Global Shifts in Industrial InvestmentHow chemical companies can harness the opportunities

$7.6 trillion dollars will be invested in industrial projects in the next five years throughout the world. The focus of investment will vary based on competitive factors in each region. The major factors in locating new plants include expectations of exchange rates, labor costs, innovation ecosystems, materials and energy costs, logistics/customer proximity and rule of law. Chemicals leaders must weigh these factors carefully as they pursue high performance in a new era of industrial production.

Sources: fDi Intelligence, a service from The Financial Times Ltd

1 All figures in US dollars unless otherwise noted. 2 fDi Intelligence, a service from The Financial Times Ltd

Cash reserves mount, waiting for the right opportunities

In the past two decades, the plant investment premise was to produce and transport to the world market from the location with the lowest cost. Justification existed to shift manufacturing investment from developed regions to emerging markets due to lower wage rates and resources costs. In the late 1990s and the following decade, China provided the ideal location for manufacturing companies from the United States, Europe and Japan.

However, the competitive winds are shifting. After making huge investments in the past decade, foreign investors, while continuing to invest in China, have begun to shift funds to other locations. In 2003, new foreign direct investment (FDI) in China totaled $108 billion1 but has since dropped, reaching only $66 billion in 2011.2 At the same time, FDI increased from $47 billion to $62 billion in North America and from $22 billion to $52 billion in India (Figure 1). The decline in China FDI, however, is partly due to the rising power of China’s domestic players, which are major local investors and growing investors in countries such as the United States and Germany.

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Figure 1. Foreign direct investment see-saw: China’s declines as North America’s rises.

Chemicals companies and their industrial customers have been building cash reserves since the recession of 2008-09 (Figure 2). At the same time, they have been throttling plant expansion and acquisitions. Their thrift mindset has resulted from uncertainty about the economic future. Company leaders are waiting for clear signals of growth. A less discussed factor, however, is that business leaders are having a hard time selecting the best places to invest.

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Figure 2. The uncertain business outlook demands that chemical companies choose investment locations wisely.

Six competitive factors driving regional investment

In the next five years, the world is expected to allocate $7.6 trillion dollars of new investment in major industrial projects.3 The focus of expected investment varies according to competitive factors for each region. Company leaders need to understand these shifts and position themselves to grow in tandem with their customers’ businesses.

An Accenture analysis of companies’ country selection rationale reveals six common criteria, including exchange-rate expectations, total labor cost,

innovation ecosystems, materials and energy costs, logistics/customer proximity and rule of law (Figure 3).

These factors are not of equal importance across all industries, nor do they always share the same meaning. With consumer products, the consuming population is considered the customer via retail outlets, and product mix and preferences vary by region. With business-to-business commerce, a provider of mining chemicals may have customers centered in minerals-rich regions.

Industrial investment country selection

Innovation ecosystem

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Total labor cost

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3 Analysis of data from Industrial Info Resources, Inc.

Figure 3. Regional competitive investment factors for the next decade.

Exchange rates

A factor that underlies all investment is the exchange-rate expectation. Except for Japan, major trading country currencies have fallen relative to the Chinese RMB (Figure 4). In 2001 a US dollar was worth 8.3 Chinese RMB; in 2011 it was worth 6.5. Mexico’s peso experienced an even greater decline, thereby enhancing the competitive position of its manufacturers. On the other hand, Japan’s currency rose in value against the RMB, a challenge for the country’s manufacturers.

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Total labor costs

Wage rates are not the only concern. Factory automation is another factor affecting competitiveness since it reduces labor costs, and allows for higher quality and throughput.

Wages. The original attraction of investment to emerging economies with large populations was low labor costs. Industries that depended the most on labor costs were among the first to shift operations from developed countries to countries such as the Asian Tigers (Taiwan, Singapore and South Korea)

in the 30 years preceding this decade. As the Tigers’ labor costs rose and China became open for investment in the late 1980s and early 1990s, investment in China boomed. However, following the same pattern, China’s unit labor costs (cost of labor per unit of GDP) relative to its main trading partners rose by 81 percent between 2000 and 2010. Exacerbating the global labor cost gap is the fact that, during the same period, the relative unit labor costs of the United States and Japan decreased by about 30 percent. The average change in Europe was about a 10 percent increase.4 (Figure 5)

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Figure 5. Relative unit labor costs have changed significantly among nations over the past ten years.

