M A R C H 2 0 17
© Lloyd Miller
Chemicals
Chemicals 2025: Will the industry be
dancing to a very different tune?
Chemical companies have been riding high, but the trends that have underpinned that performance are
shifting. Companies should reflect carefully on their strengths as they move into this new territory.
Florian Budde, Obi Ezekoye, Thomas Hundertmark, Manuel Prieto, and Theo Jan Simons
Whenever over the past decade we have examined The impetus behind this strong performance has
the chemical industry’s capital-markets been the chemical industry’s ability to significantly
performance, a very similar picture has emerged. increase earnings on a base of total revenues and
On the basis of total returns to shareholders invested capital that has grown more slowly, at a rate
(TRS), the chemical sector has, over the long term, tracking close to global GDP growth. This ability has
outperformed not only the overall market but also been underpinned by the following factors.
most of its customer industries and raw-material
suppliers.1 Within chemicals, the commodity and First, the chemical industry has increased its
specialty subsectors show similar performance, productivity over time and has distinguished
while diversified companies have trailed. There itself by holding onto the resulting profitability
have been variations on the theme over time, with gains, unlike many other industries that also
petrochemical players’ performance more affected raised productivity but simply competed the gains
by the naphtha-ethane spread and the commodity away. How did the chemical sector achieve this?
cycle, while specialty players have been more Looked at overall, the sector appears fragmented,
affected by end-market growth and mergers-and- but two decades of portfolio restructuring have
acquisitions activity, but the variations have not created a highly concentrated industry structure
changed the overall sunny picture. in many segments. That has put those chemical
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companies in a strong bargaining position relative This slowdown in financial performance reflects
to customers and suppliers. important changes in the chemical industry’s
fundamentals. First, the industry is finding it
Next, the chemical industry has benefited increasingly difficult to hold onto the benefits of its
tremendously from China’s economic growth of the productivity-improvement efforts. Paradoxically,
past two decades. China’s capacity could not be built this is happening just when advanced analytics
fast enough to meet domestic demand, so chemicals and digital approaches are creating a new wave of
had to be imported. This allowed West European opportunities to accelerate productivity gains. Why
and North American players to grow while their is the industry having these difficulties? There are
home markets were experiencing near stagnation. signs that one of the cornerstones of the industry’s
performance—its concentrated industry structure—
Last, we must keep in mind that the chemical may be weakening. How is this showing? The level
industry has an intrinsically sound business model: of competitiveness appears to be significantly
its products enable the “world of things.” Without increasing in many segments because of the
some support from the chemical industry, hardly any number of new entrants, mostly Chinese, and
of what we touch, of the buildings we live in, the food related to this, overcapacity is increasingly a
we eat, and the healthcare we receive could exist. The challenge in many product areas.
industry as a whole is therefore positioned to profit
from a wide range of trends, from sustainability to A second factor is slowing growth in global demand.
e-mobility, from commodity demand surges to major The GDP growth rate in the all-important Chinese
changes in consumer behavior. market has fallen and may decline further. Even
more important is that China’s per capita chemical
Along with these strong fundamentals, there have consumption is reaching the threshold where it is
been a number of positive developments that have decoupling from GDP growth and is projected to lag
benefited specific segments of the industry, and behind that growth in the future. China has moved
helped the industry’s overall capital-markets from its investment stage—built up infrastructure
performance. The most notable have been the across the country while much of its population has
availability of stranded gas in the Middle East and equipped itself with new homes, consumer durables,
shale gas in North America, and the upward trend autos, and other possessions—to an economy more
in many agricultural-commodity prices from 2000 characterized by services and “upgrades,” which
to 2013. provide much less demand for chemicals. A middle-
class car that a Chinese buyer trades up to does not
Turn of the tide? necessarily contain more polymers than an entry-
But this golden era may be coming to an end. Some level model.
