Strategic Overview of the Agrochemicals Market
In response to declining sales in the late 1990s and early 2000’s nearly all major agrochemical companies adopted an organic growth strategy through investment in R&D, new product technology distribution alliances, manufacturing plants and overseas subsidiaries. There has also been considerable horizontal integration to gain market share and new products.
Many companies operating in several sectors (e.g. chemicals, pharmaceuticals and agrochemicals) sold off their agrochemical divisions, which were seen as unprofitable, especially compared to pharmaceuticals. This led to the emergence of dedicated agribusiness companies from an industry once dominated by mixed petrochemical, chemical, pharmaceutical and agrochemical giants.
Anti-trust regulators enforced product divestments from newly formed companies as the industry consolidated. This created acquisition opportunities for smaller companies as an easy route to broaden their product portfolios.
Consolidation in Agrochemicals
There has been significant consolidation in the agrochemical industry over recent years.
The sales data from companies reflect not only the companies’ sales but also sales of products carried for other companies under distribution agreements. Therefore, these figures must be treated with caution. Nevertheless, these figures indicate a trend towards increasing consolidation.
Only 10 of the 20 companies that existed in 1980 were still active in 2000. Also, the number of companies controlling 80% of the market halved, from 14 to 7, between 1990 and 2000.
There has been a trend towards the disappearance of mid-sized companies in the M&A process rather than a decrease in the number of smaller companies.
Generic Strategies in the Agrochemical Industry
Evidence suggests that, at least until 2001, the agrochemical industry was in the decline phase. The chemical crop protection market was estimated to have declined in value by 7.4% between 2000 and 2001; however, sales increased in value by between 4-7% for five out of the 15 largest companies over this period. In addition, the industry appears to have grown since 2001.
Strategies in the decline phase of an industry life cycle conventionally focus on cost leadership, i.e. reducing price and controlling costs rather than investing in innovation. However, a high degree of consolidation is apparent in the agrochemical industry. Also, there is a high level of R&D spending amongst the dominant players and a high degree of innovation.
Three factors can lead to industry decline: technological substitution, demographics (e.g. changes in industry life cycle stage of industries served) and shifts in needs. In a high-tech sector, technological substitution may often be a significant driver; for example, one might expect that ag-biotech is a threat to conventional agrochemicals.
Response strategies to industries threatened in this way include: doing nothing; monitoring new developments; fighting new technology (in the courts, in the press); increasing flexibility and responding to developments; avoiding the threat by decreasing dependence on threatened sub-markets; investing in improving the ‘old’ technology; maintain sales through promotion and price cuts; or participate in the new technology.
Growth Strategies in Agrochemicals
Strategies for growth include organic growth, horizontal integration (M&A), vertical integration and strategic alliance.
Organic growth relies on outperforming the competition. Three generic strategies for successfully outperforming competitors include overall cost leadership, differentiation and focus. Generic manufacturers pursue a cost leadership strategy, whilst innovative firms follow a differentiation strategy (reliant on high R&D inputs). A focused strategy concentrates on a single market group, for example, pheromones and mating disruptors.
The high sunk costs and associated economies of scale and scope in agrochemicals favour horizontal acquisitions. R&D expenses, regulatory expenses and intellectual property may be classified as ‘non-rival goods’, which do not need to be increased to increase output. These large sunk costs also tend to favour consolidation. A further force leading to consolidation is a lack of product innovation (i.e. a weak product pipeline), which may lead firms to acquire products through M&A rather than innovate themselves.
In recent years vertical integration has increased in importance in the agrochemical industry, for example, through the acquisition of complementary seed and biotech products by companies that previously specialised in agrochemicals. Factors that influence vertical integration include the availability of complementary products and Intellectual Property Rights (IPRs). Strong demand for complementary products will increase the likelihood of vertical integration. If IPRs are well defined, then transaction costs (e.g. for negotiating and maintaining contracts) are usually low, and companies are likely to enter into strategic alliances; conversely, if IPRs are not clearly defined ( i.e. IP is not well protected) vertical integration, through acquisition, may be favoured.
Motives for strategic alliances include improving the appropriability of innovation, accessing markets (acquiring market knowledge, overcoming barriers to entry, achieving economies of scale), blocking competitors, reducing the costs and risks of innovation (R&D alliances), and accessing complementary assets.
