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Chemicals I ASHISH ARORA Carnegie Mellon University ALFONSO GAMBARDELLA University of Urbino Unlike several of the other manufacturing industries discussed in this vol- ume, the U.S. chemical industry began to experience its competitive "crisis" in the late 1960s, well before most other U.S. industries encountered growing com- petitive pressure from foreign sources and well before the onset of the "oil shocks" of the 1970s that affected prices for the industry's key raw material. Slower growth for its dominant products, including polymers, along with the growth of production capacity offshore, led many leading U.S. chemical firms to pursue diversification programs during the 1970s, with mixed results. In the 1980s, a far-reaching restructuring in the industry, consisting of divestitures and actions to focus firms on a narrower line of products and processes, contributed to improved results in many U.S. chemical firms. This restructuring process began earlier and has proceeded further in the U.S. chemical industry than in those of continental Europe and Japan. The development during the 1940s and 1950s of a group of independent developers and sellers of process technology, known as specialized engineering firms (SEFs) accelerated the international transfer of technologies and planted the seeds of the competitive challenges faced by the U.S. and European firms in the 1960s and 1970s. But the technological response of these firms, especially that of U.S. firms in the 1980s and l990s, to these competitive challenges has involved the development of new variants of existing products, customized to the needs of specific users, and greater integration between products and process iThe authors are grateful to Ralph Landau for helpful comments and to Marco Ceccagnoli for excellent research assistance. This version has benefited from David Mowery's comments and sug- gestions. We alone are responsible for all remaining errors and omissions. 45
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46 U.S. INDUSTRYIN2000 innovation. These steps have not only eroded the markets for the services and technologies of SEFs but also reduced investment in basic research. EVOLUTION OF INDUSTRY STRUCTURE SINCE WORLD WAR II2 With sales of more than $1 trillion a year, the chemical industry is one of the largest manufacturing industries in the world, as well as one of the oldest and most complex. The modern chemical industry comprises a myriad of products from sulfuric acid to fragrances and perfumes. But there have been two principal driving forces behind the industry's growth in the last half century first, poly- mer science, which developed the synthetic fibers, plastics, resins, adhesives, paints, and coatings that virtually define "modern" materials; second, chemical engineering, which made it possible to produce these materials at costs low enough to ensure their success. Petrochemicals chemicals produced using oil and natural gas as inputs- are the base of most of these modern materials and are perhaps the most impor- tant component of the post-World War II chemical industry. The United States, which has abundant oil and natural gas reserves, was the first country to develop a petrochemicals industry, beginning early in the century. World War II had a major impact on technology and the industry's structure. As part of the war effort, the U.S. government funded large programs for research and production of synthetic rubber and created massive demand for oil for aviation fuel.3 After the war the demand for cars and gasoline skyrocketed, and by 1950 half of the total U.S. production of organic chemicals was based on natural gas and oil. By 1960 the proportion was nearly 90 percent (Chapman, 1991~. Several oil companies, most notably Shell, Exxon, Amoco, and Arco, become major producers of basic and intermediate chemicals derived from petroleum feedstocks. The United States was the dominant chemical-producing nation at the end of World War II. The German and British industries had been devastated by the war, either directly by bombing or indirectly through damage to the economic infrastructure. But the chemical industry in both countries rebuilt and grew rap- idly, shifting its organic chemical production to petrochemicals nearly as quickly as had the United States.4 During the 1950s and the 1960s Japan made an aston- ishingly rapid entry into petrochemicals, leading to a rapid growth of the chemi- cal industry. Apart from the three main keiretsu Mitsui, Mitsubishi, and 2This and the next section draw upon some of our earlier work, including Arora and Gambardella (1998) and Arora and Rosenberg (1998). 3Morris (1994) provides a detailed account of the synthetic rubber case. For aviation fuel, see for instance, Spitz (1988) and Aftalion (1989). 4In 1949, 9 percent of the United Kingdom's total organic chemical production was based on oil and natural gas; the proportion rose to 63 percent by 1962 (Chapman, 1991). In Germany, the first petrochemical plant was set up in the mid-1950s, and by 1973 German companies derived 90 percent of their chemical feedstocks from oil (see also Stokes, 1994).
