THINK ACTBEYOND MAINSTREAM

Playing in the profit poolOvercoming the six big commercial value traps

2016

Novem

ber

1. GROWING PAINSSlowing growth in the chemicals industry is forcing companies to focus on capturing commercial value.

Page 3

2. IMPACT OF COMMERCIAL EXCELLENCEEnhancing performance can increase

EBIT by 3% of revenue or greater. Page 3

3. CAPTURING COMMERCIAL VALUEAvoiding common value traps is possible if one is aware

of systemic issues that undermine performance. Page 6

T H E B I G

32 THINK ACT

Playing in the profit pool

PLUS COMMERCIAL EXCELLENCE FRAMEWORK P. 5

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Slow growth in the chemicals industry is forcing com-panies to adapt to a new environment. After a strong post-recession recovery in 2010 and 2011 of over 18% p.a. revenue growth worldwide, global chemicals indus-try growth has slowed to less than 2 % p.a. over the last four years. As an example of a more developed econo-my, US chemicals industry revenue growth has slowed to just over 1% p.a. over the last four years, compared to a post-recession growth rate of over 10% p.a.

Acquisition-driven growth is one solution to the growth problem, but lofty EBITDA multiples force a firm to be extremely selective and only pursue inorgan-ic growth when synergies can be reliably captured. Get-ting more out of what one has is one of the few reliable levers for driving growth and accessing a greater share

of the available industry profit pool. In this context, we are seeing a resurgence of commercial excellence ef-forts across the industry. Known by many names – Rev-enue Optimization, Value Pricing, Sales and Marketing Excellence, and Commercial Excellence – these pro-grams can often deliver results in excess of 3-4% of rev-enues, accruing directly to the bottom line. A

Note that other "back office" (or order-to-cash) pro-cesses can add incremental value above and beyond those from Commercial Excellence programs. In prac-tice, however, actual delivery of results have been highly variable, with some programs generating far more than benchmark results, and others actually destroying value.

How do you win when growth is slowing?

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TYPICAL COMMERCIAL EXCELLENCE VALUE LEVERS

A

Source: Roland Berger

Aligning product/service offers with segment needs 0.5-1.0

Pricing data management and administration 0.5-1.0

Average Value contribution 3.0-4.0

Value pricing 0.5-3.5

Elimination of margin leakage/price enforcement 1.0-3.0

Category EBIT enhancement [% of revenue]

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COMMERCIAL VALUE TRAPSAgainst this framework, we have seen some a series of pitfalls, or Commercial Value Traps, in chemicals com-panies that hurt overall commercial performance. The-se value traps exhibit some common themes. First, they typically impact more than one value driver of our Commercial Excellence Framework. B Second, they emanate from both analytical as well as softer, or cultu-ral issues. Finally, they can be linked to some of the key chemical industry trends of the last decade: product commoditization, manufacturing shifting to lower cost regions and the resultant stranded assets, and nu-merous overhead cost reduction efforts. The following are the six major commercial value traps we have seen in chemicals.

A GUIDING FRAMEWORK: TAKING A HOLISTIC APPROACH TO CAPTURING COMMERCIAL VALUEOur experience has led us to describe commercial ex-cellence as the output of an integrated set of activities. In order to maximize their share of the profit pool, companies must define their Commercial Strategy, streamline Business Processes, take advantage of Data & Analytics and establish a supportive Governance and Organization structure. Within each area, there are three sub-categories allowing companies to identify best practices, assess gaps and strengthen high-lever-age activities. For high performance, a high degree of alignment across the range of activities is crucial.

Commercial Strategy serves as the overall guiding function that sets the direction for pricing strategy, appropriate bundling of services and products, key account strategy, and channel management ap-proaches. The market intelligence function is an un-derlying enabler for a distinctive commercial strategy. Critical to maximizing performance, commercial strategy must adapt to changing market conditions.

Business Processes allow for efficiency in engaging the customer and capturing value. Establishing prod-uct and service offering tiers with supporting decision rules, delivery policies, working capital terms and col-lection processes are all fundamental for optimizing commercial cash flow. Customer engagement rules are defined as a key component for process optimization.

Data and Analytics provide the quantitative under-pinning for day-to-day commercial decision making and identifying (and resolving) sources of value leak-age. Consistency between customers and segments (adjusting for size, cost to serve and value) and how this feeds into selling objectives and pricing is a key output from the use of solid analytics.

Governance and Organization addresses both the harder side (KPIs and organization structure includ-ing "boxes and wires") and the softer side (culture and skill sites) of commercial management and execu-tion. If not aligned with commercial strategy and goals, organizational dysfunction and frustration likely emerges with the resultant loss of effectiveness and value.

