Chemical vice president for new business and strategic development and leader of the company's biotechnology platform. "If you try to calculate what's required to have a return on all those investments, it becomes rather frightening--so that has not been our mind-set.

"We are quite prepared to spend money, and I think we have proven that, but I don't believe we are [determined] to try to own all there is to own with the objective that nobody else can get access," he adds, "because I don't think that works in real life." Still, Dow has said that alliances, licensing, and acquisitions will all play key roles in its aggressive growth plans.

Although owning everything isn't the only and may not be the most successful strategy, "if you look at the commitment of resources by the leaders--they are a tough act to follow," Shimoda points out. "They are pouring in so many resources and moving to the next level. If they continue to execute, they will pull away from the pack." DuPont and Monsanto have both said they anticipate significant returns from their acquisitions in two to six years.

Vertical integration offers market access, economies of scale, connections to customers, and a way to capture profits in a competitive market. "It's one thing to create technology at the upstream end," says Shimoda, and "another to create or leverage value around that technology and create some certainty of value capture. That's what vertical integration does."

Dow's strategy is to "really stay focused on the unmet needs at the customer level and see how we can fill them, regardless of technology or regardless of where we are in the value chain," Kaufmann says. "We are looking at this with a very open mind to see where we can add value, where we have the necessary skills and capabilities to solve customer needs, and also how we can build up more skills."

There is a consensus that having a strong technology and intellectual property platform is crucial to being competitive. "You have to have technology platforms, and it's better to have a clear intellectual property position than not have it," Shimoda says. "But at the end of the day--especially in the agbiotech area and all the downstream markets that are going to be created," he contends, the success or failure of companies will be linked with their having the structure or the strategy to realize a return on that technology investment.

Most companies appear to draw the line for ownership before the most downstream markets, saying instead they will work with the food producers. Monsanto has a grain and feed products joint venture with Cargill, and Novartis just set up a specialty grain venture with Land O'Lakes. DuPont's purchase of Protein Technologies, a major soybean processor, and its Optimum Quality Grains joint venture with Pioneer Hi-Bred put it the farthest downstream.

Still, DuPont is only at the beginning of the processing stage for crops and only in a limited way. "The world's agricultural value chain is enormous and nobody yet is 'fully' integrated," Pfeiffer says. "I suspect, given the size of the chain and the complexity and the skills required to operate effectively, that it makes sense to be doing it through alliances.

"As the entire agricultural industry reshapes and reinvents itself with biotechnology, there will be lots of opportunities for a fluid set of alliances in the players along the chain," he adds.

Perhaps ultimately more significant is horizontal integration. "Those companies that understand leverage around technology platforms and understand the 'multiplier effect,' either horizontally or vertically, will be most successful," Shimoda says. "A company has to make sure that it has the competencies to deal with that. We're going to see all different kinds of strategies."

For "pure" life sciences companies, horizontal integration applies the tools, expertise, and technology across the drug, agriculture, and nutrition areas. The next generation of agbiotech products will include more than agronomic traits, such as herbicide and insect resistance. Expectations are for value-added or "quality" traits, such as disease resistance, added nutrients, specific oil content, increased protein levels, improved yield, and drought tolerance. Life sciences companies also envision producing pharmaceuticals in plants or producing and delivering them in foods.

Table: Hoechst shifting focus entirely to life sciences

For companies retaining their chemical operations, horizontal integration means exploring and exploiting technology in more traditional chemical process and product areas (C&EN, June 22, page 13). Opportunities described include lower production costs, renewable raw materials, positive environmental attributes, higher margins, and entry into new and existing markets with entirely new materials. Producers believe there will be significant increases in R&D speed and productivity by leveraging technology.

Dow's Kaufmann suggests that "agriculture is the first arena where this unfolds, but it is unfolding on the industrial side, too." Dow has a joint venture with Cargill to develop polylactic acid, based on lactic acid produced from renewable corn-sugar sources. This technology, he notes, will complement existing polymer technologies and, although not replacing petroleum-based products, could become "10, 15, or 30% of the market over the next 10 to 15 years."

"It is pretty clear to us that biotechnology will play in many different existing Dow businesses, starting with agricultural all the way to some of the polymer businesses and some of the specialty chemicals businesses," Kaufmann says. "It's really important to look at thisas a broader tool or technology and the broader picture. This is not narrow technology."

