Chemical companies target 13% rise in capital spending in 2005, but only a modest increase to R&D is considered
R&D budgets are likely to increase at a slower, but still respectable, pace. The 20 firms that responded to this year's survey budgeted a combined $5.2 billion for research in 2005, up 2.3% over last year. At that level, spending will cover increases in the projected rate of inflation and then some. That is good news for industry sales growth, too, because well-managed R&D budgets generate new business, points out Friedrich von Gottberg, vice president and director of R&D for carbon black maker Cabot.
And the overall picture for future-oriented spending isn't too shabby. The 2005 budget for the group of 20 firms that supplied both R&D and capital spending data is $12.6 billion. As a result, spending will rise for the third year in a row from the decade low in 2002 of $11.5 billion. Still, funds earmarked for both research and new equipment are well below the decade peak of $14.3 billion in 1998.
Allow for inflation, and today's budget won't go nearly as far as it did 10 years ago. The $12.6 billion in future-oriented funds set aside for this year is only $10.7 billion in 1995 dollars.
THE RATIO OF investment in new capital and equipment to investment in research is down from what it was during the 1990s. This year, 59% of future-oriented funds are slated for capital improvements. In 1996, by contrast, a strong economy led managers to direct about 69% of funds to such projects.
Funds devoted to R&D do not fluctuate as dramatically, and thus when the economic outlook is poor, a proportionately greater share of budgets tends to go toward R&D. This year, 41% of future-oriented spending will likely be directed toward research, compared with 31% of such funds in 1996.
However, budgets are not set in stone. Unforeseen circumstances may force managers to readjust their priorities. As a result, C&EN's surveyconducted in Januarycan only provide a snapshot of a select group of chemical firms at a moment in time.
For instance, companies surveyed in January 2004 planned to increase capital spending 15.3% in 2004 (C&EN, Feb. 2, 2004, page 13). But this year's survey shows that firms ended up more tightfisted than they thought they would be. Managers had to react to dramatic increases in the cost of oil and raw materials, and some had to accept lower margins than they had counted on until new prices went into effect. Actual capital spending slipped 1.1% last year.
For R&D, the story was a little different. Last year's group expected to increase R&D a mere 0.4% in 2004. Companies this year report they actually increased spending by 3.9%.
Of 21 companies surveyed for their 2005 capital spending plans, 19 plan to increase spending on new plants and equipment. Not one plans to cut, although two plan to keep spending at the same level as 2004. This compares with 11 that increased spending in 2004, nine that cut spending, and one that had no change.
C&EN predicts that the group's capital spending as a percent of sales will be 4.7%just a tad above the 4.5% low for the decade that was achieved last year. The estimate assumes a 7% increase in sales in 2005. The group achieved a 10-year high in 1998 when spending on capital projects reached 9.1% of sales.
Half of the 20 companies surveyed expect to increase R&D spending in 2005, eight plan no increase, and two will cut back. This compares with 13 that increased expenditures in 2004, one that made no change, and six that cut their budgets.
C&EN estimates that, in 2005, R&D as a percent of sales for the group will hit a decade low of 3.3%well below the decade high of 4.5% in 1999. Survey results put this figure at 3.4% last year.
FUNDS DEVOTED to R&D buy a lot less than they did a decade ago. Though actual dollars committed to new product and process development for the group will be $5.2 billion, those funds represent only $4.4 billion on a constant-1995 dollar basis. The inflation-adjusted decade high of $4.9 billion was in 2000.
Three European firms provided some information on future-oriented spending plans. Bayer says it spent about $1.8 billion on capital projects in 2004 and will spend close to $1.9 billion in 2005. The 2004 data include Lanxess, the fibers, plastics, and rubber business that Bayer just spun off. Though the 2005 investments do not include Lanxess, Bayer plans to increase spending on core health care businesses.
However, Bayer's R&D spending will slip in 2005 compared with 2004. It spent about $2.7 billion on R&D in 2004, including Lanxess. In 2005, Bayer plans to spend $2.6 billion on research, excluding Lanxess.
Degussa plans to spend $1.1 billion on capital improvements in 2005, up from $975 million in 2004. Rhodia expects its capital budget to increase about 22% to more than $285 million in 2005.
Another survey of spending plans also finds many companies will not be so tightfisted with capital budgets. According to the American Chemistry Council's economic and statistics department, a recovery in industry profits has encouraged chemical firms to spend more freely on capital projects.
Based on a fall survey of its members, ACC anticipates that 2005 capital spending for chemical firms will increase 13%a prediction closely in line with the 12.6% increase that C&EN's January survey found. Looking ahead, ACC expects chemical firms will raise the ante again in 2006 and fund a further 6% increase in capital budgets.
Over the long term, ACC's survey predicts that basic and specialty chemical firms will shift more of their capital budgets overseas. There they are finding lower feedstock and production costs as well as rapidly developing markets. Whereas surveyed firms say they spent 71% of their capital budgets in the U.S. in 2004, they expect to spend only 59% of their funds in the U.S. five years from now.
The Asia-Pacific region, led by China, will account for the greatest shift in capital budgets by ACC members. Whereas they committed about 6% of capital budgets to the region in 2004, they plan to invest 15% in 2009. Latin America, Africa and the Middle East, Western Europe, and Central and Eastern Europe will also see some marginal increases in their share of ACC member capital outlays.
