Back to the future for corporate growth

Although cost reduction still plays an important role in growth strategies across the chemical industry, companies now place a greater emphasis on acquisitions, global expansion, and especially technology development.

Amram Shapiro
Tavor White

Throughout the 1990s, the chemical industry has focused on growth. Companies have reduced business portfolios to core products and markets, streamlined operations, and consolidated market share and volumes through asset swaps and acquisitions. They have worked hard to exploit the growth potential of their current products by considering every new global market and investing worldwide. They have explored ways to be more efficient in efforts to enhance pricing flexibility and increase market share. They have developed new applications or derivative products to leverage their existing product and technology platforms.

Yet most chemical companies find themselves facing a widening gap between their ambitions for growth and the diminishing growth potential of their current technologies and products. Company after company has realized that the only way to bridge this gap is corporate renewal: They need to develop innovative new technologies and products that can support new business. This concept is not foreign to an industry founded on innovation. William H. Perkin set the pattern for today's innovators when he first made aniline purple dye from coal tar almost 150 years ago. This pattern continues today as an industry with a long history and a long memory seeks to learn from past successes and failures.

DuPont's CTO, Joseph Miller, articulated this challenge in a 1999 Chemical & Engineering News interview: "Ultimate sustainability, viability, and the continuous development of shareholder value will require an infusion of new technology. The challenge as we increase our [R&D] budgets will be to ensure that we are selecting the right targets to work on. We need growth with enhanced knowledge intensity and diminished capital intensity" (1).

In this article, we discuss what chemical companies are doing to achieve growth and corporate renewal at the turn of another century. Pittiglio Rabin Todd & McGrath (PRTM) has been benchmarking the chemical industry's performance for more than 10 years. Last year, we completed a major benchmarking study of new product and process development at 288 companies whose aggregate R&D expenditures were more than $40 billion. The chemical industry was well represented in the study, with one segment funded by Dow Chemical, Dow Corning, and Shell Chemical. We draw on the PRTM study, our extensive experience in the chemical industry, and other trend analyses we have done (2, 3) in this discussion of corporate renewal practices.

Beyond cost cutting
We reviewed the 1992-1997 annual reports of the 15 largest U.S. industrial and specialty chemicals companies to compare industry growth and renewal practices (Figure 1). Our review found that the chemical industry's strategic emphasis shifted significantly from 1992 to 1997.

Firms continue to rely on operational efficiency and cost cutting for achieving growth. In 1992, 13 of the 15 companies we studied highlighted cost reduction in their annual reports. In 1997, the number was essentially unchanged, at 14.

Global expansion became increasingly important. Global expansion was featured in 13 of the annual reports in 1997, versus 9 in 1992. Typical expansion targets were Asian assets and markets. Because of Asia's economic difficulties, the short-term returns from these expansion moves have been lower than hoped, but the moves seem sound for the long term.

Reliance on acquisitions and joint ventures for growth is increasing. In 1997, 14 of the companies highlighted acquisitions, versus only 9 in 1992.

Emphasis on new technology development has grown substantially. Technology development was emphasized in 14 of the 15 annual reports in 1997, versus only 6 in 1992. This growing emphasis makes perfect sense in the context of chemical stock prices. In 1998, the stock values and price-to-earnings multiples of the 15 companies in our annual report sample declined by about one-third from their 1997 highs.

The best way that a company can convince investors of its growth prospects - and thus raise its market value - is to demonstrate its ability to renew itself through new technology. This lesson was reflected in our 1997 Product Development Benchmarking Study (For more information), which found that best-in-class companies (i.e., those that exhibited superior revenue and profit growth) invested twice as much in long-term technology platforms as companies whose performance was merely average.

