July 21st, 2011

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The Mid-market for Chemicals - Competitive Battleground between Domestic Companies and MNCs
Dr. Kai Pfl ug, CEO , Managemen t Con su lti ng - Ch emical s (Ltd.), D r. Bernh ard Hartmann , Managi ng D irector, A.T. Kearney Ch in a M uch has been written about the mid-level market in China - for product s ranging from cars and healt h care equipment t o consumer goods and hous ehold app liances . In the past , t he tw o key market segments were a premium segment in which global comp anies s old high-end p roduct s. A t the much larger bot t om s egment , local comp anies provided low -quality p roducts at low cos ts. Recent ly, how ever, a mid-level s egment has been expanding rapidly. It is driven primarily by the rising Chines e middle class and t heir buying crit eria s uch as product safety , reliabilit y and reas onable quality , which are get ting more prominent as t heir income increas es (while at the same t ime thes e buy ers are still more cost-conscious t han high-end cust omers ). T his develop ment is s chematically s hown in F ig. 1. As chemicals are important st arting materials for almost any kind of final p roduct , and t he qualit y of the final p roduct s trongly dep ends on the quality of the chemical used in it s p roduction, chemicals are affect ed in much the same way as other p roduct s. The mid-market is target ed both by mult inational comp anies and by domes t ic chemical companies , though coming from different direct ions . F acing intense comp et it ion and low margins in t he low-end market, domes tic chemical p roducers have started moving t owards the more profitable mid-market. This particularly applies to the larger and more es t ablis hed comp anies which already have s ufficient exp ertis e to fulfill t he requirements for product quality and s ervice in t his s egment. A t t he s ame time, multinational chemical comp anies realize that focusing exclus ively on high-end chemical products only severely limits their grow th in China, and t hus also t arget the mid-market. Such a move is sometimes also taken as a pre-emp tive at tack on Chinese companies that are exp ect ed t o try to ent er the high-end market eventually. p anies t end t o have good access to local resources , and oft en enjoy t he s upp ort of local government . Ut iliz ing t heir background in the low-end s egment , they s till have s ubst ant ial cos t advant ages even in t he mid-market. F inding qualified technical and s ales s t aff at modest salaries is easier for t hem than for multinationals as t hey do not require knowledge of foreign languages (most Chines e engineers have only limited knowledge of English). Another major advantage is t heir broad dis t ribution net work p art icularly out side of the tier 1 and tier 2 cities (as it is already est ablis hed for t heir low -end p roduct s). F inally , t hey are s up erior with regard t o local know ledge, w hich is particularly relevant in focusing on the core requirements of the mid-market. On t he other hand, t hey frequently lack all or p art of the technological know ledge to reach t he quality requirements of the mid-level. Wit h regard to mindset, they tend to focus on increasing production volume rather t han on improving product quality. Once they underst and t he qualit y requirement s of t he midmarket , they may s till rely on Western sp ecia lt y m anufa ct ure rs t o ach ieve key properties, undermining s ome of their cost advantage.

In targeting t he mid-market for chemicals,

multinat ional companies as well as domest ic c hemical p roducers have s p e cific s trengt hs and w eaknes ses . Chinese com-

China (recent past and trend)

Sales Volume

Domestic Companies

MNCs

For multinational companies, attacking the

mid-market means climbing dow n from their current high-end production. Therefore they do have sufficient technology and management exp ertise, and easily underst and the import ance of quality in the mid-market. In addit ion, t hey ow n s t rong high-end brands that may also be utilized in the midmarket. How ever, they lack local expertise and a sufficient dis tribution netw ork outs ide of the major cit ies . T heir cost s are generally higher t han those of domes tic companies, w hich is a much bigger is sue in the p rice-sensitive mid-market than in the high-end segment. Finally, by entering the mid-

Product Quality Level

China (near future)

Sales Volume

Domestic Companies and MNCs

Product Quality Level

Fig. 1: Developing Mid-market in China

July 21st, 2011

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market , they may endanger their ow n lucrat ive position in the high-end market , e. g., via cannibaliz at ion of ow n brands.

