As every economist knows, China has become the workshop of the world over the last twenty years. Everything, and almost anything, can be made in China. It is a much different world from the years of Mao Zedong’s forlorn five year plans which led to famine and poverty and a $227 per capita GDP in 1978. Today, the transition is almost complete, as China has the second largest economy in the world. It is now the world’s largest manufacturer (overtaking America’s 110 year hold of the role), has a $7,600 per capita GDP and 7% growth. It is even the world’s leading sex toy producer, with 70% of market share and is a major exporter of goods including, as Wikipedia reports, “almost every single category of industrial products.”
This includes chemicals, which make up a large part of China’s industrial power (including 20% of global chemical shipments). But historically, there has been one area where the Chinese economy has been out of pace with the rest of its astronomical growth; and that is in specialty chemicals.
As Dr Kai Pflug of Management Consulting – Chemicals, stated in his August 2015 report entitled, ‘Specialty Chemicals in China’, “Historically, specialty chemicals have not been a strength of China´s chemical industry. Generally, the maturity of the specialty chemicals segment in China is lower than in Western markets, as most state-owned chemical companies, but also many of the private ones, focus on standardised high-volume chemicals that do not require any particular application knowledge.“
But why should this be? If China has in the space of two decades become a producer of high-spec medical equipment, has a large share of all technological markets (TV’s, mobile phones, laptops, communications, automobiles), if it can send rockets to the moon and build aircraft carriers, then why isn’t it also a major player in the specialty chemicals market?
Historically, the problem lies in a lack of expertise and the ease with which chemical manufacturers have been able to make handsome profits producing basic chemicals. As Dr Pflug explains, “While local companies can typically provide the most common basic molecules, they often struggle to provide customised products and true solutions and are even further away from including value-added services in their business model. As a consequence, many specialty chemicals are either produced locally by multinational producers or are imported into China.“
The fact that multinational firms have built plants in China is well known, and according to Andrew Thomson, a director at KPMG China in his report ‘Specialty Chemicals in China; Catalysts for Growth’ this is not something that is about to change soon. He states that, “Looking at the multinational players, all of the major international companies have a manufacturing presence in China in one form or another and are approaching the market with relatively aggressive growth strategies. However, many are concerned by China’s relatively weak supply chain and poor record of intellectual property rights.”
But there are other factors behind China’s slow development into specialty chemicals, including the erratic recent history of the sector itself, as industry data specialists at IHS reported in July 2015 in their ‘Overview of the Specialty Chemicals Market’. “During the last 10 years, the speciality chemicals industry has experienced slower growth and lower overall profitability within a more competitive environment than in the preceding period. Since the Great Recession [of 2008], global consumption of specialty chemicals has grown in fits and starts. After plunging 10% in value from 2008 to 2009, consumption grew 16% in 2010, only to fall again in 2011. After very poor growth of less than 1% in 2012, consumption rebounded 7% in 2013 and grew another 4% in 2014.”
This may go some way to explain China’s hesitant participation in specialty chemicals, but that may now well change, as IHS also note that, “Despite an unsteady macroeconomic environment, global manufacturing and construction industries grew in 2014 and specialty chemical demand followed in consequence.”
This demand is not only global, but also local. As China has progressed into more and more high-tech end products, the domestic demand for specialised chemical products has also grown. A fact supported by Pflug, who notes that, “Chinese and Indian manufacturers have become key players in several specialty chemical markets, [and] the concept of China as a low-cost producer has now gone, since China is shifting from an export focus to meet growing domestic needs for higher-value, downstream products. [So that] in the past few years, [Chinese] growth in the speciality chemicals segment has tended to be 2-4% above that of all chemicals, indicating that the share of specialty chemicals in China will in the future approach the higher level typically found in Western markets.“
But there are still some major problems facing China if it is to compete successfully. It is renowned for having poor infrastructure and relatively basic logistics capabilities. Its safety and environmental record is suspect and there are also concerns from investors over intellectual property rights.
Furthermore, China lags behind other global players in electronic chemicals, in which China has a self-sufficiency rating below 50%, as well as high-end adhesives (despite its position as the world’s largest adhesives producer). At present China suffers in these two areas largely because of technological limitations. It is able to produce products with impurities on the parts per million range, but not in the parts per trillion.