Indeed, industry is embracing mergers and acquisitions in general. In 1998, the value of all mergers and acquisitions involving U.S. companies was $1.7 trillion, and that figure was surpassed in the first three months of 1999 alone. The level of mergers and acquisitions in the chemical industry is unprecedented; in 1997, worldwide transactions in the industry totaled more than $37 billion (4). All indications are that this trend will continue as companies strive for globalization, top-line growth, and corporate restructuring.

But is the acquisition route a viable renewal strategy? How far can a company get by assimilating and leveraging other companies' capabilities and assets? Perhaps the best answer is this: Acquisitions can provide an alternative path to growth, but only if unique benefits can be obtained from the acquired assets.

Riding the tiger
Companies that use acquisitions as an all-purpose instrument in their quest for growth and renewal tend to find themselves in a predicament that a client of ours once described as "riding the tiger". The problem, as the proverb goes, is how to dismount without being eaten. Once companies start buying sales as a business strategy - often paying a premium for the privilege - they need to keep doing it to sustain growth. Because of the difficulties involved in integrating new businesses and their operations and processes into the acquiring organization, companies that use this strategy often find that their operational efficiencies actually decrease with each new acquisition.

A company in this mode may find that its energies and focus are consumed by activities far from its core expertise, such as due diligence, value analysis, and protracted negotiations. In addition, shareholders tend to cast a cold eye on acquisitions that don't make inherent business sense.

Much acquisition and venture activity is focused on renewal. This strategy is centered on either finding something new in the acquired business that can be leveraged through the acquirer or leveraging the acquirer's core competencies in new markets or applications that are well known to the acquired company. Of course, this kind of acquisition puts a great emphasis on genuinely integrating the acquired business and operations, especially the development capabilities of both companies. Not surprisingly, the energies devoted to due diligence, valuation, and negotiation during the acquisition phase turn to the real challenge thereafter: effectively integrating the business and business processes of the acquired company into the acquiring company.

As companies strive to improve their fundamental growth prospects (through new technology and product and process development) and to improve their ability to leverage those developments (through acquisitions and joint ventures), they must be mindful of the cyclical nature of the chemical industry. Many enthusiastic commercial development initiatives have faltered under the pressure to produce immediate results.

Where does the chemical industry stand today on this issue? Many companies are taking more measured approaches to their businesses. They are doing a better job of balancing activities aimed at short-term results (e.g., continued emphasis on cost containment) with those directed toward long-term results (e.g., new platforms).

Our product development database indicates that some companies have fundamentally shifted the strategic balance of their portfolios toward more platform projects, and that this shift is associated with higher growth rates. As our benchmarking results become widely known, we expect to see more companies resist the temptation to resort to very short-term development projects and dramatically curtailed R&D spending during the tougher phases of the business cycle. Companies that can maintain insightful discipline during high-stress periods will be rewarded by their ability to renew themselves through new technologies, processes, and products.

What practices are the leading companies establishing to prepare themselves for growth and renewal in the next millennium? We have discovered five strategies that make a difference:
establishing a decisive and efficient development process,
focusing development through front-end planning,
maintaining a strategic balance,
integrating acquisitions, and
organizing for growth.

Establishing a process that works
The value of a dependable, efficient, and repeatable process for developing new products is not new news, but its powerful correlation to growth is. Our benchmarking database shows that across all industries (including chemicals and plastics), companies with a decisive, efficient development process grow at three times the rate of those without it (Figure 2). Companies that view development as the R&D organization's job, take an assembly-line approach to development, or have a structured development process on paper but don't follow it show poor progress; they are slower to market with new products, waste far more development resources, and don't grow quickly.

We use the term project excellence to describe the ability to develop and commercialize projects effectively. Our product-development benchmarking database reveals that most companies in the chemical industry have not attained project excellence and that companies without this foundation are profoundly hampered in their drive to increase growth and renewal.

