Supply Chain Excellence in the European Chemical Industry

Results of the EPCA-Cefic Supply Chain Excellence Think Tank Sessions Organised and sponsored by EPCA in cooperation with Cefic
October 2004

Prof. A. McKinnon, Heriot-Watt University, Edinburgh

The European Petrochemical Association

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Disclaimer: This document is intended for information only and sets out the results of a series of ‘think tank’ discussions. The information contained in this report is provided in good faith and, while it is accurate as far as the authors are aware, no representations or warranties are made about its completeness. No responsibility will be assumed by the participating associations, EPCA or Cefic, in relation to the information contained in this document.

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Contents

1. Executive Summary
2. Introduction
3. Dimensions of Supply Chain Improvement
4. The European Chemical Industry and Supply Chain
5. Supply Chain Challenges
6. Supply Chain Improvements
7. Role of the EU and National Governments
8. Conclusions
9. Next Steps
10. References
11. Annex 1

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Executive Summary

This report summarises the results of a series of ‘think tank’ discussions on the future of the European chemical supply chain convened by EPCA and Cefic. The initiative was prompted by growing concern about competitive threats to the European chemical industry. The industry’s share of the global chemical market is likely to decline as a result of the rapid growth of chemical production in Asia-Pacific countries and the Middle East. For example, it has been predicted that over the next decade their annual growth rates for ethylene production will be, respectively, 3.5 and 8.5 times faster than that of the EU.

The intensification of competition in the global chemical market will force European producers to find new ways of improving efficiency and service quality. As the scope for further efficiency gains in the production process will be limited, the supply chain is likely to become the main source of future cost savings. These savings will nevertheless be difficult to secure because, at the same time, supply chain costs will be subject to several inflationary pressures.

Transport infrastructure is becoming increasingly congested, fuel and labour costs are rising, downstream supply lines are lengthening, customers are demanding shorter order lead times and environmental and safety controls on the distribution of chemicals are steadily tightening. National governments and the EU are also committed to internalising more of the environmental cost of freight transport in higher taxes. The resulting increases in transport costs will impact more heavily on those sectors, such as chemicals, which are relatively transport-intensive, rely heavily on road transport and spend an above-average share of sales revenue on transport.

A series of measures are proposed which collectively could transform European chemical supply chains. They would not only offset the upward cost pressures, but also enable companies to offer a superior distribution service more cost-effectively. Some of these measures, such as the rationalisation of product ranges, improved functional co-ordination and transport modal shifts, could be implemented by individual companies working independently. The vast majority, however, would require inter-company collaboration.

Some would involve collaboration along the vertical supply chain and result, for example, in an increasing proportion of chemicals being dispatched in bulk loads, more effective application of the cost-to-serve principle, greater reliance on vendor managed inventory and the relaxation of the monthly payment cycle.

Other measures would need horizontal collaboration between similar firms at a particular level in the chain. These would include the development of swap arrangements, the pooling of logistical resources and co-ordinated action to improve the level of supply chain skills in the chemical industry.

Logistical service providers would have a crucial role to play in the implementation of most of the proposed actions. Many of the LSPs serving the chemical industry are small businesses that can deliver a reliable service at reasonable cost, but often lack the resources, expertise and incentive to provide innovative supply chain solutions. The report examines ways in which stronger, mutually-supportive relationships can be fostered between chemical companies and LSPs.

Given the enormous contribution that the chemical industry makes to the European economy in terms of output, employment, downstream linkages and international trade, the EU and national governments have a vital interest in ensuring that the distribution of chemicals remains competitive. They can assist this process through the continued liberalisation of freight markets, particularly for rail, short-sea shipping and inland waterways, enhanced support for intermodal transport, the standardisation of equipment and ICT networks and the upgrading of transport infrastructure. The chemical industry should be ready to take advantage of the EU’s expanded Marco Polo II programme which aims to facilitate the transfer of freight to rail and water-based modes.