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Source: Roland Berger

B

COMMERCIAL EXCELLENCE FRAMEWORK

Commercial capability

Offer & policy management

Strategy & positioning

Deal execution

Control & monitoring

BUSINESS PROCESSESSTRATEGY

1. Clear pricing objectives and goals

2. Synthesis and usage of market intelligence

3. Target segments and positioning

4. Tiered offer structure5. Reference price architecture

(product & service)6. Transactional rules & policies

10. KPIs and reporting11. Structure, governance and

culture12. Skills and incentives

7. Pricing software and tools8. Value & price

communication9. Pricing consistency

DATA AND ANALYTICSGOVERNANCE/ORGANIZATION

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1UNCOVER THE ROOT CAUSES The most common problem in commercial excellence initiatives is the failure to recognize the interdepen-dencies between value drivers. As a result, improve-ment efforts are focused in the wrong area(s). Below are some common examples that we have seen:

Incentive structures: A company trains its sales team on the principles of value pricing, but the team remains incentivized on sales volume. Man-agement then questions why the results are less than satisfactory. Changing customer preferences: A polymers com-pany holds price against new entrants without rec-ognizing that customer preferences have changed. What was once a leading product is now commod-itized and share is given up to lower cost rivals.

Examine the "system" and know where to best intervene. Strive for true root cause analysis.

2DON'T DIGITIZE TOO EARLY Digitization is currently a hot topic in the chemicals in-dustry. While we see considerable future value from digitization in commercial functions – are you ready for it now? Digitization can enable back office efficiencies, increase accuracy of predictive models for demand forecasting and pricing, streamline new product devel-opment as well as provide front line tools to improve sales force productivity. However, in order to realize the value, companies need a strong foundation –customer data must be dependable, good segmentation rules (in-cluding targeted service levels) and the business leader-

ship must be aligned against clear commercial goals. The costs of digitization efforts are high, and paybacks will be low if there are cracks in the commercial foun-dation. For a more detailed perspective on the potential for digitization in chemicals, please refer to our publi-cation Master the Maze (June 2016).

Target digitization to high value pockets, but only after underlying data integrity is established.

3ENSURE CUSTOMER SEGMENTS AND NEEDS ARE PROPERLY DEFINEDOne of the most prevalent commercial challenges across the chemicals industry is product line commod-itization. C Faced with competitive threats ranging from foreign competition, new competing products, changing customer preferences, down gauging, and in-creasing comfort levels with lower quality product; his-torical wisdom about one's product positioning versus customer needs have frequently been proven wrong. The implications are many including misaligned ser-vice levels, poor demand forecasting, and importantly, inability to price for value.

Must challenge assumptions about the competitive position of one's product portfolio and how it currently aligns to customer needs.

Avoiding the Commercial Value traps.

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Source: Roland Berger

1) List price based on Plastic News estimates; actual transaction prices may differ

C

PRODUCT LINE COMMODITIZATIONReal price per pound of select plastics vs. time

Real price1) [USD/lb]

1.0

1.2

1.4

1.6

1.8

2.0

2.2

2.4

2.6

2.8

3.0

3.2

3.4

1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018

Polycarbonate (Injection GP)CAGR -3%Polyester (PBT 30)CAGR -2%

Nylon 6CAGR -3%

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Align governance structure to market structure (regional versus global) and drive decisions to the proper level. Authorizations to deviate from existing pricing guidelines must be treated as more than a "rubber stamp".

6ENSURE REQUISITE SKILLS ARE IN PLACECommercial functions are growing in complexity. Customers are rapidly increasing in sophistication via use of "should cost models", unbundling the value inherent in aggregated product offers, and leveraging fast information flow in negotiations. These changes force commercial personnel to play multiple roles: technical service expert, corporate marketer and brand builder, working capital optimizer and lead ne-gotiator. Commercial skills and selling effectiveness are essential to ensuring employees can successfully tackle each role and capture commercial value. How-ever, the chemicals industry has not generally kept up with the pace of change across the industry and the challenge will only augment as digitization (see above) creeps into commercial areas.

Identify and fill skill gaps in negotiation, product understanding, and principles of value pricing.