important indicators have changed over the past
few years. While the industry’s 15-year performance Looked at globally, we estimate that the last
still looks good, a closer look at the past five years decade’s 3.6 percent growth rate for petrochemicals
is less favorable: not only have chemicals lagged the may go down by between 0.5 and 2.0 percentage
total stock market since 2011 in TRS performance points over the next ten years, depending on
but the industry’s return on invested capital (ROIC) assumptions for regional GDP growth. For
performance has flattened, and for some chemical an industry with an estimated capacity creep
subsectors, decreased. somewhere between 1 and 2 percent annually,
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this could be a dramatic shift. Other sectors are the technology content of companies’ offerings. But
likely to see similar reductions in growth rates— that industry structure is changing fast as many
although the growth in overall chemical demand new—in particular, Chinese—players enter the game.
will continue to outpace GDP. In agrochemicals, for
example, changes in diet as well as the potential to Next, the global playing field is leveling off again,
tap enormous productivity reserves in the existing and so potentially shutting off another growth
food chain could suppress overall chemical demand. avenue. Chemical production has historically
tended to be local—produced in the region where
There are also signs of longer-term shifts. We it is consumed. But the last ten years have seen a
think the specialties model is increasingly under departure from that pattern: significant imbalances
threat. A long-standing belief in the industry is in raw-material prices (the cost of stranded and shale
that moving portfolios downstream and to a higher gas versus oil), labor costs (China versus developed
specialties content is a reliable way to help solve the economies), or just regional mismatches in supply
challenges of growth and value creation. But we are and demand (China growth) resulted in a significant
increasingly skeptical. The universe of specialties is internationalization of the chemical industry and
not well defined and as a result is hard to quantify, related growth opportunities for many players.
but we think it is getting smaller. Innovation to However, given the context of oil prices moving
develop new differentiated—and thus specialty— to lower levels since 2014 and Chinese labor costs
products has become a game of inches. With the rising, it is fair to speculate that this development
exception of innovative crop protection, we would be might go into reverse in the coming years.
hard pressed to name a single chemical blockbuster
developed in the last ten years. Even in application As if all of these shifts were not enough to deal
development, the segments where consumers are with, the global chemical industry must also
willing to pay for leading-edge solutions are not recognize that it has to operate in an environment
getting bigger, since the fastest-growing markets that is increasingly nationalistic. The trade and
(China and India) have only a limited appetite investment policies of a number of emerging-
for premium grades. Expanding in application market countries have always been somewhat
development will compensate for only part of the protective (and may have become even more so
margin erosion in the upstream core business. recently), and the incoming US administration
appears to embrace a similar attitude. As Brexit and
Digital innovations may further hasten this trend; other developments underline, a similar trend can
an increase in e-commerce driven by distributors or even be observed in Europe.
platforms such as Alibaba could even accelerate this
commoditization of specialty companies’ product In parallel with this resurgence of nationalism,
and service offerings. In certain areas, such as state-owned enterprises (SOEs) are taking an
agrochemicals, that have more of a B2C character, increasing share in the industry. SOEs’ share
Internet platforms may become as disruptive as we dropped sharply during the 1980s and ’90s, when
have seen in other consumer spaces. Our skepticism many governments sold their stakes in national
about specialties is reinforced by our research, oil companies, many of which owned significant
which shows that segment profitability already chemical activities. With the rise of China and
appears to be much more dependent on industry other developing countries, this trend has reversed.
structure (in effect, the number of players) than on SOEs, however, often are held accountable to
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different standards than private and listed players— in today’s environment of record profitability for
financially, strategically, and otherwise. They also European petrochemical makers, good times rarely
tend to have much deeper pockets than publicly last forever, and the need for closures could resurge.
traded companies, which may find it difficult to More broadly across the industry, companies could
compete when it comes to the development of be forced to restructure in almost all parts of the
new technologies. world, and we foresee players trying to attain greater
economies of scale through new waves of M&A.