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CHEMICALS TABLE 1 Chemical Production, 1913-1993: Selected Countries 47 USABritain Japan GermanyRest of the world World 19131.53 (16)1.1 (11) 0.15 (2) 2.4 (24)4.82 (47) 10 19279.45 (42)2.3 (10) 0.55 (2) 3.6(16)6.6(30) 22.5 19388(30)2.3 (9) 1.5(6) 5~9(22)9.2(33) 26.9 195171.8 (43)14.7 (9) 6.5 (4) 9.7 (8)63.3 (32) 166 197049.2 (29)7.6 (4.5) 15.3 (9) 13.5 (8)85.4 (49~5) 171 1980168.3 (23)31.8 (4.5) 79.2 (11) 59.3 (8)380.4 (53.5) 719 1993313.5 (25)49.6 (4) 208 (17) 98.6 (8)580.3 (46) 1250 Note: Sales given in billions of Reichsmark up to 1938, in billions of Deutchmark for 1951, and in billions of U.S. dollars thereafter. Percentage share in total world output given in parentheses. Source: Eichengreen (1998). Sumitomo several other companies, such as Asahi Chemical, Maruzen Oil, and Idemitsu, made considerable investments in petrochemical plants (Hiking et al., 1998). The technological lead of U.S. chemical producers in petrochemicals was eroded as oil companies and engineering design firms diffused the technology internationally. Technology for producing a variety of important products from the basic petrochemical inputs such as ethylene to materials such as polyethylene, polypropylene, and polyester became more widely available. Moreover, the development of a world market in oil meant that the oil and natural gas endow- ments of the United States did not prove to be an overwhelming source of com- parative advantaged By the end of the 1960s, European countries and Japan had succeeded in closing much of the gap with the United States. Since then, relative shares in world output have largely remained constant, with the exception of a small de- cline in the U.S. share and a rise in the Japanese share (Table 1~. In the 1980s a cheaper dollar and declining growth opportunities in their home markets prompted European firms and, to a lesser extent, Japanese firms to expand heavily into the U.S. market. The expansion, accomplished through direct investments, as well as acquisitions and alliances, underlined both the globalization of the industry, as well as the declining U.S. dominance. Since most of the leading companies in the world are highly globalized, one must be cautious in linking the performance of 5Government regulation of oil imports in the United States also played an important part. Since the late 1930s, the oil industry had been regulated by the government. Among other things, production of individual companies was regulated to prop up the domestic price of oil. After World War II, the regulations were extended to restrict imports of oil. The net effect, according to Chapman (1991), was that the crude oil acquisition costs for U.S. refineries was 60-80 percent higher than the landed costs in Western Europe through the late 1950s and 1960s. However, one should note that many U.S. firms have access to another cheap source of light hydrocarbons (such as ethane, propane, and bu- tane) namely, natural gas.
