Where is the chemical industry going?

Business Economics, Oct, 1999 by T. Kevin Swift

Prices are often based on cost effectiveness and value-and-use considerations vis-a-vis other alternatives. Patent and other intellectual property protection is very important, and development costs are high. These factors influence the economics of the business. As a result, life sciences have typically enjoyed profit margins that are multiples of those in basic chemicals. Long-term prices have been rising, although large customers (HMOs, retail pharmacy chains, etc.) have increased bargaining power, and profit margins have been under pressure. Competition is largely based on innovation, product development and differentiation, geographical coverage, price, and customer service.

Technology advantages are extremely important in life sciences, and increasing convergence occurs between biology and chemistry as biotechnology innovations further diffuse. Indeed, life sciences is synonymous with innovation. As a result, R&D spending in life sciences as a percent of sales are the highest among all industries. For pharmaceutical companies, R&D spending ranges from 15 to 25 percent, while crop protection companies typically spend 10 to 15 percent of sales on R&D. Capital needs are moderately high but flexible. Plants are usually batch-oriented synthesis or formulating operations, where quality control and a clean environment are critical. Beyond a certain size, scale does not matter. Microbial fermentors or mammalian cell bioreactors would typify many biotechnology operations. Pharmaceutical companies are increasingly outsourcing their fine chemical needs in order to focus on R&D. For a number of pharmaceuticals, biotechnology represents a more efficient and cost-effective means of manufacture.

Strategic acquisitions, alliances and research agreements as well as investment in internal capabilities are important in life sciences. Some consolidation is occurring and concentration is relatively high. (For example, the top ten firms account for more than 75 percent of world crop protection sales.) Sustainable product differentiation and intellectual property are significant competitive factors. A number of life science companies have vertically integrated downstream into seeds. This, in turn, will adversely affect the demand for crop protection products based on traditional chemistry. For pharmaceuticals and other health care products, demography will play a large role in long-term demand trends. International competition is rising, bringing with it increasing import penetration in pharmaceuticals. There is also increasing penetration by generics, while development costs continue to rise.

Outlook

Exacerbated by the Asian crisis, the $1.53 trillion global market for basic chemicals, specialties, life sciences and related products barely increased in 1998 (following a 4.8 percent gain in 1997). A number of national and end-use markets for chemicals softened and price competition increased in face of global overcapacity.

TABLE 4

U.S. CHEMICAL INDUSTRY LONG-TERM GROWTH PROSPECTS

                                   1998               1998-2010
                                 Chemical                Real
                              Value of Output           Growth
                               ($ billions)             (% pa)

Basic Chemicals                    $177         [greater than] 1 1/4
Basic Industrial Chemicals          163                  1 1/4
Fertilizers                          14                  1 1/2
Specialties                          96                  3 1/4
Life Sciences                       100                  4 3/4
Consumer Products                    46                  1 3/4
Total                              $419                  2 1/2