I’ve spent the past few months meeting with innovation leaders at several global chemical companies. Without a doubt, the power of digital is becoming top of mind, and most companies are asking hard questions about how their organizations will be impacted by advanced digital capabilities.
For chemical companies, operational efficiency is a huge priority. It’s therefore not surprising that many digital initiatives focus on reducing unplanned downtime and maintenance, improving worker safety, and streamlining the supply chain or back-office processes. Each of these initiatives generally addresses issues within a clear-cut organization (e.g., maintenance and engineering) and, therefore, is relatively easy to sponsor and initiate.
But what about efforts to redefine business models or ways customers engage with a chemical supplier? Compared to other industries, there are still relatively few activities in these areas. Why?
Follow the money
Let’s face it: cutting costs equals more profit hitting the bottom line. In my career, I’ve led several enterprise-wide initiatives to dramatically reduce SG&A and operating costs and fully appreciate the power of this important tactic. But, in the relatively high fixed cost world of chemical production, is this the best way to drive enterprise value from digital? Simple math indicates that this isn’t the case.
Consider this example: For a hypothetical company, 25% of revenue is spent on raw materials, 10% on other variable costs (energy, shift labor, etc.), and 35% on relatively fixed costs, yielding 30% gross profit (GP). In this scenario, any product manager would inherently know that more GP can be driven by growing volume and revenue. In this case, a 10% volume increase drives 21% more gross profit (365 versus 300). To achieve the same net benefit (assuming the cost of raw materials doesn’t change), a 10% reduction in fixed costs would still require a 30% decrease in other variable costs. This is very challenging; fixed costs are very difficult to decrease without costly write-downs, and non-raw-material-related variable costs simply don’t give you enough leverage.
So why are most companies investing in operational efficiency when it is clear that growing revenue drives more profit than cutting costs? There are three potential answers:
- Operational efficiency is well understood and appreciated. Digital initiatives in this area generally target clearly defined processes and issues that are familiar to people from the production line to the boardroom. Granted, IoT, predictive maintenance, augmented reality/wearables, and advanced analytics are complex technologies. However, within the context of operational efficiency, they can be applied to clearly defined use cases that impact a relatively narrow scope in a company. In short, it is far easier to test and validate key assumptions by focusing on processes and people within a controlled environment. And these early initiatives build capability and muscle memory to make future endeavors easier.
- Growing volume/revenue is notoriously difficult for chemical companies. Chemical leaders understand the correlation between better products, services, customer experience, and increased revenue. But there is great skepticism regarding the role digital can play in this arena. The truth is that most chemical companies are relatively uncomfortable with changing how they engage with customers and how they compete. The true capability of digital is not yet fully recognized or embraced.
- Collaboration across the value chain is relatively weak. Most activity between chemical suppliers and their customers are arms-length transactions. Few chemical companies actually have rich dialogues with their customers, and there is relatively little emphasis on mutual value generation. And, the same is true in reverse: most companies that buy chemical products can’t easily envision why their supplier would want or need to be more engaged.
The case for a broad digital agenda
Does this mean that companies should continue to focus digital on operational excellence? No. I’ve witnessed firsthand how exploring new business models and rethinking customer engagement are driving surprising results. Bringing chemical suppliers and their customers together in design thinking workshops is yielding tremendous insights and opportunities to create and share value. In some cases, the simple act of discussing digital innovation concepts across the supplier-customer relationship actually reveals issues and opportunities about products and services that have never been recognized. It is clear that this dialogue should strengthen and continue.
The great news is that many operational efficiency initiatives can (and should) be extended to address customer engagement and even new business model initiatives. Two potential examples:
- Expand predictive maintenance into predictive quality: Improving yield, reducing scrap, and optimizing inputs all drive significant cost savings. However, this also forms the basis for entirely new business models and customer engagement. Advanced technical service and micro-product differentiation are just a couple of ways that companies are helping their own customers realize higher value – thereby driving a higher share of wallet or improved pricing.
- Expand improved order confirmation into differentiated service policies and outcome-based models: Customer service representatives and supply chain personnel are eagerly embracing new ways to confirm customer orders and deliver on their promises. Digital enables much greater visibility into the real-time situation of inventory, production, and logistics so that effective order commitments can be made in real time. But, this can be taken much further. Why do service policies (e.g., minimum order quantities, lead times, shipping conditions, etc.) remain static when every customer has different needs and preferences? Through digital customer engagement, there are opportunities for customers to rethink how they define service policy so they can differentiate themselves and capture higher pricing or share of wallet. Taken a step further, this forms the basis for shifting towards billing for outcomes instead of deliveries.
Without a doubt, chemical companies should continue to focus on operational excellence initiatives. However, I believe that companies risk leaving the majority of potential business value on the table unless they recognize and address the revenue upside tied to these efforts. This is not easy, and it certainly makes things far more complicated. But other industries have already proven that the case for action is strong.
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