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48 U.S. INDUSTRYIN2000 firms with their so-called national industnes. With this proviso, we also note that the leading U.S. chemical firms have performed better than their European coun- terparts in the last decade or so, suggesting that perhaps the decline in U.S. dom~- nance has been stemmed (see Figures 1 and 2 and discussion below). In 1992, seven European countries Germany, the United Kingdom, Italy, France, Netherlands, Belgium, and Denmark taken as a group produced about 20 percent more than the U.S. chemical industry output; as indicated earlier, these figures have been fairly stable over the 1980s and early l990s. Japan, as Table 1 also suggests, has been increasing its share of world chemical production, producing a little less than two-thirds of the U.S. level in 1992. Even so, Japan's share of world chemical production is smaller than its share in world manufactur- ing. By contrast, Europe as a whole has a higher share of world chemical output than it does of world manufacturing output, while the U.S. share in chemicals is about the same as its share in manufacturing output. Although the relative shares of the leading industrial countries in terms of output or exports have been largely constant over the past thirty years, there are some clear patterns that emerge at a more disaggregated level. First and fore- most, within most subsectors, relative output and export figures have been fairly stable over the 1980s and early l990s. European production of pharmaceuticals in 1991 was about 90 percent that of the U.S., with Germany and the United Kingdom. each producing about 30 percent of the U.S. output, and these figures were largely constant over the 1980s. For the same penod, Japanese production had been increasing slightly and by the end of the 1980s was about 70 percent of ~ US-AVG-ROI ~ EURO-AVG-ROI 30.00 25.00 20.00 15.00 10.00 5.00 0.00 ~_ ~ CD (D to CD (D CO (DCC ~CD CO ~CD CO CD CD <0 ~CD (D ~co ~o ~CD ~0 FIGURE 1 Pretax return on investment for leading U.S. and European chemical compa nies, 1987-1996. Source: Global Vantage database from Standard and Poor. See text for details of sample.
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CHEMICALS 350.00, 250.00 200.00 1 50.00 1 00.00 50.00 49 I ~ US-AVG-PROD - ~ EURO-AVG-PROD I ~ __ ~- 0.00- , , , I , . . . . ~_ ~ CD (0 CO CD (D ~CO CD CD CD CD `0 (D CO (D CD CO (O Go ~0 ~Cal rat ~ FIGURE 2 Labor productivity: total revenue per employee, for leading U.S. and Euro- pean chemical companies, 1987-1996. Source: Global Vantage database from Standard and Poor. the U.S. output. In terms of exports, Germany alone shipped 20 percent more than U.S. exports, increasing slightly over the 1980s, while the United Kingdom exported about as much as the United States. Japanese exports, on the other hand, were only about 20 percent of the U.S. level, albeit increasing slightly over the 1980s. Similarly, in industrial chemicals (ISIC 351-352), German exports are about the same level as U.S. exports while Japan and the United Kingdom each has exports of about 40 percent of the U.S. level.6 Table 2, which provides an output index for selected chemical subsectors, shows that drugs and pharmaceuticals have grown the fastest of all subsectors in the United States, followed by synthetic polymer-based sectors such as rubber and plastic products and plastic materials. Although data for Japan and Europe cannot be compared directly with each other or with the United States, tentative conclusions can nonetheless be drawn. In Japan, basic petrochemicals and aro- matic products (such as benzene) remain the major growth sectors. By contrast, pharmaceuticals, basic chemicals, and specialty chemicals have shown the great- est growth in Europe. These patterns are borne out by patent statistics. U.S. chemical patenting is relatively specialized in drugs, and the degree of this spe- cialization increased between 1973 and 1996. Chemical patenting in the United Kingdom is specialized in drugs and agricultural chemicals and away from plas- tics and fibers. Relative to their share in overall chemical patents, the Japanese patent heavily in plastics and fibers and away from drugs and agro-chemicals. As one might expect, German chemical patenting is relatively specialized in indus- trial organic chemicals. 6All figures from the CMA (1997).
