China distribution challenge
China is proving a difficult market for multinational distributors to enter. Strategy& senior executive advisor Krishnan Narayanan and senior consultant Tong Zhang talk to ICIS journalist about the opportunities for players interested in gaining access to one of the world’s largest and fastest-growing chemical markets. Read the full interview published by ICIS as part of its annual “Top 100 Chemical Distributors” review.
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Multinational distributors have – so far – failed to make big inroads into the China market. For those who succeed, however, the prize could be immense
China C distribution challenge
WILL BEACHAM LONDON
hina is proving a difﬁcult market for multinational distributors to enter. With the exception of Brenntag and Univar, which have taken their ﬁrst steps, global groups do not play a large part in the country’s distribution market, still dominated by domestic players in a highly fragmented market. Yet there could be more opportunities for players who take the right approach in this challenging market, and the prize – access to one of the world’s largest and fastest-growing chemical markets – is an attractive one. Joint ventures are seen as one of the most obvious ways to gain entry. According to Krishnan Narayanan, senior executive advisor at consultancy Strategy& (formerly Booz and Company), there is signiﬁcant market growth of up to 7-9%/year in commodities and specialties for both direct and distribution channels in coastal and inland parts of China, though distributors have not always captured these rates in the last three to four years. “Growth should be better for distributors, given that they have sets of locals customers emerging as a result of changes to the Chinese economy, which [has] become much more driven by domestic demand rather than exports. That’s leading to companies in end-user industries becoming much more powerful.” As most of these are medium-sized – and therefore served by distribution channels – one would expect the distribution market to be growing more quickly, but this has not been the case over the last three to four years. Growth rates for distribution have been similar or even lower than for direct in China.
China’s distribution sector is moving fast
42 | ICIS Chemical Business | 21-27 July 2014
INLAND SOARS Narayanan says the inland areas of China – which are still developing compared to places like Beijing and Shanghai – are growing quickly. This is especially true where they have signiﬁcant end industries such as automobiles in Wuhan. These areas can grow at around double the rate of the rest of the country. “Growth rates from solvents to real specialty chemicals can be anything from 16-18%. So it is still a great place for distributors. In the small to medium-sized enterprise (SME) sector, growth rates for commodity chemicals are higher than for higher margin specialties, which are more difﬁcult for distributors to shift.” There is a lot of price pressure, which causes margin challenges, especially for those selling commodities. China is, he says, a very difﬁcult market for global distributors to grow in. The market is incredibly fragmented with the top 10 distributors having only 15% of the whole marketplace compared to around 50% in Europe, according to Strategy& analysis. The biggest player in China distribution is SinoChem and all of the big ones are Chinese.
The largest global distributors such as Univar and Brenntag are trying to do things in China but they haven’t been that successful at entering the market on their own, according to Narayanan, though there have been some limited joint ventures (JVs). He says it is really important for any Chinese JV partner to agree to allow their global counterpart to grow with them into new territories. “Any expansion the local player does in high value, high growth inland areas; it’s not a fait accompli that the global partner will go with them. They would have to invest more and are sceptical about doing so because they’re not really making very much money in China.” with a track record in North America and Europe can offer its know-how and some of its processes to a local player that might help distinguish it in this highly fragmented market. “But they are still selling, as a distributor, to a set of SMEs which are not after know-how and technical solutions. On the ﬂip side if you can say to a local player that they are not differentiating themselves on the market and that adding solutions provision will allow them to sell value-added products; the question then is whether the demand exists yet from the SMEs.” it expected from its distribution channel in China. According to Tong Zhang, senior consultant for Strategy&, one of the primary reasons for the lack of growth was a lack of cooperation between the direct and distributor channels. The direct team had a lot of small customers but without the resources to win new business. Distributors had larger customers, which required a more sophisticated service they could not offer. “Also they had been using the same distributors for 20 years.