At least not yet. For huge strides are being made with China’s infrastructure, that will greatly help China’s geographically diverse chemicals industry. As Moi-Fung Goh and her team observed in the recent ATKearney report, ‘China 2015: Transportation and Logistics Strategies’ stating that, “The Chinese transportation and logistics industry is poised for major growth over the next five years, portending significant changes for its five main segments; express, road freight, rail freight, contract logistics and international freight forwarding. As the boundaries between these segments blur, consolidation will accelerate and network coverage and density will grow.”
Other experts believe that China will grow into the specialty market, but that it will simply take time, especially given the state of the producers at present, and the time it takes for research to develop into end products. One of them is John Morris, Global Head of Chemicals at KPMG, who said that, “China is moving up the value chain, but this process cannot happen overnight. At present the specialty chemicals sector is unregulated and fragmented. Many companies in the sector are privately owned and make just one or two products.”
This fragmentation and slow expansion is a point taken up by Andrew Thomson of KPMG, who states that, “Although Chinese companies are growing, and likely to become stronger as the industry consolidates, the process may take years. To date, domestic companies have tended to integrate towards the upstream end of the value chain – looking to buy up suppliers of their inputs in order to reduce and control their costs, rather than develop more sophisticated products and services and thereby raise margins.”
Certainly China has already taken a foothold in the feed additives market. It is a major producer of vitamin, mineral and amino acid additives, and following ChemChina’s 2006 acquisition of Adisseo, it is now a part of the methionine market. So it seems that the process of moving towards the wider margins of spec chems is underway.
This is an increasingly logical step; as manufacturing in China continues to expand, the need to have suppliers of all products close to demand becomes more pressing. This is after-all, one of the reasons why western firms started moving East in the first place, a fact that hasn’t changed as the Chinese chemical market will soon represent one third of global demand.
As the Chinese economy matures, salaries and land prices have risen, which reduces the profit margins in all Chinese goods, but makes the draw towards specialty chemicals, with their larger margins, all the more attractive.
Indeed, as the world economy matures, and standards of living rise across the planet, the overall demand for specialty chemicals will too, as a June 2015 report from MarketsandMarkets outlines. “The specialty chemicals market is projected to register a CAGR of 5.42% between 2015 and 2020. Asia-Pacific is also expected to witness the highest growth between 2015 and 2020. This region is the largest and fastest-growing market for specialty chemicals with a CAGR of 6.35% expected between 2015 and 2020.”
The report continues to define how much of this global market growth will be centred on Asia, and China in particular, as it states that, “Growth in the developed nations is constrained by debt, adverse demographic factors, and tighter fiscal policies. However, growth in emerging markets will be much higher. In particular, China will have the highest growth rate of all regions during the next five years. China is seeing some short-term setbacks in its economy and the forecast of consumption for specialty chemicals has been downgraded slightly from the historical range of 8-9% to 7% per year. Nevertheless, it will continue to power the growth of global specialty chemicals during the next five years.”
Business consultants at PWC agree that demand is rising, stating in their report entitled ‘New Opportunities in China for the Chemicals Industry‘, that “Market demand in China is shifting from chemical commodities to specialty chemicals, creating new market opportunities for multinational corporations. Chemical companies can take advantage of new business opportunities from the rising demand for specialty chemicals in China.”
It is often generally perceived that it is easier for Chinese businesses to start producing specialty chemicals due to the vast array of government regulations set up to control the industry. Whilst these can be a problem for all producers, when demand is running high, local officials often turn a blind eye to enforcement for local Chinese businesses, as they are eager to get the plant up and running rather than ensure all the necessary safety and environmental procedures are in place. This can often be to the disadvantage of foreign companies hoping to set up in China, especially those without local market and cultural knowledge.
But still there are reasons for non-Chinese firms to look to the Chinese specialty chemicals market to do business. As Pflug notes, “China’s local companies frequently still do not have a strong position in higher-end specialty chemicals. Approaching specialty chemicals with a commodity mindset, they generally do fairly well as long as customers simply require specific molecules that can be produced without further service. However, they struggle to offer formulations and services.“
With this in mind, whilst there may be numerous problems to overcome and whilst the competition may be fierce, it does seem that an entrepreneur with the right specialised product, formulated and serviced with a market in mind, can still reap the benefits of the growing Chinese specialty chemicals market.