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so U.S. INDUSTRYIN2000 TABLE 2 Index of Chemical Production in the United States, European Union, and Japan 1990 = 100 Japan 1992 1993 1994 1995 1996 All chemicals 102.0 100.1 105.5112.4 113.9 Petrochemicals 104.5 102.2 109.4120.3 122.6 Aromatics 119.3 127.1 132.9149.3 144.3 Alkalis and chlorine 97.0 94.2 93.898.6 97.1 Inorganic chemicals end pigments 96.2 90.8 90.995.6 93.4 Organic chemicals 105.7 102.0 105.4116.5 119.7 Cyclic intermediates and dyes 105.9 104.8 116.3126.0 126.2 Plastics 99.4 96.3 102.2110.4 114.5 Synthetic fibers 106.3 106.9 108.8116.1 112.7 Synthetic rubber 97.5 91.9 94.7105 106.6 Fertilizers 95.5 92.9 91.491.7 89.4 United States 1986 1988 1990 1992 1994 1996 Chemicals and products Basic chemicals Alkalis and chlorine Industrial organic chemicals Synthetic materials Plastic materials Synthetic fibers Drugs and medicines Soaps and toiletries Paints Agricultural chemicals Rubber and plastic products Source of U.S. data: Chemical & Engineering News, 84.69 94.76 100.00 102.77 106.99 111.92 80.83 88.34 100.00 98.81 90.22 86.36 85.94 97.84 100.00 98.33 106.49 110.72 79.60 93.52 100.00 95.33 96.76 97.33 86.44 98.54 100.00 104.28 113.45 122.42 82.58 97.48 100.00 104.93 116.37 128.33 91.14 100.72 100.00 102.99 107.11 109.37 85.84 93.09 100.00 113.25 119.93 132.39 88.39 97.30 100.00 100.10 106.11 104.20 100.77 106.41 100.00 95.69 109.38 119.81 74.50 89.64 100.00 99.60 99.40 102.69 84.82 95.66 100.00 108.46 125.92 130.69 June 23, 1997. European Union 1991 1992 1993 1994 1995 1996 1997a Chemical industry (NACE 24) Basic chemicals (NACE 241) (excluding fertilizers end nitrogen compounds) 97.6 97.7 Pesticides and other agro-chemicals (NACE 242)(including fertilizers and nitrogen compounds) Paints, inks, and varnishes (NACE 243) Pharmaceuticals (NACE 244) Soap and toiletries (NACE 245) Other chemical products (NACE 246) 100.1 102.7 97.7 85.9 97.4 98.3 106.8 113.6 99.2 103.1 100.3 103.5 102.3 109.1 113.4 115.5 119.1 96.2 104.7 107.8 108.5 111.3 89.2 90.9 100.5 104.0 109.7 97.8 105.3 105.3 106.6 110.1 114.7 120.4 129.4 130.9 133.4 102.8 109.0 108.1 108.2 112.1 104.2 108.4 109.0 112.1 116.1 aOnly January-April. Source of E.U. data: Our calculation based on ESCIMO database (European Chemical Industry Coun cil).
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CHEMICALS 51 Overall, however, the relative positions of the major industrial producers has not changed much in the last 25 years.7 Indeed, the major change has been the increase in chemical production outside the leading industrial countries (see Table 1~. In 1959 the United States, Japan, and Western Europe accounted for virtually all chemical exports. By 1993 their combined share had fallen to two-thirds, with the rest coming from Asia, particularly South Korea and Taiwan, Eastern Europe, and the Middle East. Much of the capacity addition took place during the 1970s and especially the 1980s. Following the big technology push in the industry during the 1950s and 1960s, technology diffused more widely than it ever had before. Specialized engineering firms played a key role in creating a global market for process tech- nologies for a large number of basic and intermediate chemicals. The maturing technology, along with increasing competition and slower demand growth, low- ered the payoffs to traditional types of innovations. Commercialization became more expensive and required ever more sophisticated knowledge of customers and the market. Faced with overcapacity, the industry restructured, beginning in the 1980s in the United States, and a few years later in Western Europe. The drive to reduce cost dominated the initial restructuring phase, driven in part by the relentless pressure from shareholders and their representatives. Major re- alignments of the product portfolios of many firms followed, with many mergers and acquisitions and the rise of entirely new firms in the industry. During this phase, many firms cut down on R&D and refocused R&D expen- ditures on short-term projects and away from more fundamental research. In the past couple of years, there are some indications that the industry may be entering a new phase of technological change and R&D spending appears to be picking up as well. Nonetheless, the restructured firm portfolios beg the question of who will perform the basic research that continues to be very important for the future of the industry. The current situation points to the possible need for increased government support for R&D in an industry that has hitherto largely financed its research by itself. POLYMER CHEMISTRY: "MATERIALS BY DESIGN" With synthetic dyestuffs as its engine of growth, Germany dominated the chemical industry from the 1870s until World War I.8 Advances in organic chem- istry clarified how carbon atoms are linked to hydrogen and other atoms to form 7The production and export figures are based on STATCON, while the patenting figures are based on U.S. patents. Details of the analysis are available from the authors on request. The German chemical industry was strong in other fields such as inorganics and high-pressure chemical processing from coal. BASE for instance had developed the contact process for sulfuric acid, and it was responsible for many process innovations, which culminated in the development of the Haber-Bosch process. BASE (within I.G. Farben) also pioneered research in the 1920s and 1930s on coal hydrogenation to produce synthetic gasoline.