4COMMIT TO CAPTURING AND SYNTHESIZING MARKET INTELLIGENCEMany years of cost reduction across the chemicals in-dustry has resulted in the erosion of a comprehensive competitive and market intelligence function. D Too frequently, market intelligence is deemed to be a non-essential component of SG&A spending that can be outsourced. Unfortunately, outsourcing of market data typically leads to access of only threshold infor-mation, available to all competitors. Without an infor-mational advantage, there is limited ability to make superior commercial decisions. The advantage of strong market data is evident in the below examples:

In commodities, rigorous competitor cost-to-serve models allow for much better pricing decisions. In specialties, market intelligence can help one move from merely solving a customer's technical problem to defining tactics to capture the fair share of total value created. Without a solid market intel-ligence function, any commercial value gains will be fleeting.

Resolve market intelligence gaps or pricing enhancements will be temporary at best and may destroy value in the near term.

5ALIGN GOVERNANCE STRUCTURE WITH THE MARKETCompanies must organize their commercial gover-nance structure to mirror the market. For example, if markets operate globally and a firm is structured re-gionally to supply that market, customer procurement organizations will leverage one region against the oth-er to obtain the lowest overall cost of supply. In this situation, the firm has ceded advantage to the custom-er. On the other hand, if a firm uses global supply chains to serve regional markets, it will likely suffer high cost-to-serve and overly complex commercial ac-tivities. Inherent in any chosen structure are decision rules and authority levels. Autonomy must be provid-ed, however possible, to the front line with manage-ment commitment to minimize price leakage due to "unique" circumstances.

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D

SAMPLE BEST-IN-CLASS MARKET INTELLIGENCE FUNCTIONOBJECTIVE: Inform management decision making and communications by providing detailed information on macroeconomic data, industry trends and competitive actions at the right time.

Management decisions

Divisional KPIs

Pricing changes

Earnings guidance

Expansion capital approval

Plant rationalization

Cost reduction targets

Firm positioning

Inputs

Macroeconomic data

Energy forecasts

Technology benchmarking

Trade data

Target segment demands

Competitor financial releases

Competitor supply disruption

Commercial team insights

Outputs

Segment attractiveness

Price forecast

Industry cost curve

Value-in-use analysis

Competitive strategies

Internal vs. External

communications

Internal (management)

External (commercial team)

External (investor relations)

Internal (management)

Internal/external (management/press)

Internal (management)

External (PR,IR)

Source: Roland Berger

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Starting, or redirecting, a commercial excellence jour-ney requires a thoughtful effort to ensure resources are being focused on the highest return areas. The use of a diagnostic frame against best practices forces a holistic review of the commercial function and leads to much greater payback on the resource investment. E In these days of slowing growth, increasing the sophis-

Where to start?

SAMPLE COMMERCIAL EXCELLENCE DIAGNOSTIC

E

Source: Roland Berger

tication and analytic rigor of commercial activity should be a critical component of every company's game plan. If done properly, efforts should be self-fund-ing and establish a solid foundation for growth and selective deployment of differentiating solutions. Most importantly, it will enable the capture of an appropri-ate portion of the available profit pool.

STRATEGY > Gaps in segmentation and product positioning > Market intelligence function needs to be rebuilt

BUSINESS PROCESSES > Transactional policies inconsistent > Reference price structure well-accepted by customer base

GOVERNANCE AND ORGANIZATION > Well understood KPI system > Incentive system misaligned with strategy objectives

DATA AND ANALYTICS > Data integrity issues contribute to value leakage > Cost-to-serve models versus competitors lack recent technology changes

Target segments and positioning

Pricing consistency

Tiered offer structureUse of market intelligence

Value and price communicationSkills and incentives

Reference price architectureClear pricing objectives

Pricing software and toolsStructure, governance and culture

KPIs and reporting Transactional rule and policies

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11THINK ACTPlaying in the profit pool

Roland Berger, founded in 1967, is the only leading globalconsultancy of German heritage and European origin. With 2,400 employees working from 34 countries, we have successful operations in all major international markets. Our 50 offices are located in the key global business hubs. The consultancy is an independent partnership owned exclusively by 220 Partners.

FURTHER READING

KEEP THE DRAGON FLYING

China has been the growth driver for the chemicals industry over the previous decade (10% YoY), but has slowed to an average of 7-8% in the last few years. Our article explores the implications of the recently announced 13th Five-Year Plan on various segments of the chemical industry and assuages some anxieties around growth in general.

MASTER THE MAZE Digitization. The word seems to be on every- one's lips, from market pundits to industry thought leaders. And leaves many executives in the chemical industry wondering whathappened to the asset- intensive industry they used to know.

KNOW THYSELF

Growth is emerging as a fundamental challenge across many industries. In 2012-2015, only 23% of companies (14% of invested capital) delivered profitable growth. Underlying GDP growth has slowed, competition has become increasingly intense, and companies have focused on “upgrading” their businesses resulting in the exit from less profitable sectors.

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