In summary, the long list of supply chain improvement measures identified by the think tank group fall under six general headings: collaboration, segmentation, co-ordination, system optimisation, standardisation and liberalisation. Many of the measures are mutually reinforcing and, if implemented as part of a package of supply chain improvements, could yield major economic and environmental benefits. Some will, nevertheless, require fundamental changes in business processes, trading practices and managerial mindsets.

The report outlines a series of steps which the industry can take to progress this initiative and promote the implementation of the improvement measures. A ‘road-map for action’ has been compiled comprising five tracks, each of which will require a ‘champion’ and supporting team of industry specialists. Companies and individuals are strongly encouraged to support this programme and ensure that European chemical supply chains are restructured to meet the impending competitive challenges.

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Introduction

The Supply Chain Excellence initiative was established jointly by the European Petrochemical Association (EPCA) and the European Chemical Industry Council (Cefic) in December 2003. This industry-wide initiative has had three principal goals:

• To examine opportunities for using supply chain management to increase the long-term competitiveness of the European chemical industry
• To learn lessons from supply chain best practice in other sectors
• To recommend changes to the design and operation of European chemical supply chains

Over the past decade, many chemical companies around the world have overhauled their production operations. In Europe, the scope for further cost reduction in the production process is now limited, given the size and age of much of the plant capacity. There, nevertheless, remains significant potential for improving the efficiency with which chemical products are distributed. Indeed, few other activities offer as much potential for cost reduction. Realising this potential may not be easy, but competitive conditions in the global chemical market will force European producers to make radical changes to their supply chains. It has been suggested that supply chain productivity improvements of 3-5% per annum may be required to maintain the competitive position of the European chemical industry. This creates a compelling case for change.

Supply chain costs represent an average of 8-10% of sales revenue for chemical companies[^1]. They represent a much higher proportion of the net value added. At roughly 37% of value-added in the chemical industry, supply chain costs are significantly more important than in other industrial sectors, such as metal products, building materials, automobiles and paper where the equivalent percentages are, respectively, 18%, 26%, 28% and 30%[^2]. This reflects the relatively low value per tonne of chemical products and relatively high costs of moving and storing them, given their bulky and hazardous nature. It also highlights the need for supply chain issues to be given greater priority within the chemical industry.

A ‘think-tank’ was set up comprising senior supply chain managers in large chemical companies and other logistics specialists to examine these issues (Annex 1). This group has taken a medium to long-term view of the development of the chemical supply chain, looking forward 10-15 years. It has adopted a broad perspective on the supply chain challenges facing the industry. A wide range of economic, industrial, environmental and technological trends has been examined and forecasts made of their likely impact on the chemical supply chain. In the true spirit of supply chain management, particular emphasis has been placed on collaborative initiatives involving producers, their customers and logistics service providers. Consideration has also been given to the role that government can play in either facilitating or inhibiting supply chain improvement.

For the purposes of this study, the US Council of Logistics Management’s definition of supply chain management was adopted[^3]:

"Supply Chain Management encompasses the planning and management of all activities involved in sourcing and procurement, conversion, and all Logistics Management activities. Importantly, it also includes co-ordination and collaboration with channel partners, which can be suppliers, intermediaries, third-party service providers, and customers. In essence, Supply Chain Management integrates supply and demand management within and across companies."

Within this context, ‘logistics management activities’ comprise transport, warehousing, inventory management, materials handling and related information processing. It is important to emphasise that logistics involves much more than the physical movement of products.

Attention has focused on supply chains downstream of chemical plants and has not considered the inbound flows of feedstock.

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Dimensions of Supply Chain Improvement

The think-tank found it useful to conceptualise the proposals within a four-dimensional framework (Figure 1). Some measures could be implemented by individual companies working independently. The vast majority, however, would require inter-company collaboration. This could take place along the vertical supply chain and involve co-operation between producers, distributors and/or customers. Some initiatives would need horizontal collaboration between similar firms at a particular level in the chain. The fourth dimension represents the relationship between companies at any stage of the supply chain and logistics service providers (LSPs). LSP’s would have a crucial role to play in the implementation of most of the proposed actions.