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52 U.S. INDUSTRYIN2000 more complex molecules. Over several decades German firms developed this knowledge into a general purpose technology for producing new dyes such as alizarin and indigo. Moreover, they soon discovered that the organic chemistry behind the creation of synthetic dyestuffs could also be harnessed for other appli- cations such as pharmaceuticals and photographic materials. If synthetic dyestuffs represented the start of "materials by design," polymer chemistry represents its maturation. The theoretical work of Herman Staudinger and other German scientists in the 1920s, postulating that many natural and syn- thetic materials such as cotton, silk, and rubber consist of long chains of the same molecule linked by chemical bonds, pointed to ways of developing a series of new products by using different building-block molecules and changing the way in which these molecules were connected. Long and systematic experimentation was still needed to produce commercially successful products, but over time the advances in the scientific understanding of the relationship between molecular structure and physical properties made the research much more productive. A key challenge in producing a polymer is controlling the length and physi- cal structure of the macromolecule. Catalysts are the main instrument used for this purpose because they permit control over the rate and manner in which mono- mers connect to each other. The discovery of the Ziegler-Natta catalysts for the production of linear polyethylene and polypropylene is probably the most suc- cessful case. Indeed, research into new catalysts remains the focus of research efforts involving existing polymers, and the recently developed metallocene cata- lysts are viewed by many as a major breakthrough for plastics (Thayer, 1995~. As with synthetic dyestuffs, polymer science was marked by knowledge- based economies of scope. By establishing relationships between properties of materials and their molecular structures, polymer chemistry provided a system- atic basis for product innovations in several downstream sectors. For example, the macro properties of the polymer material, such as its strength or malleability, can be changed by varying the physical orientation of the molecules in a polymer chain. In addition, by applying heat and pressure, or by controlling density or melt indexes, many polymers can be made into any desired shape. The same basic material can then be used as a fiber, sheet, or film or molded to form a component or product of a specific shaped The product may be further fine- tuned in other ways. For example, chemists learned that engineering resins could be enhanced and extended by adding fillers and reinforcements such as glass or carbon to the polymer (Seymour and Kirshenbaum, 1986~. By varying the amounts of these materials, one could produce different grades of the engineering 9For instance, nylon with less than 15 percent crystallinity can be used to produce soft shopping bags, women's underwear with 20-30 percent crystallinity, sweaters with 15-35 percent crystallinity, stockings with 60-65 percent crystallinity, tire cords with 75-90 percent, and fishing lines with more than 90 percent crystallinity (Mark, 1994).
