Speaker: Lee McMaster, Chemicals Business Group President
Event: North American Chemical Distributors (NACD) Annual Conference
Location:
Date: 12/04/2003

I’m so glad to be here today.   Distribution is a very important part of how Dow does business, and we are working to strengthen our relationships with our distributor partners.  

This is a very dynamic time for chemical distributors and producers.   Our industry is going through a transformation, driven by a wide array of trends and factors. I’d like to describe those factors today, talk about which ones we can control and manage, and what companies can do to survive ... and even thrive … in the future.

SLIDE 2: Industry Summary: North America Chemical Distribution  

I’d like to start by describing the state of the chemical distribution industry … an unvarnished look at the reality of our situation.  There are more than 700 distributors in North America, and overall their revenue is flat.  If you look at the overall profitability of distributors as a whole, they’re not covering their cost of capital.

At the same time, chemical manufacturers’ sales through distribution just about cover those manufacturers’ cost of capital, on the whole.

Industry fundamentals have slowed acquisitions/consolidation of the chemical industry and of distributors.   And there are lots of opportunities for cost and service improvements!

The bottom line is that the chemical distribution industry in North America … and the chemical manufacturing industry in North America … are low-margin, low-growth industries.

SLIDE 3:   Why is our industry in this state?  The factors:

So why is our industry – producers and distributors – in this state?   Let’s look at the drivers.   

• Commoditization – every product that we today consider a specialty is becoming more commodity-like every year.   The same goes for the services we provide; nothing remains unique for long.
• Globalization continues, as more production shifts overseas.
• Hydrocarbons and energy spikes are expected to continue, and the chemical industry no longer can be the shock absorber. The cost must be passed along to customers.
• Retailers and consumers demand constantly lower prices.   This so-called “Wal-Mart effect” I’ll talk more about in the few minutes.
• EH&S pressures continue as strong as ever.
• There are too many distributors chasing a mature market …
• Too many duplicative and underutilized assets on the ground …
• And too much inefficiency – freight redundancies, etc.

Now when you look at this list, you can see that most of these are external factors – the economy, the business environment – that we have no control over.  But there are three factors here – the last three on the list – that we do have control over.  These three factors are of our own making.  This is the reality we’ve created.

I’d like to examine each of these a bit more, and describe how we can take action to change the state we’re in.

SLIDE 4:   Chemical Industry is undergoing another historic and permanent shift

First, it’s important to understand that the chemical industry is undergoing an historic and permanent shift … of the same scale and magnitude as only two other transformations in the last century.

The first transformation was in the 1950s, post World War II, when world events created a climate in which the U.S. chemical industry grew rapidly.  No longer overshadowed by the German chemical giants, and able to tap into innovations driven by the war effort, U.S. chemical companies grew rapidly and commercialized new products at an astounding rate … products that are still with us today like STYROFOAM, water borne coatings, personal care products – all based on what we now call the business of chemistry. The chemical industry continued to innovate and grow with the U.S. economy.  And the chemical distribution industry developed and grew with it.

Then, in the 1970s we suffered through two OPEC oil crises.  At the same time, the integrated oil producers aggressively forward integrated into petrochemicals, and the chemical industry began the process of globalization.  Markets which had been strictly regional were now opening up.  U.S. and European companies began expanding overseas and building truly global operations.  All of this increased the competitiveness of the industry, with longer time periods required to absorb the ever increasing scale of new plants.  This drove the cyclicality of the chemical industry, with wide swings in profitability between the peak and trough. It was a new reality, quite different from the previous era.

SLIDE 5: Chemical Industry is undergoing another historic and permanent shift

Today that reality is still with us, but with another new challenge superimposed … what some have called the “Wal-Mart effect”.

Downstream customers demand constantly lower prices, and constantly improved quality and functionality.  The trend toward “big box” retailers, and consolidation in other downstream industries, shifts the negotiating power to the customer more than ever before.  While Wal-Mart pursues the noble goal of everyday low prices for its customers, its policy towards suppliers is sobering:  “the price Wal-Mart will pay suppliers must drop every year, year after year, period.”   The big boxes are even beginning an effort to cut out wholesalers and have manufacturers produce finished goods directly for them.

This is not to say that the big boxes are villains, but rather that they are visible examples of how customer pricing power is squeezing profit-killing concessions out of their suppliers. To survive in the face of pricing demands from customers – and consumers – those of us up the supply chain, including chemical companies and distributors, need to take drastic measures. 

And you don’t need to take my word that this is a fundamental macro-economic shift of major proportion.   Articles last month in the Wall Street Journal, Forbes, NPR, Fast Company and Inc. magazine all examined this new dynamic and what it means for our economy. 

So in 2003, our industry is at a turning point.  It’s time for some self-examination.