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Automation and robotics

One measure of development in this field is robotics usage. Although it is difficult to assess robot prices over time due to size and capability variations, there is consensus that prices continue to fall. Perhaps prices reached a critical point of affordability in the past few years, with industrial robot sales rising 30 percent in 2011, according to the International Robotics Federation. Also, advancements in sensor technology, software and processing power have enabled robots to do multiple tasks at high speeds and low cost. This is reducing the case significantly for building in low labor cost regions.

The United States, Europe, Japan and Korea are among the global leaders in robotics use5 (Figure 6). Robotics intensify the labor cost differential and reduce the need for labor, as can be seen in automotive manufacturing. Car manufacturers are among the leaders in the development of robots in industrial manufacturing. New auto plants located in the Southern United States have a higher degree of automation and about half the wage costs of

factories in the Midwest. Volkswagen, for instance, recently completed a new plant in Chattanooga, Tennessee, capable of producing 150,000 vehicles per year.6 In response, steel and other suppliers have announced related expansions in the vicinity.

If the United States were to increase robot use to the levels of Japan, Germany and Italy, which have the highest use of robots per unit of output, Accenture estimates the United States could lower its cost of goods sold, on an aggregate level, by more than $100 billion dollars per year.

While China is rapidly growing in robotics usage, its speed has not been enough to catch up with companies in the highly industrialized countries. Major investments in developed countries will pursue greater efficiencies, such as automation and robotics as part of new production schemes. China has been employing robots more aggressively in recent years, despite the desire to boost employment rates and the size of China’s middle class. Foxconn, a leading assembler of electronics in China and Taiwan, plans exceptionally high-level robotics by 2013.7

Figure 6. Robot use intensity is growing rapidly in South Korea, the United States and China. The United States is among the highest in growth.

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5 World Robotics 2011, International Federation of Robots 6 Volkswagen Inaugurates New Plant at Chattanooga/U.S., Volkswagen press release, May 24, 2011 7 Robots don’t complain or demand higher wages, or kill themselves, The Economist, August 6, 2011

Sources: Accenture Research analysis of “World Robotics 2011,” The International Federation of Robotics; Oxford Economics

Shifts in industrial manufacturing come as companies comb the world rethinking the ideal location for the next expansion. Manufacturers are realizing they should begin with the premise of building where demand is, unless there is a compelling reason to go offshore. Other factors enter in, however, and global regions vary in their investment profiles based on competitive factors (Figure 7).

North America will be responsible for 21 percent of investment between 2012 and 2016. Most investment will occur in industrial manufacturing, power, chemicals, and minerals and metals. Most of industrial manufacturing represents a broad category of non-resources industries, including automobile, electronics, electrical equipment, plastics conversion, metals fabrication and other industries. North America has the unique distinction of growth in this sector, expected at 7 percent per year from 2012 to 2016, faster than in any other region. As the world’s largest consumer market, the United States looms as the top location. Canada, Mexico and Central America are attractive near-shore alternatives.

Europe is projected to account for about 11 percent of new project spending in the next four years. The largest, in aggregate, investments will be in pharmaceuticals/biotechnology, pulp and paper, refining, and minerals and metals. These investments reflect Europe’s still abundant forest resources in the Baltic area, but also high-technology position

in life sciences and an aging population, which will create increasing demand for healthcare. In addition, Europe’s position in auto and machinery manufacturing, which the metals industry will serve, is also strong.

Asia and the Middle East will account for 57 percent of new investment until 2016, driven by China’s continuing ability to produce large volumes of commodity consumer goods and the Middle East’s energy cost advantage. Southeast Asian countries, such as Vietnam and Bangladesh, are preferred for labor-intensive industries such as electronics assembly and apparel. However, inadequate supply chains in this region favor only the most commoditized products.

