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Chemicals are in the crosshairs of global efforts at decarbonization. As an energy-intensive industry that relies on hydrocarbons for raw materials, reducing emissions will require huge investment. And as a key supplier to many other industries, the chemical sector is crucial to the decarbonization efforts of its clients as well.
Moreover, due to the central position they occupy, chemical companies have an opportunity to influence ESG innovation across entire value chains. Potential interventions include those to reduce emissions and waste, replacing inputs with lower-carbon alternatives, and the recovery and recycling of materials and products at end-of-use or end-of-life. Innovation in products, processes and business models can help value-chain players to comply with and, in some instances, even shape regulation.
This is a big deal for chemical groups. Those who prepare early to comply with more rigorous environmental, social and governance (ESG) standards will build an advantage – within the industry, with their clients and with society more broadly. The key lies in innovation. The technologies for achieving 75% of the emissions cuts needed to reach net zero by 2050 are not commercially available today, according to the International Energy Agency (IEA).1
Our latest industry research shows that innovation portfolios are already responding to the ESG challenge. However, few companies are taking advantage of the full suite of strategies available to them. It’s important that they start to, because reaching net zero will require a root-and-branch transformation of how companies manage innovation.
1 Sarah George, “IEA: Most technologies needed to achieve net-zero aren’t yet mature,” Euractiv, July 7, 2020.
The first trend we observe is that successful companies innovate beyond regulatory requirements. Anticipating the knock-on effects of regulation, new client demands and changing consumer habits are important drivers of innovation. In B2C industries, for example, ESG is now a factor in corporate purchase decisions as the carbon footprint and traceability of materials becomes ever more important to consumers and for ESG reporting. Companies that anticipate and prepare for higher ESG standards will have a competitive advantage.
But where should chemical companies invest in innovation? We observe that the best results are obtained when organizations align their innovation strategies with their authentic identity or ‘true north.’ This means selecting ESG innovation projects that are most relevant to a company’s business.
Third, successful chemical companies are adopting a hybrid operating model for innovation. On the one hand, companies need to continue to develop incremental innovations, which meet the needs of clients and deliver fast returns. On the other, companies need to think ahead to longer-term challenges, such as meeting net-zero targets. This requires setting aside research time and budgets to develop disruptive innovations that will likely be more costly, but that are crucial for achieving longer-term goals.
We believe companies that adopt such a hybrid model are better positioned to exploit new business opportunities because they are both close to the customer and focused on disruptive innovations.
Fourth, we observe that chemical groups are stepping up collaboration in innovation ecosystems. The complexity of ESG challenges is such that no single company today is likely to have all the answers. As a result, innovation is becoming more open, and innovation ecosystems are growing larger and more versatile. Such an approach is important for research that requires significant investment, but for which returns are uncertain and may lie well in the future. In our research, we found that two-thirds of the companies interviewed are externalizing part of their R&D, spending an average of 5% of their innovation budgets on external providers.
Fifth, chemical groups need to leverage more external funding for innovation. Full ESG compliance will come at a cost that cannot be footed by the industry alone. According to a study for the German chemical industry association VCI,2 the country’s chemical companies will need to invest an additional €45bn between 2020 and 2050 to reduce their carbon footprint to zero. Governments are making funding available to assist with ESG-driven transformations. Successfully capturing these funding opportunities depends on having a good process in place – one that spots funding opportunities early on, efficiently prepares grant applications and manages the funds well, in full compliance with legal frameworks and regulations.
Last but not least, companies that adopt new innovation impact metrics will be better able to measure the contribution of their R&D efforts to the bottom line. This differs significantly from the way ROI has been assessed in the past. A “total impact” return on investment for innovation has longer lead times than the two to three years allowed for incremental product innovation. In addition, positive and negative external impacts – such as reduced energy consumption or innovations that contribute to public health by resulting in cleaner air or water – enter into the calculations for total impact returns.
2 Verband der Chemischen Industrie e.V. (VCI), Working towards a greenhouse gas neutral chemicals industry in Germany (Summary of the DECHEMA and FutureCamp study for the VCI), Sep. 2019.
A global price on carbon emissions, as discussed during COP26, would help level the innovation playing field for the chemical and materials industries.
To reach net zero within the next 30 years, the chemical industry needs to change how it innovates. Collaboration, funding and a long-term view will become increasingly important, as will the way we measure success. ESG-driven innovation holds the key to the future of the chemical industry, so it’s important to get it right.
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