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CHEMICALS 53 resin. Ultimately, polymer chemistry supplied a common technological base in five distinct areas plastics, fibers, rubbers and elastomers, surface coatings and paints, and adhesives.l° The striking feature of these examples is that the underlying technological base generated opportunities for linking product markets that, to a final user, would appear to have nothing in common with each other. Because the technol- ogy had to be adapted for specific uses, commercializing a new polymer product required knowledge of the use of the material. In other words, there were econo- mies of scope but, in order to realize those economies, firms had to become knowl- edgeable about downstream users in a wide variety of markets. As with synthetic dyestuffs, the rise of polymer chemistry opened up vast new opportunities in the industry. But unlike dyestuffs, these opportunities were exploited by a much larger number of firms with comparable commercial and technological capabilities and from many countries. Consequently, even small information leaks allowed very rapid imitation. Thus, many chemical companies and some oil producers found themselves operating and competing in very simi- lar markets. For example, Union Carbide, Goodrich, General Electric, I.G. Farben, and ICI performed research on polyvinyl chloride (PVC) and produced the polymer from the very beginning. Similarly, Dow, I.G. Farben, and Monsanto were all involved in polystyrene from very early on. Du Font, ICI, BCC, Monsanto, Kodak, and many others invested in various kinds of polyamides, acrylics, and polyesters (Spitz, 1988; Aftalion, 1989~. The net result was an increase in competition in virtually every market segment. Thus, ironically enough, the diffusion of polymer science meant that the cru- cial problem in innovation shifted from how to produce different products to what to produce. Companies had to decide which applications were to be developed among the many that could be produced. This increased importance of "what to produce" increased the relative importance of marketing and downstream links with users to find out how to tailor products for their needs (Hounshell, 1995~. These trends are well illustrated by Keller's (1996) case studies of innova- tion in polymers. For instance, Keller notes that Quantum Chemicals, one of the largest producers of polyethylene, does little fundamental research in polyethyl- ene processes. Instead, it focuses on process improvement and optimization of processes licensed from other firms including Du Font, Union Carbide, and BP. It competes by providing "customer service" rather than lower prices or superior lessee Landau (1998) for a detailed discussion of two major innovations polypropylene, and puri- fied terephthalic acid for polyester. Spitz (1988) discusses how different the activities involved in the development of synthetic fibers were from those for plastics. ~ iAs noted earlier, the only exception to this was the research into catalysis and the improvement of existing catalysts. However, it is worth noting that cost reduction was not the only motive here. Rather, catalysts make possible greater control over the properties of the final product and thus cata- lyst research can be seen as an integral part of product innovation.
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54 U.S. INDUSTRYIN2000 properties of the product itself. Its research staff helps customers use various grades of polyethylene more efficiently in their processing equipment. To this end, Quantum has a large collection of commercial- and semicommercial-scale polymer processing equipment, including film lines and injection molding equip- ment, which it uses to demonstrate how its products would work. This and other examples show that polymers are increasingly seen as part of a system, rather than a product itself. Thus the desired properties will vary according to the vari- ous uses to which the polymer will be put. This implies that the effective econo- mies of scope are more limited than those implied by the technology itself. As noted earlier, the opportunities opened up by polymers induced a number of firms to enter, with the inevitable result that profits were sometimes below expectations. Even though individual firms may have been disappointed by the returns to their investments in synthetic polymers, there is no denying that syn- thetic polymers and chemical products based on these polymers were very suc- cessful, accounting for nearly 20 percent of the total value of shipments of the U.S. industry in 1970. The success of synthetic polymers owes a great deal to a steep drop in the cost of basic petrochemicals, which are the building blocks for synthetic polymers. This cost reduction was realized through process innovation, both radical and incremental, in petrochemicals and polymers. In turn, the devel- opment of chemical engineering was key to the progress in chemical processing technologies. CHEMICAL ENGINEERING: THE SCIENCE OF THE CHEMICAL PROCESS If polymer chemistry is the science of chemical products, chemical engineer- ing is the science of the chemical process. The job of the chemical engineer is to develop manufacturing processes for chemical products that emerged from labo- ratories, using commercially available equipment and inputs instead of the glass beakers and expensive reagents used in laboratories. The objective is to produce at unit costs that are low enough to make the product commercially viable, typi- cally by scaling up production to produce large quantities of output in a continu- ous flow plant.l2 Beginning with the concept of unit processes, chemical engineering was an attempt to abstract the essential and common features of chemical processes for a wide variety of products. The systematic isolation, categorization, and analysis of the basic processes (unit processes and, later, unit operations) common to all chemical industries meant that an engineer trained in terms of unit operations i2Scale up has therefore been a traditional focus of chemical engineering. As we discuss below, with slower growth and increasing product differentiation, the focus may be changing to emphasize flexibility and reduction in the cost of small scale production (see for instance Shinnar, 1991).