Latin America will represent only 2 percent of world investment due to continued struggles with restrictive business practices. However, strong areas of investment continue in natural resources and in certain industrial manufacturing areas, such as pulp/paper, minerals/metals, power, and refining. In the fabrication/assembly industries, automobile and furniture manufacturing are very strong, particularly in Brazil. Oil and gas is also large area for investment in Brazil, with the development massive offshore discoveries. While exploitation of these deposits will take some time due to technology and other hurdles, downstream refining and petrochemical production are part of the development plan.

An overview of investment dynamics by region

North AmericaIndustrial manufacturingPowerChemicalsMinerals/Metals

EuropePharmaceuticals/BiotechnologyPulp/paperRefiningMinerals/Metals

AfricaMinerals/MetalsIndustrial manufacturingPowerOil/Gas

AsiaPowerIndustrial manufacturingMinerals/MetalsOil/Gas

OceaniaPowerOil/GasMinerals/MetalsPulp/Paper

Central AmericaPulp/PaperMinerals/MetalsPowerRefining

South AmericaPulp/PaperMinerals/MetalsPowerRefining

Figure 7. Investment is being driven by regional competiveness factors relating to natural resources, manufacturing efficiency and business environment.Top four major industry for investment for each region (based on investment size), 2012-2016

Sources: Accenture Research analysis of Industrial Info Resources, Inc. data

Innovation ecosystems

As labor costs rise in China and with continuing concerns over intellectual-property theft, companies are selecting to construct mid- to low-volume manufacturing operations, especially those with leading technologies, in the developed regions. They are looking for a strong engineering and science talent pool and a solid legal system to protect intellectual property. Samsung recently started up a $3.6 billion Austin, Texas, facility that supplies processors for Apple’s iPhone and iPad.8 Part of the reason for the expansion was proximity to the top-notch engineering program at the University of Texas.

Likewise, engineers from Texas A&M and other institutions in the Louisiana-Texas corridor have fostered continuing development of technologies in the oil, gas, refining and chemical industries. Similar innovation zones can be found where collaboration among universities, community colleges, local government and industry enables the United States to outpace other countries in innovation. The United States spent approximately $428 billion on research and development in 2011, with the next largest investment being China (US$175 billion), Japan (US$152 billion), Germany (US$88 billion) and South Korea (US$53 billion).9

Far from a mechanical process, innovation essentially comes from talent. The high technology and sophistication levels of manufacturing processes in the United States, Europe and Japan require top technical talent. This is also where the next level of innovation will continue to come from.

The Accenture Looking Ahead to 203010 study of chemical use in the European Union showed the region’s ability to stay ahead of import competition by continuing to emphasize high-end manufacturing. Innovative mittelstand, or midsized, companies, which collaborate with larger manufacturers and universities, are a key to the region’s continuing inventiveness.

One of the biggest drivers to innovation across many industrial goods is the development of materials technology. In discussions with manufacturers, Accenture determined that, in the past few years, new products in electronics, automobiles and other applications have been dependent on advancements in materials technology. In other words, materials (such as resins, solvents and coatings) technology enables other industries to achieve breakthroughs in weight reduction, miniaturization and durability. Original equipment manufacturers and equipment makers frequently achieve these developments on their own, often with little involvement from chemicals companies.

Innovating with customers engenders loyalty. Chemical companies stand to gain by proactively partnering with their customers’ businesses and equipment suppliers to compete in highly demanding industries that are growing in North America.

8 Exclusive: Made in Texas: Apple’s A5 iPhone chip, Reuters, Dec 16, 20119 2012 Global R&D Funding Forecast, Battelle and R&D Magazine, December 201110 Looking Ahead to 2030, Accenture, 2011

Materials and energy costs

Minerals and energy are key inputs to manufacturing industrial products. The availability of these inputs across regions weighs on selection of manufacturing locations. Energy intensity is highest in the energy industry itself (with refining as an example) as well as other basic industries (Figure 8). In the case of chemicals, energy is a key raw material and utility input, accounting for more than 15 percent of chemical gross output in the United States.

