The past three years have been turbulent for the chemicals industry, and that turbulence is likely to continue. Most notably, the COVID-19 pandemic has disrupted supply chains and sparked labor shortages that continue to put pressure on operating costs. At the same time, global trade dynamics have driven rising production costs and margin pressure.
Industry professionals expect these disruptions to continue over the next three years. They anticipate ongoing pandemic-driven labor shortages and cost escalation, but they expect no changes in distribution channels, with third-party distribution predicted to remain 40%-50% of companies’ sales.
These are among the findings of L.E.K. Consulting’s first annual U.S. Specialty Chemicals Survey of 260 chemicals sector professionals across a broad range of industries and executive functions. The survey was conducted in late 2021. It reports on key issues impacting the industry such as supply chain, sustainability and digitization.
The added costs driven by COVID-19 labor trends and government regulation may lead to increased consolidation and vertical integration as organizations seek to maintain margins and streamline processes.
Our survey examined several disruptive forces that are all driving up prices. We discuss each in more depth below.
COVID-19’s impact on labor supply will outlast the pandemic
Among the major lasting effects of the COVID-19 pandemic is a significant labor shortage that is disrupting the entire chemicals industry. Approximately 80% of survey respondents indicate that labor shortages are impacting core areas of their business. Respondents strongly agree that labor shortages are affecting distribution (56%), the supply chain (55%), sales and client satisfaction (51%), and manufacturing operations (49%) (see Figure 1).
Supply chain disruptions are extensive. And across the board, the labor shortage is driving up wages. Sixty to eighty percent of professionals in the chemicals sector expect labor rates to increase over the next three years, with an average total wage hike of 8%-10% anticipated by 2024. These higher labor costs are being felt throughout the value chain. Leaders of chemicals companies expect 60%-70% of labor costs to be passed along to customers across all end markets and expect their own organizations to shoulder the burden for the additional 30%-40% of wage increases (see Figure 2).
The workplace transformation is likely to be permanent — and to impose its own costs
Industry leaders anticipate the transformative impact of the pandemic on the labor market and the workplace will be long-lasting (see Figure 3). Not surprisingly, more respondents expect to adopt hybrid working models this year than in 2021 (64% versus 36%). This may indicate a partial return to the workplace for office workers after two years of remote work, but still suggests continued disruption and the emergence of a “new normal.” And COVID-19’s impact on labor costs is expected to reverberate long after pandemic restrictions are lifted thanks to long-term actions taken to address health and safety concerns in the workplace, such as a greater anticipated use of personal protective equipment in 2022 than in 2021 (72% versus 27%) and more frequent and intense cleaning (72% versus 25%).
Vaccine mandates are another factor that may prolong the labor shortage and add to wage pressures. More than half of respondents anticipate vaccine mandates this year for some (61%) or all (55%) of their workforce. Of note, expectations around vaccine mandates haven’t changed much — at the time of data collection in late 2021, 58% of survey respondents indicated they already require this for all employees, compared to the 55% who indicate they expect to do so in 2022. It will be interesting to see whether vaccine mandate expectations change in next year’s survey.
Regulations are also driving up costs
Beyond COVID-19, there have been other recent disruptions affecting costs in the chemicals industry. Government regulations (e.g., increased scrutiny of PFAS, tightening stringency on toxic substances, increased enforcement of existing laws) impacted chemicals manufacturers in multiple ways over the past three years (see Figure 4). Over 70% of respondents report that government regulations impacted operations continuity, price, production costs and supply base. Most notably, more than half of respondents report that changes in U.S. governmental regulations had a significant impact on price (55%), production costs (53%) and continuity of operations (53%). Regulations also had a significant impact on supply base for 49% of respondents, a significant impact on company greenhouse gas emissions for 47% of respondents and a significant impact on energy efficiency for 45%.
Despite headwinds, distribution strategies appear to be unchanged
In response to all these disruptions, industry leaders may make marginal tweaks to their distribution strategies but do not anticipate major change, as third-party channels remain the primary route to market. Leaders of the specialty chemicals sector expect to stay the course in sales channels — with direct sales continuing to account for more than half of sales for the next three years (compared to third-party sales). Survey participants expect direct sales to remain steady through 2024 across all chemical types, accounting for around 50%-60% of total sales across segments including industrial, consumer, agricultural and pharmaceutical (see Figure 5).
On average, chemicals professionals surveyed prefer regional distribution (ranked first as a preference by 41%), closely followed by end-market specific distribution (ranked first as a preference by 37%). Broadline distribution was a distant third (ranked first as a preference by 22%). This may be because broadline distribution is less specialized and therefore more commoditized, while regional and end-market specific distribution allow companies to focus on higher-margin or more secure opportunities.
The turbulence of the past three years is not going away anytime soon, according to industry professionals polled in the 2021 U.S. Specialty Chemicals Survey. While respondents are staying the course on distribution, they anticipate that cost and margin pressures will continue. Watch for an accelerated pace of mergers and acquisitions as a challenging decade for the industry continues.