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CHEMICALS 55 could mix and match these operations as necessary to produce a wide variety of distinct final products. The separation between product and process innovation also made possible a division of labor that was to affect the competitive position of the leading chemical producers, a theme explored in greater detail later in this chapter. The general purpose nature of chemical engineering made it possible for university research and training to play an important role in applying engineering science to the practical problem of designing large-scale processes. Chemical engineering was a distinctly American achievement, which testi- fies to the unique nature of the university-industry interface in the United States.~3 The large size of the market had introduced American firms to the problems involved in large-scale production of basic products, such as chlorine, caustic soda, soda ash, and sulfuric acid as early as the beginning of this century. This ability to deal with a large volume of output, and eventually to do so with con- tinuous process technology, was to become a central feature of the chemical in- dustry in the twentieth century. This focus on large-scale production had additional benefits when it turned out that the new petrochemical technologies had strong plant-level economies of scale, with capital costs rising by less than two-thirds when production capacity was doubled. Because "scaling up" output was not a simple matter, and involved considerable learning, early experience with process technologies gained Ameri- can firms a head start when petrochemicals became the dominant feedstock after World War II. In an earlier era, this head start might have been expected to last for a long time. In petrochemicals, however, the rise of a new market for engi- neering and construction services, and eventually for process technology itself allowed other countries to catch up quickly. EXTENT OF MARKET AND DIVISION OF LABOR The rise of this new market involved a new division of labor and involved a new type of firm specialized process design and engineering contractors, here- after the SEFs. In addition to supplying proprietary processes, some SEFs also acted as licensers on behalf of chemical firms and provided design and engineer- ing know-how. During the past ten or fifteen years, SEFs may have declined in importance but in the post-World War II period as a whole they have played an important role in developing new and improved processes and a crucial one in diffusing new technologies. As one might expect, given the comparative emphasis on large-scale produc- tion, the United States enjoyed an early lead in chemical engineering of plants. The first SEFs were formed in the early part of this century, and their clients were i3See Landau and Rosenberg (1992) for a discussion of the role of M.I.T. in the development of chemical engineering as a discipline. The discussion here is based on Rosenberg (1998).
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64 U.S. INDUSTRYIN2000 leading European countnes, similarly shows R&D spending has grown there, primarily in the life sciences area.24 The slowdown in R&D spending also reflects a growing international panty in technological capabilities. Recent estimates suggest that Japanese firms are now at par with their European and U.S. counterparts in R&D spending as a percentage of sales. R&D intensity in the Japanese chemical industry has been rising steadily during the last ten years, from less than 4 percent in 1985 to well over 5 percent in 1995, making it more research-intensive than the European and U.S. industries (Figure 3~. However, this trend may not be sustained in view of the recent, well-publicized, recession in Japan. 60 4 3o~ gold of | US A Jap" EU EU 1% _ _ _ _ (' ~ ~ ~ ~ ooze _ _ _ . _ ~ _ ~. . . . . 5* ~_~ = ~ _ . . Note: Estmadc for r1 ,A<~ ED .d~ _ l from Gerrr~ry, UK, Belgium I Nearly From S~n~Ital~' 15B5 15~6 15B? 1!~8 15~9 1~0 15~1 1~2 1~3 1~4 1~5 FIGURE 3 Chemical industry R&D spending as a percent of sales: International com par~sons. