Unlock the Secrets of Capital Management in Chemicals
Managing Capital in Chemicals
Chemical companies' capital deployment is closely tied to their overall value and financial well-being. When ROIC increases from 12.0 to 13.0 percent (an 8.3 percent improvement), EV surges by 22.0 percent. But as ROIC continues to rise, the impact on EV becomes less significant. CFOs face a complex landscape of challenges when trying to improve ROIC through better capital management, exacerbated by rising project costs, labor shortages, and macroeconomic headwinds. These challenges include highly technical projects with communication barriers, "gaming the system" due to trust deficits, information asymmetry within projects, deprioritized capital capabilities, and disruptions cascading through the portfolio. 2: The average project cost has increased by approximately 26 percent since 2020. This makes it crucial for companies to stay within budget to safeguard returns, especially in the face of margin declines. Optimizing capital deployment is now a pivotal task for CFOs as it directly affects a company's financial health and overall value.Optimizing Capital Management in Chemicals: Five Questions for CFOs
What is the best way to determine what and where to spend?In a balanced portfolio, trade-offs are inevitable. Active discussions across the C-suite are needed to determine which projects best support business priorities. CFOs have four cash allocation avenues. Sustaining and compliance capital expenditures typically make up about 1.5 to 2.0 percent of the asset base for top performers. Growth capital expenditures are based on quantified risk-adjusted return targets and historical ROIC estimates. Strategic initiatives involve plotting investments to achieve commitments like net-zero goals or M&A strategies. And other uses of cash require balancing "should spend" with returns to shareholders. 2: How should my return expectations be different in a rising-interest-rate environment?From 2022 to 2023, capital project costs increased by about 10 percent. For a hypothetical $100 million project with a 15 percent internal rate of return (IRR) in early 2022, it required an investment of $110 million in late 2023 and yielded only a 12 percent IRR with 3 percent margin compression. To achieve similar returns to 2022 highs, companies need to either reduce capital expenditures by 15 percent or improve gross margins by 10 percent. The most effective approach often involves both actions.How can I improve project outcomes or control risk across my portfolio and on large projects?CFOs have a significant influence across five key stages of the project life cycle. In the concept development phase, they can set strict criteria and evaluation processes to ensure consistency and quality in project business cases. Engaging actively at this stage helps control portfolio quality and manage risk. During the design stage, CFOs can challenge existing scopes and push for standardization to reduce costs and improve returns. Examples include guiding design teams to the minimal technical solution and ensuring appropriate use of standard industry specifications. 2: Before financial investment decision (FID), CFOs can lead an independent review team similar to those in private equity. Major projects often have average cost overruns of 79 percent above the initial budget and schedule overruns of 52 percent. These overruns can often be prevented by performing due diligence similar to M&A transactions. Independent reviews before FID bring in external data and perspectives to validate and challenge estimates, plans, and budgets. In the procurement and contracting phase, CFOs are crucial in evaluating joint ventures and partnerships and avoiding complacency. In the execution phase, they maintain controlled communication and ensure a financial mindset.How can I focus the technical project teams on financial outcomes?CFOs can take four actions to encourage technical project teams to adopt a financial perspective. Role modeling by approaching major projects as independent businesses and appointing project directors with a CFO mindset. Developing financial expertise within the team and facilitating team development with coaching and tools. Communicating the financial impact alongside technical information in a compelling story. Reinforcing the use of financial terms through approval decisions and project updates. 2: These efforts help cultivate a financial mindset throughout the organization, aligning technical teams with broader financial objectives.How can I drive transparency on major projects to better predict what’s coming?CFOs have three interdependent levers to enhance capital project transparency. Integrating new technical solutions allows them to drill down into data at a granular project level and address productivity issues early. Improving performance management processes involves structured meetings with up-to-date data and clear escalation paths. Nurturing project leaders with the right mindsets, capabilities, and behaviors is essential for effective project management. 2: Tools, systems, and people should work together to create transparency and results. Today, chemical CFOs must balance shareholder returns with escalating costs and implement solutions to address critical questions.Unlock Business Potential in a Geopolitical World
How a Proactive Approach to Geopolitics Can Generate Value
Many management teams and boards have aligned their corporate strategies with geopolitical realities. They have appointed chief geopolitical officers, set up intelligence units, and developed response plans. Some advanced leadership teams are taking it a step further by exploring ways to create value amid geopolitical disruption.
Accelerating growth is one area where businesses can thrive. By assessing growth scenarios and identifying opportunities, companies can attract new customers and capture more market share. For example, Caterpillar was well-positioned to increase sales in Australia and Chile due to free trade agreements. Shifts in trade corridors are already reshaping industries, and business leaders must monitor where foreign direct investment lands.
Portfolio rebalancing is another crucial aspect. Geopolitical shocks can cause stable business segments to falter, while overlooked ones may offer new potential. Companies need to continuously assess and reallocate capital to higher-growth, lower-risk segments. One private equity fund redirected portfolio companies to more stable geographies, and a global dairy organization sold off a business unit and reinvested in a growing region.