Mos t of what domestic and mult inational

companies need to do to success fully enter t he mid-market can be directly deducted from these st rengths and weakness es . F or multinationals , the three key issues are obtaining a cost p osit ion t hat allow s profit ing from t he mid-market, achieving s ufficient dis tribut ion, and p rot ecting t he high-end market . The first one generally means localizing as many parts of t he value chain as possible - not only production but also other areas that can provide savings, such as local raw mat erials sourcing, reducing the number of expatriate employ ees et c. T he second, extending the dist ribut ion network, is necess ary as p ot ent ial mid-market customers are more numerous and more regionally dispers ed t han t he p remium customers target ed via t he existing dis tribut ion network of the multinationals , and at t he s ame t ime, t he low er margins in this s egment make t he involvement of t hird-part y distributors les s att ractive. T hirdly, protect ing t he e xi s t in g (a nd gen er al ly h ighl y profitable) premium segment means that the offerings made to t he high-end segment cannot jus t be extended to the mid-level, but need to be clearly differentiat ed - which ess entially is jus t a nice way of say ing t hey need to be reduced. A n established w ay to achieve such a differentiation is via establishment of a second brand. An example t hat

is s o success ful that it is act ually used as case s tudy in bus iness schools is that of Dow Corning's "Xiameter" s econd brand. The offerings sold under this brand compris e st andard s ilicones , and s ales are only conduct ed online. Technical s ervice is nonexis tent. Thus cost-conscious cust omers can obt ain s tandard s ilicones at lower p rices w hile premium cus tomers are p revented from s witching to t he X iamet er brand via the additional services only available to p remium cus tomers . T he X iameter brand now accounts for about 30% of silicone sales and is being extended, a sign of its benefit s for the company as a whole. A nother way for a mult inational comp any t o est ablish a second brand in China is t o acquire a s uit able domest ic company. AkzoNobel has just done this recently wit h t he acquisit ion of Prime, a Chines e producer of auto refinish coatings well-established in the mid-market. This approach obviously gives AkzoNobel immediat e acces s t o t he cust omer and dis tribution network of the acquired company and thus sp eeds up the presence in the mid-market.

lications etc. It may also be p romot ed via direct or indirect cooperation w it h es tablis hed mult inational comp anies (e.g., res earch coop erat ion, ingredient branding etc.). The second, p roduct imp rovement , can p art ly be achieved by inves tment in research. In fact , s everal domest ic comp anies s uch as Yip (in acet at e s olvent s) and Sinorgchem (in rubber chemicals) in 2010 est ablis hed R&D centers that w ill in the long run imp rove t he offerings of t hes e comp anies and make them more comp et itive w ith multinationals. O ther areas which can be used t o imp rove product qualit y to reach mid-market levels are the es tablis hment of s tat e-of-the-art p roduction facilities and quality control. Finally, dep ending on t he chemical segment, domes t ic comp anies may have t o es tablish or imp rove t heir technical s ervice offerings t o be succes sful in t he mid market - t hough in s ome s egments s uch as t he s ilicones mentioned before, t he mid market segment may not even require t echnical service.

In contrast , t he key challenges for domestic companies t o target t he mid-market are to est ablis h or up grade t heir brand, to imp rove t he p roduct and it s qualit y, and t o p rovide t echnical s ervice in line w it h the demands of the mid-market . T he first challenge of brand building of cours e may be done by way of t radit ional market ing, including act ivit ies such as advert is ements , particip ation at fairs and conferences, pub-

So w ho is more likely to dominate t he Chines e mid-market in chemicals in t he near future, M N Cs or domes tic comp anies ? M ost likely , only comp anies that are very localiz ed w ill be success ful in supp ly ing t his segment as it is bot h p rice-sens it ive and local in its requirements . T herefore only domes tic comp anies or multinationals with a high degree of localization have a realis tic chance of becoming t he market leaders in t he s egment . n