DuPont is also "completely convinced that biotechnology will have the same revolutionary effect on our business that polymer chemistry had back in the '30s. The rate at which that revolution is going to take place is still uncertain," Pfeiffer says. "Having life sciences businesses as part of a larger enterprise gives us a much stronger business position and financial position to weather the potholes that will inevitably appear.

"At the technology level, biotechnology is in many ways chemistry, biology, computer science, and engineering," he continues. "Therefore, there is a considerable amount of overlap and critical mass that we feel we can have with a larger research effort and a broader research effort."

Pfeiffer points to DuPont's current biomaterials research and its development of a fermentation process for the polyester intermediate 1,3-propanediol. "As the science develops, the application of it to biomaterials can be a significant growth opportunity on the materials side."

The speed at which an evolution in technology has occurred, "sometimes makes it feel more like a revolution," he comments. "But it really is an extension of the cross-disciplinary [approach] that a world-class research organization in a chemical company has anyway."

Despite the bullishness toward biotechnology, there are many uncertainties ahead. Roger E. Shamel, president of Lexington, Mass.-based Consulting Resources, says, although the "stage is set for a bioevolutionary transformation of the chemical industry . . . much of the biotechnology research that could potentially have the largest impact is still at an early stage and is not expected to have much effect for 10 or more years."

Agbiotech products had a much longer genesis and more difficult commercialization--more regulatory hurdles and slower acceptance--than maybe once anticipated. Yet between 1996 and today, transgenic crops--mostly Monsanto's--have gone from just 2% to more than 25% of U.S. acreage of those crops. Now with the muscle of larger companies behind new products and Monsanto's demonstrated success in capturing market share, they only expect that field to grow.

In chemical markets, biotechnology has yet to be fully exploited to develop new materials. Producers point to success in pharmaceuticals and in fermentation processes and biocatalysis for enzyme, organic and amino acid, and some fine chemicals production. Producers must still address issues of making biotech-based chemical production cost-effective, identifying market needs or creating demand with new products, and making products with new or improved functionalities or properties that surpass existing products.

"The technology is evolving every day, and you could argue that the half-life of it is not more than two or three years," Kaufmann surmises. "The only game in town is new products with new functionalities at reduced cost."

Most executives will admit that the bet on life sciences presents risk, but they say the risk is not whether there will be a biotechnology revolution, but rather how fast it will come and how big it will be. Scientific, regulatory, product, and market hurdles may arise and delay the payoff. Clearly, they say, there will be market opportunities, and they emphasize that their companies are accustomed to competing in technology-based markets.

"Those companies that can stay ahead of the curve in understanding and exploiting the strategic pathways coming to light through biotech-based research and development will be the companies that will grow and prosper," Shamel concludes.

Nevertheless, many analysts and consultants envision consolidation and a future landscape with only four or five major players. Before it failed, many believed that Monsanto's merger with American Home Products presaged this trend. Now rumors of a merger between Hoechst and Rhône-Poulenc are circulating, and Zeneca is also considered a likely merger candidate.

And just as there is no single corporate structure or business and management approach, there is no paradigm for success. Different companies obviously believe that any mix of chemistry, biology, specialization, differentiation, acquisition, and partnering can influence their success.

To compete successfully will take many things, Pfeiffer says. "It's going to take a very strong commitment on the part of management and shareholders because this is not going to be a road that will always be smooth. It's going to take an ability to acquire and manage an extraordinary world-class research effort so you have a very, very strong technology base.

"And I believe it does take the ability to manage the complexity of differentiation," he adds. "Even for pure-play life sciences companies, agriculture is different than health. But I also think it's going to require the financial strength of a combined company to invest for the future while at the same time delivering value to the shareholders every year.

"The good news is that, however it plays out, the opportunity for value creation in life sciences is so enormous that there is going to be room for multiple solutions," Pfeiffer says. "Conventional wisdom would say that whoever gets there first and is biggest is going to win. I think first and biggest this time has more to do with invention and new knowledge and less to do with market position.

"As the technology shifts so much, and the demand continues to grow at exponential rates, being the biggest is not necessarily going to mean being the best and the longest term survivor," he continues. Among other things, it will take "brains and luck."

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