It isn't that companies haven't been trying to improve. Most chemical businesses have implemented some kind of a staged and structured development and commercialization process that is cross-functional in intent. However, their piecemeal approach to this process has been worse than ineffective; it has been counterproductive. Development cycle times may actually lengthen as half-digested protocols are put in place, creating a short-term drag on growth. Without a foundation of decisive and efficient execution, the timing and the prospects of development projects are very unpredictable, and new technology and product pipelines based on these projects are notoriously unreliable.

During the past few years, we have helped many chemical companies upgrade their development approaches and reach best-in-class levels. Such upgrades typically involve improvement in three areas:
Project management. Sophisticated templates that incorporate benchmarked cycle time and resource standards help development teams to come up quickly with accurate, meaningful, and useful work plans. Then, teams can compare their projected results with those of similar projects at other companies and make better trade-off decisions that take into account time, resources, and risk.
Information about portfolio and resource allocation. Better linking and consolidation of project information help companies to forecast resource supply-demand balances and evaluate overall portfolio risk and return.
Decision making at project and portfolio levels. Inefficient decision making at both these levels is the most important overlooked factor in disappointing performance.

Our product-development benchmarking database clearly reveals the costs - in terms of project cycle time and time to profitability - of not having these best practices in place. Best-in-class chemical companies complete projects 23% faster (on a complexity-adjusted basis) than average companies. Companies that have implemented best practices enjoy superior project-level performance and much shorter time to profitability for platform, major, and minor projects (see Figure 3 and Project characteristics).

The cost of failing to institutionalize these best practices also is evident at the portfolio level, in the form of significantly lower overall returns on R&D investment (5). Over time, this shortfall translates into a much lower capacity to commercialize new products and renew the business (Figure 4).

Project excellence cannot be achieved without effective decision making. Although companies eager to improve the productivity of their development organizations tend to focus on execution, nearly one-half of all delays in the development process are caused by decision makers, not development teams. Best-in-class companies avoid such delays by managing not only their development projects but also their development pipelines, matching project commitments to project resources.

Another benefit of project pipeline management is that it reveals fundamental long-term gaps between a company's growth plans and skill sets. Many chemical companies are understaffed for growth, often in marketing and manufacturing. The best approach to effective management is to implement an enterprise-wide pipeline and portfolio management information technology (IT) system that is closely linked to project-specific data. The best-in-class companies are beginning to take exactly this approach, after many false starts this decade. The difficulties in implementing such IT systems should not be underestimated; they are not simply technical difficulties. The sudden transparency of project data can have real cultural repercussions - for example, people can no longer hide their "pet projects" from the rest of the organization. Implementing a pipeline and portfolio management IT system enterprise-wide will require dealing with more than only management-change issues. The company also must define portfolio analysis, develop a common framework for comparing projects, and establish decision processes to ensure that critical decisions are based on appropriate information.

In the context of the development process, effective top-level decision making requires the informed input of product-development teams. Team members must analyze the entire value chain associated with a new product, evaluate various scenarios for managing their projects, optimize project scheduling and timing, examine all the critical project risks, and develop contingency plans for managing those risks (Scenario: Decision making).

Focus: Front-end planning After a reliable process for executing development projects has been established, development planning becomes a tremendously rewarding activity. Top-performing companies narrow their development agenda to (and then concentrate on) a few genuinely important initiatives. Meaningful targets can be set at an aggregate level for growth from current operations and for corporate renewal from new technologies and platforms. The starting point for such planning often is an analysis of the gap between the corporation's ambitions for growth and renewal and the likely amount of incremental growth expected from current products and markets. Spanning the gap generally calls for developing something genuinely new, such as a new platform or business, or for integrating acquired assets into the business in a way that fully leverages their value.

The next challenge is to identify platforms or businesses that are worthy of focus. Many techniques are useful, but none of them are foolproof. High-level development planning is anything but a game of connect-the-dots; it calls for good intuition as well as good information. That said, three planning techniques have proved especially useful in helping companies set high-level development priorities: technology strategy, platform planning, and product strategy.