Optimizing Core Business Operations
Business leaders can enhance organizational resilience by assessing how geopolitical shifts affect their operations. Operating footprint decisions are crucial, as seen with Samsung and Apple. Supply chain disruptions have led many companies to source from multiple vendors and use advanced technologies.
One CPG company constructed a digital twin of its supply chain to understand the effects of geopolitical shifts. It reduced reliance on third-party manufacturing sites and improved various aspects of its operations. Other companies are leveraging industrial policies for domestic production and supply chain localization, like Tesla.
Geopolitical tensions also complicate talent management. Companies can review talent concentration patterns and localize important functions. Egis maintained operations in Ukraine during the conflict by pivoting to remote work. A global bank relocated employees to avoid visa and trade restrictions.
Multinational organizations' technology and data footprints are exposed to geopolitical risks. Global IT leaders need to assess and hedge against these risks. Google chose Finland for data centers, and Malaysia offers incentives for data centers.
The Capabilities and Strategies Required to Respond to Geopolitical Disruption
Business executives need to broaden their view of corporate strategy. They must monitor geopolitical risks and economic policies and incorporate them into their planning. Scenario planning and tabletop exercises help leaders make informed decisions and focus on controllable factors.
Future-proofing multinational organizations is essential. Companies need to anticipate the impact of potential laws and regulations. Some rely on structural segmentation, while others focus on resolution planning to ensure stable growth pathways.
Establishing a dedicated geopolitical functional group can help companies respond quickly. Led by a geopolitics officer, it provides regular opportunities for boards and senior leaders to discuss geopolitical risks and opportunities.
Finally, establishing a crisis response playbook is crucial. It provides a guide for working through volatility during geopolitical events. One semiconductor company delegated responsibilities during supply chain disruptions.
As our overview shows, a proactive approach to geopolitics is essential but challenging. Organizations need insight, foresight, oversight, and the right capabilities. The effort is worthwhile, as those who act on the shifting world order will be tomorrow's market leaders.
Unlock the Power of Risk Management for Business Growth
Emerging Risks and Challenges
Risks are emerging at an astonishing pace, as evidenced by most insurance CROs using early-warning KPIs for a broader set of risks than those considered material under their Own Risk and Solvency Assessment. For instance, while only 20 percent of insurers incorporate data and technology risks in their latest ORSA, a remarkable 50 percent use early-warning KPIs for these risks. Climate risk stands out as a notable exception; 60 percent of respondents consider it material, but only 25 percent have an early-warning KPI in place.
Many emerging risks, such as data and technology, cyber, and climate risks, are now prominent in companies' risk taxonomies. Additionally, several challenges are adding to the complexity of the CRO's task. One of the most significant is the scarcity of talent, both in attracting and retaining it. Half of the survey respondents reported difficulties in filling roles in data and technology, cyber risk, and nonlife underwriting.
Transforming the Risk Function
Across all insurers in the survey, it's clear that the role and status of the CRO, as well as the risk function itself, must evolve. The size of the risk function varies widely, from 0.07 percent to 2.8 percent of the total workforce (with an average of 0.8 percent), and the average risk budget represents only 0.3 percent of operational expenses. This indicates diverse operating models with no clear market best practice.
The actual role of the CRO is expanding, including risk-based decision-making, managing the relationship with the CEO and board, communicating the company's risk position, and aligning the overall risk appetite and framework. However, only 34 percent of survey participants said the second line has veto power on important decisions, and only 17 percent reported that business units' decisions are often changed due to collaboration with or challenge from the risk team.
Inconsistent Adoption of Best Practices
In our work with organizations, we've identified four best practices for involving risk in decision-making, but none have been fully adopted by insurance companies. Two-thirds of respondents have fully implemented processes to ensure comprehensive risk dialogue, even in time-constrained situations. Also, two-thirds have a transparent set of criteria for key event-driven decisions. Half of respondents said the CRO is fully involved in strategic decision-making with veto or escalation rights. But only a third are actively mitigating risks prior to commitment, and 17 percent report having no active risk mitigation at all.
Next Steps
For insurers looking to enhance the risk function and integrate it more fully into daily decision-making, we recommend fully implementing the four best practices. They should elevate the risk function to the strategic agenda, give the CRO a seat at the table with appropriate touchpoints. Reconsider the risk function operating model in terms of lines of defense to ensure proper governance and efficient interactions with business units. Ensure the risk function has adequate resources in terms of talent and analytics capabilities. Use the risk function as a source of competitive edge by considering postmortem analyses and involving it in financial planning and strategy building.
Today's evolving risk landscape requires a new, more forceful approach to assessing and responding to risk. While corporate leadership involves the risk function, the transition to a true thought partner is ongoing. CROs need authority, resources, and support to reorganize and build capabilities, influencing business decisions. Elevating the risk function will transform it from a control function to a strategic advantage for business growth.