ACC's survey predicts a 3.4% gain in 2005 R&D spending by basic and specialty chemical firmsslightly more than the 2.3% rise C&EN's survey projects. ACC members say they plan an additional 3.2% increase in research spending in 2006.
A breakdown of data in the ACC survey shows that R&D spending for new product development rose from 54% of 2003 budgets to 60% in 2004. Basic and applied research budget shares both declined. "The challenging business environment may account for allocations that are tied more closely to bottom-line results, a trend likely to continue into 2005," ACC economists say.
The pressure for bottom-line results has driven most chemical firms to adopt a stage-gate management process for research projects. Developed by Robert G. Cooper, a cofounder of the Product Development Institute, stage-gate management is a product development methodology designed to rapidly move ideas from conception through feasibility studies to development and on to product launches. It is designed to discard notions that can't make the cut at increasingly rigorous decision gates.
Software developer Sopheon markets a software application called Accolade that is designed to track and automate the stage-gate process. Andy Michuda, the firm's chief executive officer, says 78% of chemical companies employ some form of the stage-gate process. A strict application of the process helps companies get a higher return on the dollars they invest in R&D, he contends.
"Decision-making is critical to the rate of return" on dollars invested in R&D, Michuda says. In the past few years, many firms have tried to automate the stage-gate process to bring greater rigor to the discipline. Those who succeed can achieve significant savings, he says.
A typical company funds 23% of the ideas it screens, about half of which make it through to commercialization, Michuda says. About 46% of funds are spent on failures. A firm that employs the best stage-gate practices funds only 5% of the ideas it screens, however, and half of those make it to commercialization. Such a firm ends up spending only 20% of its budget on failures, he says, and overall employs its R&D funds more efficiently.
A key to success, Michuda says, is filtering out bad ideas early on in the stage-gate process, because costs to bring ideas to market increase as they make it past each hurdle. By weeding out those less likely to succeed early on, a firm can devote greater resources to the most promising prospects.
The stage-gate process is fine for managing established businesses, says Cabot's von Gottberg. But uncompromising application of stage-gate processes can be limiting in the management of breakthrough technology, leading to "rash decisions made on too little information."
Cabot attributes its success at breakthroughs in chemical mechanical planarization slurries, insulating nanogels, and carbon black for ink jets to a very flexible board of business and technical experts. This kinder, gentler view of the stage-gate process sees patience as a virtue, von Gottberg says.
IT IS TRUE that the stage-gate process minimizes waste and expense, acknowledges L. Louis Hegedus, senior vice president of R&D for Arkema in North America. But using stage gates "is pretty standard procedure," he says. More interesting and as important, he argues, are techniques to measure and manage research output.
Firms put money in capital projects and expect a certain rate of return for the investment, Hegedus explains. They are much better off if they manage R&D similarly instead of considering it just another expense of doing business.
"We calculate the impact of past research on current sales. We also measure the anticipated impact of our current R&D portfolio on future business." Arkema, set to spin off from French oil giant Total in 2006, annually spends more than 3% of sales on R&D, or about $190 million.
Hegedus says his firm uses both trailing and leading indicators to help it see what part of its sales comes from R&D and where growth opportunities are likely. A good trailing indicator would be to divide total sales generated by developmental research projects over a five-year period by the average research budget for the same periodincluding failed projects. Such an exercise yields a "good measure of R&D performance," Hegedus says. By seeing how the numbers change over time, "you can measure the impact on sales over time," he says.
Some companies are finding ways to invest in high-risk projects by partnering with the government. For instance, last June, Rohm and Haas received a $2 million Advanced Technology Program award from the National Institute of Standards & Technology to develop a new acrylic polymer catalyst with the California Institute of Technology. Rohm and Haas must kick in significant funds, too.
Such partnerships "add to our competencies," explains Catherine Hunt, the company's director of technology partnerships. "We can't afford the risks of going it alone." For its part, Rohm and Haas must show that if the research were successful, the U.S. economy would somehow benefit. For instance, the project might generate more jobs, save energy, or improve the quality of life, Hunt says.
Rohm and Haas takes an additional risk here, too. If the firm does not commercialize discoveries made with the government funding, "the government could take it and it could end up in our competitors' hands," Hunt cautions.
The Philadelphia-based firm is looking for other opportunities to further institutionalize and leverage risk. "We are looking for additional work with the Department of Energy and the National Science Foundation. However, we are a global company, Hunt says. "We have good scientists around the world. We are also looking for opportunities to participate in research with European Union government entities."
Hunt is not alone in her desire to fund research with good potential payoff while reducing the price a firm must pay to do so. While capital expenses rise and fall dramatically from year to year, slow but steady R&D budget increases over time are a mature industry's way to manage and leverage risk.
Download a PDF Of Chemical R&D & Capital Spending Tables (36 K)
The PDF includes the following Tables:
1- Research Spending
Outlays by major U.S. chemical firms to increase modestly worldwide in 2005
2 - Capital Investments
On average, 21 U.S. chemical companies plan a 13% increase in worldwide spending this year