Technology strategy is focusing on the company's technological capabilities (and/or its access to such capabilities) and opportunities to apply them in innovative and profitable ways. Platform planning is identifying discrete opportunities to develop technological springboards for new families of products, then assessing them from an investment perspective by calculating the flow of project opportunities that they would provide. Product strategy is a focus on determining, in very concrete terms, what it will take to launch a winning family of products with a consistent vector of differentiation (6).

Platform economics differs from product economics in that platform investment decisions are based on the projected economics of a series of products, rather than only the first application. In the chemical industry, new platforms often are new processes, and the associated plant-level investments in process capability may not be justified by the first product that results from a given capability. Platform plans often are embodied in product and technology road maps. These road maps realistically depict the intended course and mix of major technology programs and new products. Product and technology road mapping, when done properly, has considerable predictive value for planning resource allocations and market introductions.

The chemical industry offers many examples that illustrate how effective front-end planning leads to focus on renewal and growth. Consider, for example, how Dow Chemical has focused much of its growth efforts on four technology and market platforms: advanced materials for electronics, biomaterials and bioprocesses, coatings, and catalytic polymer modification. Richard Gross, vice president of R&D at Dow Chemical, has said that by investing in these four major platforms through internal development and through acquisitions and joint development, Dow plans to develop and commercialize many new markets and build entire new businesses (7).

Our benchmarking results underscore the value of focused and proactive front-end planning. Best-in-class chemical companies are much more proactive in generating new opportunities than the rest of their industry. They obtain a significantly higher percentage of their new ideas from market planning, innovation, and competitors' products (Figure 5). In contrast, most companies in the industry obtain a much higher percentage of their new ideas from customer suggestions - a very reactive approach to feeding the development "front end". Customer feedback is important, but customers tend to regard companies' development efforts as a free resource when, in reality, they are highly constrained.

Technological breakthroughs and major innovations address deeply felt needs that the customer does not know how to satisfy. Not surprisingly, renewal projects are based more often on proactive intuitions of opportunity than on reactive responsiveness to customer requests.

Without a well-defined product strategy, technology development investments are difficult to plan. The technology strategies of best-in-class companies are closely linked to product strategies. Technology plans must be synchronized with product plans and market segment plans to provide the highest degree of leverage from technology investments (Figure 6). Without this link, companies spend millions of dollars developing new capabilities that never result in commercialized products (Scenario: Reactive development).

Maintaining the balance
The problem of strategic balance is all too familiar to cycle-bound industries such as chemicals and applied materials. How does a company sustain investment in growth and renewal while under pressure for short-term results? Our benchmarking data confirm what makes intuitive sense: Companies with higher growth rates invest in a balanced portfolio of platforms, major projects, and minor projects. When run well, the more modest projects reduce short-term pressures by keeping current customers satisfied. And that strategy, in turn, helps companies to stay the course with major and platform projects that open up significant new opportunities.

One Way to outsource: Joint development agreements

Best-in-class companies determine which major platforms and technology development efforts are good matches for their strategies, technological competencies, and the amounts they can afford to invest. Much emphasis is placed on leveraging supporting capabilities: the value chain, manufacturing, and customer service. Top-performing companies set goals and targets annually and track progress toward goals during the year. R&D budgets are driven by the strategic balancing process - not set from the top arbitrarily.

We have seen many companies that do not follow such a tightly linked process (Scenario: Growth targets). A well-balanced strategic process ensures that the following questions are answered:
What are the growth targets? How will they be achieved?

Are resources focused on a mix of short-term and long-term opportunities?
Are investments in key markets adequate?
What are the specific platform plans (including expected timing of specific product lines to be launched) that will drive growth?
What skill-set gaps will need to be filled to achieve growth targets? In what time frame?
How can new technologies be leveraged to the greatest extent possible?