In industries with a high degree of substitutability for products on the demand side and economies of scope on the supply side, an escalation strategy may be profitable. In some sectors in the agrochemical industry (e.g. maize insecticides), there is a high degree of substitutability with ag biotech (genetic modification) technology on the demand side and economies of scope in terms of R&D spend on the supply side. The escalation strategy involves investing large amounts in R&D whilst simultaneously engaging in mergers and acquisitions to ‘leapfrog’ competitors and gain a dominant market share.
Strategies for Competing in Technology-Based Industries
A company’s product strategy is at the heart of the overall company’s strategy. Five broad strategies are commonly found in technology-based industries such as agrochemicals: leader, fast follower, late adoption, specialist and combination.
In the leader strategy a highly innovative firm attempts to create a temporary monopoly by creating a novel product that is the first of its type on the market, inaugurating the product life cycle. The company can then realise premium margins through pricing high (‘skimming’), or penetrate the market by pricing the products low relative to the competition. This strategy requires state-of-the-art R&D facilities and usually a substantial R&D investment. Therefore, it is the most financially risky of the strategies employed.
The fast follower enters the market early in the growth stage of the product life cycle. Using fast, flexible and responsive R&D, and learning from the mistakes of the leader, the innovative product of the leader is copied and improved. This strategy relies on effective marketing skills to win customers away from the innovator.
Late adopters copy an existing product and enter the market during the growth stage, or later in the product life cycle. By leveraging skills in process development, volume production, organisation and distribution, overheads are minimised, and cost advantage is achieved through economies of scale.
Specialists adopt existing products and adapt them to small (specialist) market segments. Strong skills in R&D for product design are required for this strategy.
The combination strategy employs two or more of the strategies above. For example, a company may be a leader in some key products for which it has specialist R&D expertise but a late adopter for other products contributing to its portfolio.
Innovation and R&D
Conventionally, R&D spending reduces as an industry reaches maturity or decline. An unconventional view is that increased R&D spending is essential to rejuvenate a declining industry. Companies that spend more on R&D in difficult periods reap benefits from improved products and processes, leading to higher profits.
In a survey of European chemical firms, the three most important objectives of innovation cited were to increase and maintain market share, improve product quality and reduce process costs in a cost-leadership strategy.
It has been hypothesised that successful innovation reinforces a firm’s size and market power. Innovation improves firm performance in three specific operation areas, process, product and organisation. Process innovation exploits economies of scale, reducing manufacturing costs. Product innovation creates profits through the discovery and patenting of new products with improved performance characteristics. Organisational innovation reduces costs by exploiting economies of scope. Additionally, ‘market innovation’ is concerned with identifying new (better) markets and new (better) ways to serve target markets. Changes in the supply/distribution networks would be classified as organisational innovation.
Product innovation in the agrochemical industry operates within a framework determined by the interaction of the regulatory system (i.e. field tests to prove efficacy, toxicology and environmental tests to prove safety etc.), patenting system and market competition. As a result, in Agrochemicals in Europe product innovation accounts for a higher proportion of total R&D spending than any for other chemical industry sectors.
Agrochemical companies can follow a strategy based on sales of generic products, a strategy based on the sale of branded products containing innovative compounds, or a combination of the two. Approximately 35% of the products on the market in 2000 were patent-protected proprietary (branded) products, 35% were off-patent proprietary products, and 30% were generic products.
Generic compounds are generally 25% cheaper (for consumers) than branded products. During the last decade, the number of independent generics producers increased considerably as more and more compounds became ex-patent. In addition, increasing regulatory requirements, which have led to many older agrochemicals being withdrawn from sales, as well as the price premium for novel products and the ability to differentiate through innovation, have helped stimulate the hunt for new active ingredients.
Finding new, effective compounds is becoming increasingly difficult and expensive. Between 1975 and 1995, screening costs increased by 369%, and chemical development/formulation costs increased by 150%. In the same period, field-testing costs rose by 233% and toxicology, residue analysis metabolism, and environmental studies costs rose by 1150%. There is also a trend towards greater product specificity and more complex (expensive) synthesis. In 2000 the estimated cost of bringing a new active ingredient (AI) to market was estimated at €150m.