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Nature and Scale of the European Chemical Industry and Supply Chain

The EU has the largest chemical industry in the world. In 2003 it accounted for just over a third of total global chemical production, worth 556 billion Euro. Of the thirty largest chemical companies in the world, fifteen are headquartered in Europe and they collectively account for 29% of global chemical sales. The industry contributes roughly 10% of value added by manufacturing in the EU and 2.4% of its gross domestic product[^4]. Approximately three million people work in the industry[^5], 12% of all manufacturing employment in the EU. The industry is also unique in supplying virtually every other sector of the economy with essential materials (Table 1). The competitiveness of all these other sectors is partly dependent on the efficient supply of chemical products. It is for this reason that the chemical industry has been described as the ‘anchor’ of a modern economy.

Table 1: Distribution of Domestic Consumption of Chemicals in the EU

Sector	% of Domestic Chemical Consumption
Consumer products	30.3
Agriculture	6.4
Textiles and clothing	6.3
Construction	5.4
Automotive	5.3
Paper and printing products	4.5
Electrical goods	3.9
Metal products	2.5
Industrial machinery	1.9
Office machines	0.7
Rest of manufacturing	6.1
Rest of industry	10.3
Services	16.4
Source: Cefic[^6]

Over the past twenty years the European chemical market has become more fully integrated, with the proportion of sales confined to national markets declining and the proportion of cross-border sales sharply increasing. Between 1993 and 2003 the share of domestic sales plummeted from 55% to 25%, while the proportion of intra-EU business rose from 27% to 46%[^7]. This has had a significant effect on chemical logistics. As the geographical distribution of production capacity has changed little, products have had to be moved over greater distances. This was facilitated by the formation of the Single Market and liberalisation of international road haulage operations in 1993, though mounting congestion on European transport infrastructure is now making these longer hauls more expensive and less reliable.

An increasing proportion of EU-produced chemicals are being exported to other parts of the world. This has risen from 18% in 1993 to 29% in 2003[^8]. Chemical producers have had to develop their international distribution networks to accommodate this growth. The value of extra-EU exports far exceeds the return flow of imports: in 2003 for every 1bn Euro of chemicals imported, 1.85bn Euro worth was exported. The chemical industry’s trade surplus in fact accounted for 45% of the EU’s total manufacturing trade surplus in 2002[^9]. The ability of European chemical companies to sustain this position and continue to make a vital contribution to the EU’s international trade balance will partly depend on the competitiveness of their global supply chains.

In summary, changes in the pattern of trade both within Europe and globally have had the effect of lengthening supply lines and generally making the production and distribution of chemicals more transport-intensive.

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Supply Chain Challenges

The early think tank discussions reviewed external trends and developments likely to influence the chemical supply chain. These were grouped under six headings following the conventional PESTEL approach to market analysis: political, economic, social, technological, environmental and legal:

Political

• Enlargement of the EU
• Liberalisation of the European rail, port and shipping markets
• Government support for transport infrastructure and services

Economic

• Future availability and price of oil
• Erosion of the customer base to Eastern Europe and the Far East
• Competition from chemical imports from other regions
• Changes in consumer demand
• Variable economic and financial conditions

Social

• Changing social legislation on recruitment, dismissal, working-hours etc.
• Shortage of staff with required skills
• Changes in the public image of the chemical industry

Technological

• Development of e-business networks
• Advances in information and communication technology
• Diffusion of scanning and tracking devices
• Development of business software

Environmental

• Internalisation of the external costs of freight transport
• Tightening environmental controls on logistics operations
• Increasing terrorist threat / tightening of security
• Increasing congestion on European transport infrastructure

Legal

• Proliferation of laws, regulations and directives
• Increasing complexity of business law
• Growth of the ‘compensation culture’