The largest competitive change in world energy affecting manufacturing investment involves natural gas in North America. Gas is not easily shipped or stored so it tends to be regionally priced, whereas crude oil is traded globally, disallowing significant cost advantages at local levels. By using unconventional technology to tap previously unattractive deposits of natural gas (such as shale gas), gas supply has become more abundant, pushing gas prices down and away from the recent link to oil prices (Figure 9).

Several significantly large-volume chemicals can be manufactured from natural gas components, including, for example, ethylene (by far the dominant petrochemical), methanol and ammonia. While ethylene can be manufactured from “liquids,” such as certain refined products, flexible plants can switch to “light” raw materials, or feedstocks such as ethane, which are obtained from natural gas.

North America has a significant amount of flexible ethylene capacity to take advantage of low-priced ethane. The new gas advantage has made it the world’s second lowest-cost region after the Middle East. This development has spurred the announcement of about 10 million metric tons per year of new ethylene capacity under study in North America, after many years without significant expansion. Some of the capacity growth is targeted near ethane sources in Appalachia, which will enable producers to serve the substantial industrial customer base located in the US Northeast and Midwest regions with distribution expenses.

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Figure 8. Energy intensity is highest in the basic industries. Gas and electricity (much of which is sourced from gas), makes up most industrial energy usage.

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Sources: Accenture Research analysis of US Energy Information Administration’s Manufacturing Energy Consumption Survey; US Bureau of Economic Analysis

The energy, steel and minerals industries are also significant energy users and have benefitted from lower cost gas supplies. These sectors are expanding and represent markets for chemicals as well, such as oilfield, metals finishing and mining chemicals.

One downside of the shale gas boom is the lack of co-products associated with liquids ethylene manufacture due to the shift to gas raw material. Vital parts of the industry are affected, such as some plastics and rubbers, which have experienced shortages of butadiene. Some specialty chemicals, such as adhesives and certain intermediates, have suffered from shortages as well. The industry can be assured of growth in domestic industrial markets for those products, and companies should look for alternative ways to increase supply.

Logistics/customer proximity

Rising costs of shipping are an important factor in global competition. The Shanghai Containerized Freight Index for rates to the United States West Coast from China rose 42 percent between October 2009 and March 2012. Bunker C fuel-oil prices, used by oceangoing ships, rose about 67 percent in the same period. Underlying oil prices are a key factor in

rises in freight rates and volatility. United States parts suppliers have indicated that freight rates are one of the factors impacting costs to manufacture overseas. This development discourages long supply chains and promotes local production.

In addition, manufacturers involved in complex assembly operations, such as automobile manufacture, are placing greater importance on having suppliers co-located at automobile production facilities. For instance, Volkswagen’s new plant in Tennessee includes a supplier park with 9 major suppliers in the immediate vicinity. Likewise, Toyota’s truck plant in Texas has half the space dedicated to supplier operations. The Toyota Texas truck plant includes a network of 21 separate parts and components suppliers producing on-site. A benchmark for Toyota, it was the first automotive assembly plant to integrate many supplier parts production operations with assembly operations.11 The trend is shifting away from the old model of auto transplants importing a large portion of their parts. This represents a significant domestic demand for chemicals such as automotive fluids, industrial lubricants, paints and coatings, adhesives, engineering plastics, foams, elastomers and other compounds.

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Figure 9. The gas to oil ratio is making North America the second most competitive world region for olefin and methane-based chemicals manufacture.

Sources: EIA Short-Term Energy Outlook (March 6, 2012 release), Accenture Research

11 http://www.toyoland.com/toyota/texas.html

Rule of law

The World Bank’s 2011 ease of doing business analysis, which ranks 183 different countries on ten metrics, assigned the US an overall rank of number four, 83 slots ahead of China. While China did not rank as poorly in terms of the enforcement of contracts, at 16 (versus the US at 7), manufacturers continue to be concerned with intellectual property theft.12

Companies have noted that after relocating production to regions with weak legal regimes, their know-how is often adopted by others locally and they often create competitors from their suppliers which gain key bits of knowledge on the manufacture of sub-components.