Firms may seek R&D alliances to reduce costs. Collaboration is often seen as the best option for R&D, especially for smaller companies that cannot afford R&D costs themselves. The use of strategic technology partnerships (STPs) has been increasing in recent years; for example in 1996, Hoechst invested US$ 90m in STPs. However, joint ventures are less likely where the protection of intangible assets is important to the firm.
R&D has become increasingly focused to achieve as high a ‘hit rate’ as possible for novel compounds. One approach, termed ‘patent buster’ or ‘me too’ is to look for chemical analogues of existing novel compounds. Molecules are also being designed to act on particular molecular targets or to mimic naturally occurring compounds known to have pesticidal properties. The use of advanced screening technologies has augmented this.
To protect their R&D investment, innovative companies must fight generic competition through effective patenting, regulatory and marketing strategies. Up to 10% of the total R&D spend may be on product support and defence.
Patents are developed with as greater scope as possible, usually covering all possible derivatives of the AI. This acts as a deterrent against patent busting and allows the favoured AI to be hidden from competitors. Further patents (e.g. processes etc.) may then be sought to build up a ‘patent wall’ to protect the AI.
Process innovations can be used to make manufacturing less capital-intensive, increase economies of scale, and change the proportion of fixed costs. Innovative processes may be used not only to lower costs but also to protect a product from generic competition. Agrochemical companies may use process patents (e.g. for isolating isomers of a racemic mix) to protect an active ingredient (AI) from generic competition. If the patented process is cheaper than other methods, this will prevent generic competition. If a generic manufacturer uses a different process, which results in an AI with different impurities from the branded product, a new set of regulatory data may have to be submitted.
Organisational innovation exploits economies of scope by changing the organisation’s structure to reduce costs. Developing and structuring internal resources innovatively can lead to a hard-to-replicate differential advantage. For instance, in MNEs centralising R&D may lower R&D costs.
However, decentralising R&D units support market penetration or expansion (as decentralised units interact with the locality and acquire local knowledge). Finding the right balance of autonomy and central control for activities such as R&D and marketing units is important in this context to gain optimal strategic advantage.
Marketing, Patenting and Regulations
The agrochemical distribution industry is highly consolidated. Farmers rely on advice from the distributors’ agronomists for their crop protection needs. By producing specialised formulations for specific distribution companies (with distributors’ labels), which allow agronomists greater choice in their use (e.g. by using increased AI concentrations), agrochemical companies can build up long-term relationships with the distributors.
The chemical industry is moving from a product-centric to a customer-centric industry. By using linked marketing arrangements with the distributors, in which distribution companies agree to sell a balanced product range, agrochemical manufacturers can increase sales of their off-patent (older) products. Differential pricing may be achieved by producing slightly different formulations for different countries under the same trade name. Parallel import regulations prevent the movement of non-identical products for safety reasons, allowing manufacturers to charge different prices in different countries. Strategic pricing of this type is typical of a non-contestable industry with significant sunk costs and a low threat of entry.
Manufacturers can also support sales of their older AI portfolio through the use of ‘composition of matter patents’. By patenting a mixture of AIs where a synergy (in terms of efficacy) is found between an on-patent and off-patent compound, the commercial life of the off-patent, AI can be extended. This may also be achieved by differentiating off-patent AIs from generics by using safer formulations and delivery systems.
All formulations must be registered with the relevant regulatory authorities for the country or region in which they are sold, whether novel or generic. Submitting a registration package containing chemical, efficacy, toxicological and environmental data is extremely expensive, time-consuming, and a significant barrier to generic manufacture. Some data may be available from the public domain from the original registration but can only be used if a generic formulation is exactly the same as the branded product in every respect.
Agrochemical companies may join together to form ‘task forces’ to register generic formulations, splitting the cost between them (e.g. based on market share). Precisely the same amount of data has to be produced when registering a generic compound as was used for the original registration of the branded product. One method of protecting a new product is to carry out as many regulatory tests as possible, for instance, using data from 10 residue trials when fewer are required, making the cost of registering a generic version prohibitive for a smaller company when the patent expires.
Patents are usually granted for a period of 20 years in the UK, and up to eight years may have elapsed before registration is complete. Therefore, it is essential to optimise registration times to increase the on-patent sales period of a product.