These factors can influence the management of the chemical supply chain either directly or indirectly through their effect on products, the production process, the customer base and structure of marketing channels. From this list, five major challenges were identified as likely to have an important influence on supply chain management in the European chemical industry over the next decade:

4.1 External competition from lower cost producers

As a result mainly of the rapid expansion of the chemical industry in Asia-Pacific countries, particularly China, and the Middle East, the share of the global market held by European producers is likely to diminish. It has been predicted that between 2002 and 2015, Ethylene production in the Middle East and Asia will expand, respectively, 10.1% and 4.2% per annum, by comparison with an annual growth rate of only 1.2% in Western Europe[^10]. Middle Eastern producers will be able to exploit their feedstock advantages, while in the Far East the buoyant growth of manufacturing, much of it ‘off-shored’ from North America and Europe, will drive the expansion of the chemical sector. New cracker capacity being constructed in these regions is in much larger and more technically advanced plants that can achieve significantly lower unit costs than their European counterparts. To remain competitive in export markets and minimise import penetration into the European chemical market, companies producing chemicals in Europe must continue to cut their costs. As the scope for further reductions in production costs is limited, given the age, size and locations of European plants, much of the cost saving will have to accrue from improved supply chain management.

Inter-regional comparisons suggest that opportunities exist to cut European supply chain costs. It has been estimated, for example, that the cost of distributing a tonne of commodity plastics in Europe is around 59 Euro, approximately 12 Euro per tonne higher than in the US, despite the fact that the average length of haul for chemical products is much greater in North America and labour costs significantly higher[^11]. The cost differential appears to be due in part to the much higher proportion of plastics in Europe sold in packaged rather than bulk form and the much greater reliance on rail for long haul transport in North America. Section 5 explores how this cost differential could be narrowed.

4.2 Changing customer requirements

The European customer base is steadily eroding as large users of chemicals relocate their production to lower labour cost countries in Eastern Europe and the Far East. Retaining these customers involves extending the supply lines and providing a distribution service over long distance which is competitive with local producers. This is made even more difficult by customer pressures to reduce order lead times and provide delivery within narrower time-windows. As the chemical industry in the Far East expands, it will not only enjoy lower production costs, but will also benefit from supplying domestic customers over relatively short distances.

4.3 Increasing congestion on European transport networks

It is projected that there will be a steady increase in the level of road traffic congestion across Europe. The European Commission has forecast that the overall cost of traffic congestion will increase by 142% between 2000 and 2010 to reach 80 billion Euro, equivalent to 1% of the EU’s gross domestic product[^12]. This will not only increase average transit times; as capacity limits are reached across much of the network, delivery reliability will decline, reducing service quality and inflating transport costs. As a very high proportion of European chemical traffic currently moves by road (Table 2), the industry will be particularly exposed to this adverse trend.

Table 2: European Modal Split for Chemicals (2001) (excluding pipelines and short-sea shipping)

Mode	% of tonnes-lifted
Road	92 (national) / 68 (international) / 89 (total)
Rail	6 (national) / 13 (international) / 7 (total)
Inland waterway	2 (national) / 19 (international) / 5 (total)
Source: Eurostat[^13]

In 2001, chemicals accounted for 5% of freight tonnes lifted in the EU and around 8% of tonne-kms[^14]. Their share of cross-border freight tonnage was roughly twice as high, reflecting the high volume of intra-EU trade in chemicals. The relatively high transport-intensity of the chemical industry is also revealed by average length of haul statistics. Consignments of chemicals move an average of 114 km on the road network and 386kms on the rail network, whereas for all commodities the average hauls are respectively 77 and 214 kms[^15]. The chemical industry will therefore be more exposed to congestion problems on European transport infrastructure.

4.4 Tightening environmental control

Environmental controls on the movement of all types of freight are steadily tightening. Governmental organisations have suggested that current taxes on freight transport, especially by road, would have to rise significantly to fully recover environmental costs[^16]. Governments are particularly concerned about the projected