The electronics industry has become particularly sensitive to this and is beginning to prefer manufacturing new or specialized products in countries with strong intellectual property protection track records, such as the US, Europe, Japan and Taiwan.

12 Doing Business, World Bank, June 2011

What leaders will do to create competitive advantageChemical leaders will need a clear vision of the future market potential at home and abroad. With this understanding, the winners will carefully align differentiated products and services according to the needs of customers, while not diluting resources on extraneous activities.

Actions in the coming years are likely to include:

Concentrating on large, competitive domestic customers. Many industries in developed economies have transitioned to high-end or performance products. These industries will require higher levels of service, support and innovation. Large-volume customers, however, will remain valuable and should not be viewed as fading markets. For global chemical companies, business models must be adopted which allow them to operate effectively in the highly specialized markets of developed regions and the volume-based markets of emerging regions.

Reducing costs and improving supply chains to serve demanding customers in developed regions. Serving regions with varying industrial characteristics also means providing differentiated service levels.

Investing in automation. Whether in the optimization of continuous processes or the application of robots in batch process and rubber/plastics products manufacturing, the ability to increase output with less labor and higher quality is the essence of producing competitively around the world.

Optimizing plant construction to keep capital costs low and avoid cost overruns will be critical to preventing the destruction of any operational cost advantage outlined above. This will involve a more focused approach to project management.

Getting involved early on in customers’ new product innovation, development and commercialization. An Accenture customer preferences study14 for chemicals indicates buyers value innovation more than achieving a better unit purchase price when the innovation helps them reduce their own costs (through improved productivity and reduced supply chain costs). Companies must also stay on top of customer trends to understand where the next breakthroughs will be manufactured, especially considering that other industries are counting on new chemicals and materials as a basis for future products. Improving manufacturing and business processes will enable chemical companies to excel at serving local customers. They will also be able to leverage the knowledge to enter into new markets.

Fostering innovation for the long term. Productivity advances have reduced knowhow to fewer employees—and innovation comes from talent, not assets. Thus, chemicals companies need to spur the innovation process by enticing more students to consider careers in the industry, and by developing training and knowledge-retention systems. Other ways include school partnerships or funding public laboratories; increasing and promoting the sustainability contribution of the industry; co-funding education programs; and tapping new talent channels.

Focusing on safe havens. In every region there are large markets not subject to high levels of import competition, due to structural or import-cost barriers. Examples include construction, agriculture, food and some segments of rubber and plastics (e.g., pipe and packaging).

Given the global shifts under way, careful capital expansion planning will be necessary for a long-lasting competitiveness. Once again, the industry is being reminded of the never-settled nature of international business. Regions will continue to take advantage of the shifts and the course of supply chains will be altered. The industry leaders will remain keenly aware of the trends and make wise investment decisions to pursue high performance.

13 The Accenture Customer Preferences Study for Chemicals: The call to become customersmart, 2010, www.accenture.com/us-en/Pages/insight-customer-preferences-study-chemicals-2010-summary.aspx

About the AuthorsPaul Bjacek leads global chemicals and natural resources research. He is based in Houston.paul.bjacek@accenture.com

Larry Oglesby, is an Atlanta-based senior executive in Accenture Strategy.larry.e.oglesby@accenture.com

Special thanks to Cyronne Counts, Patricia Faust, Gaurav Sharma and Karin Walczyk.

About AccentureAccenture is a global management consulting, technology services and outsourcing company, with more than 246,000 people serving clients in more than 120 countries. Combining unparalleled experience, comprehensive capabilities across all industries and business functions, and extensive research on the world’s most successful companies, Accenture collaborates with clients to help them become high-performance businesses and governments. The company generated net revenues of US$25.5 billion for the fiscal year ended Aug. 31, 2011. Its home page is www.accenture.com.

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