CHINA JV STRATEGIES Selling as a distributor in China involves mainly selling to local players as these still dominate the market compared to multinationals. So it would be incredibly difﬁcult for a foreign player to enter the market on their own and be successful. “Partnering is an obvious fall back, as is not entering at all. But given the prize, it’s difﬁcult to imagine that one would want to stay away too long. The scope, governance and details of any JV need to be carefully thought through. I would advise companies not to sign a JV which is speciﬁc to one region, as you won’t beneﬁt from the organic growth of your ur local partner,” he says. It is important to hightners light to Chinese partners the advantage of a relationship with a global bal, player. If a large, global, r proven distributor
“But if you can address the talent challenge and go credibly, the prize is enormous”
KRISHNAN NARAYANAN Senior executive advisor, Strategy&
M&A ENVIRONMENT None of the local distributors have a global proﬁle at all, making it difﬁcult to track M&A. Narayanan says that over the last couple of years, he has seen almost no consolidation. “One good reason for this is that they’re not making tonnes of cash to go out and buy other players. They are small and have thin margins; also they can’t leverage cash from overseas operations as they are mainly domestic. I can’t see this changing in the short term.” It is also important to realise that many Chinese distributors are part of larger state-controlled chemical producers. Narayanan says there is no reason why global distributors cannot be successful in a market where global manufacturers are present. It is very difﬁcult for a global player without a local team talking to local customers to build a business better than the local players themselves. “A lot of these distributors are still small and family-owned and therefore the talent in distribution here is not signiﬁcant. But if you can address the talent challenge and go credibly, especially Chinese to Chinese to your customers, then the prize is enormous.” DISTRIBUTION CASE STUDY Strategy& did a piece of work for a multinational producer that was not seeing the growth
“If you’re using a partner who can’t support your business, you won’t grow your revenue”
TONG ZHANG Senior consultant, Strategy&
If you compare the distribution landscape now to 20 years ago, it has changed completely, with some not growing. If you’re using a channel partner who can’t support your business, you won’t grow your revenue.” Zhang says management systems need to be in place to allow growth through, for example, a pricing strategy. If you have a tough internal transfer price for your distributor, they will add their margin, and the ﬁnal price will be uncompetitive. “Twenty years ago this was OK because the US companies had the technological advantage. But now pricing is going down and local competitors are emerging.” He says you also need incentives for the distributor to grow the business. If a producer wants its distributor to expand into fast-growing inland China it will need to invest in supply chain capabilities, especially wide warehousing coverage.
SHOSHAS WIN IN CHINA
SHOSHAS ARE trading companies set up in Japan as buying agents for raw materials for the emerging auto industry. In southeast Asia almost 100% of sales to auto manufacturers go through shoshas – there is almost no direct procurement at all. They are like distributors except they represent buyers rather than sellers, according to Strategy&. Narayanan believes that over the last couple of years, shoshas have moved into non-auto businesses and are trying to grow by becoming distributors in China because of slow growth in Japan. They have had a lot of success, since they are big and impressive organisations to work for and have been good at hiring local staff. “I see these as a threat to local distributors. They may well have the desire to gobble up some smaller distributors in China. These shoshas are showing that it is possible to be successful as a foreign player in this market. They are sourcing and selling within China.” Shoshas have been selling to Japanese customers in China, so are already well established there. And they are much more familiar with the Asian market than, say, a German distributor would be. They have also set up some fully-owned subsidiaries in China such as Inabata, which has a subsidiary called Inabata Guangzhou. ■
CHINA PRICE PRESSURE One reason for price pressure in China is increased supply. In the past multinational chemical companies like BASF, DuPont and Dow dominated in specialty chemicals. But now, according to Zhang, we cannot ignore the local, emerging chemical companies that are trying to catch up with the multinationals. Another issue is that producers often steal a distributor’s customers when they become big. In China this happens all the time, and it is a difﬁcult dynamic to deal with. Distributors struggle because they build a customer’s size, then they lose it. According to Narayanan, China is the most sophisticated market in emerging Asia. In the performance polymers market, at least 30% of sales are premium and specialty products. ■
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