To answer these questions, companies must have the appropriate analytical tools. As with resource decision making, strategic balancing benefits enormously from the use of an enterprise-wide pipeline and portfolio management IT system. Companies can use such a tool to analyze their present investments in R&D as well as to forecast future cash flows from expected new product commercialization.

Integrating acquisitions
Realizing "inorganic growth" - that is, through acquisition - requires more effort than simply choosing the correct acquisition targets; it requires integration across all business processes to capture the true value of the acquisition. Few firms put the same level of effort into integration that they put into selecting an acquisition target and negotiating its purchase. However, the longer it takes to complete the integration, the greater the odds of not meeting the growth goals. The longer the new organization remains in transition, the higher the likelihood that quality will suffer, productivity will decrease, customers and employees will get frustrated, and inefficiencies will linger. Such issues dramatically reduce the true value and effectiveness of a growth program that relies on acquisitions.

Two-thirds of acquisitions never achieve their financial targets and produce outright losses to shareholders because of their inherent risks. Failure manifests itself in several outcomes: departure of key talent from the acquired firm, slowdowns and strikes, lack of integration of the sales channels, lack of technology transfer between the two entities, and lack of effective decision making.

Our experience has shown that four kinds of activities minimize these risks:
creating an acquisition integration plan that is based on the logic of the acquisition and focused initially on immediate actions to take control of the business;
implementing standard business processes in product development, supply-chain management, strategic planning and budgeting, human resource management, and market planning and sales;
rationalizing product lines, facilities, and research assets; and
consolidating functional responsibilities.

In its highest form, acquisition integration itself is seen as a value-adding business process.

Organizing for growth
In addition to a structured acquisition process, leading companies understand that going beyond "organic growth" - that is, growth from within - often entails creating new structures and accountability. More now than at any other time in our memory, in fact, companies are looking for novel organizational structures and approaches that might fare better than the traditional ones. Why? Maybe traditional organizational and decision-making arrangements cannot support both current and new core businesses simultaneously. Examples of new and different organizational and financing structures include IBM's Chairman's Fund; DuPont's establishment of the position of Vice President, General Managers; Seagate's establishment of a technology steering committee; and Nortel's Venture Board.

Some of these alternative approaches involve securing a top-level commitment (including the board of directors) to stay the course after a development effort is approved and launched. Sometimes, companies assign managers other than those with large profit and loss accountabilities to build new businesses with renewal themes. Such dedicated growth organizations ensure that appropriate acquisitions are effectively integrated into ongoing operations.

The feature common to all these approaches is recognition that true renewal is not "business as usual". Without the right resources and a committed leadership, renewal will not happen - even with sound planning, strategic balance, and great execution. This is what organizing for growth is all about: decisively staffing and funding renewal projects, then supporting those projects politically, financially, and intellectually.

We have observed many companies that take a piecemeal, or nonintegrated, approach to product development. As a rule, best-in-class companies enjoy superior results (Best-in-class performance).

The chemical industry was founded on and has repeatedly returned to innovation as the wellspring of its renewal. We see evidence of this pattern continuing today. The practices that we have described for renewal through development and innovation are not simply the recommendations of a consulting firm; their validity and value are being proven, day in and day out, by the chemical industry's most growth- and renewal-oriented companies.

References
(1) Thayer, A. M. Chem. Eng. News, 8 Feb. 1999, p. 17.

(2) Shapiro, A.; White, T. CHEMTECH 1994, 24(3), 20-24.

(3) White, T.; Shapiro, A. CHEMTECH 1995, 25(12), 12-18.

(4) Morgenson, G. International Herald Tribune, 10 Sept. 1998, p. 17.

(5) Ginsberg, B.; McGrath, M. PRTM's Insight, Summer 1998, pp. 14-17.

(6) McGrath, M. Product Strategy for High-Technology Companies; Richard D. Irwin, Ed.; McGraw-Hill: New York, 1995.

(7) Fairley, P. Chemical Week, 18 Nov. 1998, p. 51.

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