This list would not be complete without a mention
of the debate around the circular economy. This The only major exceptions might be India—where
is mostly relevant for plastics, but since plastics all indicators suggest that the local growth is going
consume the majority of petrochemical products, to continue, albeit from a low base—and China. But
this has the potential for industry-wide impact. We many areas of the Chinese chemical market these
estimate that roughly two-thirds of all plastic ends days are already oversupplied and overserved. We
up in a landfill or the environment at large. Because would argue that Chinese supply needs a broad and
plastic waste degrades slowly, it accumulates, and drastic consolidation.
it is not unlikely that the chemical industry will
become subject to regulation and pressure from Incumbent specialty-chemical players
customers to do more regarding recycling and must prepare for further encroachment of
demand reduction. Given the rather low growth commoditization and erosion of their historical
rates projected for the sector, as previously advantages when attackers from developing
discussed, such regulation could potentially result markets gain more experience and become
in a scenario in which the need for conventionally increasingly technologically savvy. The value-add
produced material would not only stop growing but potential of many Western specialty-chemical
even (though not in the short term) could shrink. conglomerates will be challenged even more
intensely than today, and so will their questionable
If just a few of these shifts gain substantial claim that they can upgrade their portfolio in a way
momentum, the chemical industry will face a decade that generates value for shareholders.
very different from, and much tougher than, the last
one. What are the implications for the industry? At the same time, the long-heralded shift of the
chemical industry’s center of gravity to Asia
Into a new world will actually take place. As much as Western
The first and perhaps most significant implication players have tried to prepare themselves for this
would be that with growth rates only a little above development, many still have only a limited grasp
annual capacity creep, there will be less need for of what this will mean and the mind-set shifts
new builds. Most new investments will either required to face the fact that they will move from
replace existing assets or need to displace others. the center of the industry to its sidelines. The
For example, the new crackers in North America historical track record of multinational companies
will target Asian markets and compete with exports in China and other Asian countries has been mixed
from Middle East producers. The latter’s exports at best. At some point, they will need to consider
to Europe may increase as a result, increasing much closer partnerships with Chinese players to
pressure on European petrochemical players in the grab hold of one of the last opportunities to become
medium term. While this scenario seems remote an insider in what will be the largest chemical
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market. There may be a fit here with the interests How can you increase your presence in China as
of local companies: as Chinese players grasp the a foreign-based company, in view of the changes
opportunities for consolidation in their home under way that we have outlined in this article?
market and expansion globally, they may value And if you are a Chinese company, what role will
access not just to Western companies’ technology you play in a likely consolidation of
but also to their successful business approaches. the industry?
As a general statement, strategies for chemical What are your strengths, and how can you build
companies may become simultaneously simpler on them through transformational M&A to
and more challenging. They may become become a champion in your target segments?
simpler because the imperatives of productivity
improvement and functional excellence—in other What will be the most value-creating operating
words, executing a chemical-business model better models for multibusiness companies that
than most competitors in the field—will be even straddle specialties and commodities?
more obvious than today. Without this executional
excellence, companies will lack the financial How will you use digital to ride the next wave
strength and the credibility to lead in a game that of commercial, supply-chain, and operations
will include a lot of M&A. Strategy development, performance improvement?
however, will also become much more difficult:
it will be much more challenging to identify the 1 Based on analysis of performance back to 2000. See Bing Cao,
remaining opportunities for growth that exceeds Obi Ezekoye, and Michael Glaschke, “Chemicals and capital
GDP and to develop approaches to capture those markets: Still a strong performer,” McKinsey on Chemicals, July
opportunities in a value-generating way. 2016, McKinsey.com.
Florian Budde is a senior partner in McKinsey’s
Frankfurt office; Obi Ezekoye is an associate partner
in the Minneapolis office; Thomas Hundertmark is
We are the first to acknowledge that any attempt to a senior partner in the Houston office, where Manuel
look into the future has limitations, and we present Prieto is a partner; and Theo Jan Simons is a partner
this perspective based on careful observation of in the Cologne office.
the industry as a starting point for participants
thinking about strategies for the next decade. As The authors wish to thank Megha Agarwal, Juan
Pablo Barreira, Bing Cao, Arturo Pizano, and Adam
chemical companies head into this new and more
Youngman for their contributions to this article.
challenging territory, they need to take stock of
their strengths and weaknesses. Here are some
Copyright © 2017 McKinsey & Company.
questions to advance that reflection:
All rights reserved.
How is the industry structure of the segments in
which you participate going to evolve, and what
are the implications for future profitability?