SLIDE 6:   Duplication in U.S. Chemical Distributor Assets

First, let’s examine the state of U.S. chemical distributor assets.  This map shows assets – terminals, warehouses, etc. – of four large national distributors.  That’s a lot of overlap. 

And when you consider that much of the capacity utilization in those tanks and warehouses is very low, that’s a lot of duplicative, unnecessary capacity.

Now in your mind, overlay all the terminals and warehouses of the 700+ regional and independent distributors.

And again … now overlay all the terminals and warehouses of Dow and other chemical companies you do business with.   I think you know that we also have a lot of capacity that’s empty and underutilized. 

We tried to actually show all this on the map, but it had so many dots…   !

Needless to say, these assets are ripe for consolidation.

SLIDE 7:   Cost Along the Distribution Channel

Now let’s consider how those assets are used.   Here’s a schematic of our chain, which you’re all very familiar with.  Now of course, not all products go through all these steps … some skip a few steps … but this is illustrative of the redundancy in the chain. 

Needless to say, there are a lot of duplicate assets, and a lot of working capital, and extensive time and human effort here.

This chain is ripe for streamlining.

SLIDE 8:   Where is the industry headed?

So that’s where we are. 

And where are we headed?   What does the future of our industry hold for us?

What is our end state that we’re working toward, and how will we get there?

SLIDE 9:   What will our industry look like in 10 years?  The producer prospective

Think about what we’ll be like in 10 years.   Of course none of us has a crystal ball.  But I’ll share with you my predictions for the future of the chemical distribution industry.

First let’s look 10 years down the road – from the producer’s perspective.   I believe that in 10 years …  

• Industry fundamentals will continue to drive to continuous cost reduction and a low cost-to-serve model, where customers will only pay for the product functionality and services they believe are essential.
• Producers will sell more products through distribution as they look for ways to further reduce cost by streamlining the supply chain.
• Expect an increase in off-shore suppliers, especially for upstream petrochemicals, from low-cost feedstock areas like the Mid East, to put more pressure on manufacturing and supply chain efficiency. 
• All of these factors make reductions in supply chain costs even more critical, since it will be one of the necessary fundamentals for competitiveness. 
• And, even more so than today, only the strongest will survive.

SLIDE 10:   What will our industry look like in 10 years?  The distributor perspective

Now let’s look 10 years down the road – from the distributor’s perspective

• Suppliers will develop more cooperative relationships with their distributors.  These relationships will provide additional ways to reduce costs, become more competitive.
• There will be more alliances among regional distributors – like Omnichem.
• Large nationals will continue to sell a broad product offering and hone their service offering to meet the increasing demands of their customers to reduce cost to serve.   They will leverage their learnings on a national basis. Regionals will sell to a niche, and must be more focused to survive.
• Barriers to exit continue to be a primary barrier to profitability.   Many distributors would like to shut down and write off old, underutilized assets, but can’t because of legacy environmental issues, or the impact on their balance sheet.  Because of this, we expect the number of distributors to decline slowly, through consolidation of sites and some acquisition of small distributors. But all of this is happening much too slowly.

Again, only the strongest will survive.  So those are my predictions.  And what will it take to survive in this new world?

SLIDE 11:   How to Survive:  Collectively reduce the total cost to serve

Distributors and producers need to move to a low cost-to-serve position.  We will need to find ways to take advantage of those opportunities we mentioned before – improving capacity utilization, reducing redundancies, etc.

There’s also the opportunity for asset reductions – which reduces cost to serve and improves working capital. But combining assets and working capital brings certain ramifications; there are barriers – environmental legacies, impact on balance sheet.

We will need to simplify pricing and other transactional processes so we can use e-commerce more, and have less manual processing and re-work.

Distributors will need to work more closely, in a cooperative relationship with their suppliers. This may mean the distributor selects a smaller number of suppliers to build these relationships with. The relationships will need to be based on trust, and open and transparent exchange of information, so that they can then work together on a number of ways to reduce their respective costs.  Examples include:

• Reduce supply chain costs from freight and inventory reductions. 
• Move to hubbing and spoking, fewer combination TT, etc.
• Better inventory planning so we can lower DSI.

It won’t be easy. Each company will have to make its own way and define what approach is right for it.

SLIDE 12:   Our Future…Together

It’s a journey that we’ve only just started.  It may appear a bit frightening … but also exciting for those who embrace the challenge … because the results could be significant:

• We can improve our bottom line – both producers and distributors
• We can increase our sustainability
• We can become more attractive to employees and investors
• We can provide better service and value to customers.

I’m hopeful that’s what our future holds.

As you enjoy the rest of the conference, I hope you’ll keep the dialogue going about where our industries are headed, and how we can each shape our future. 

Thank you.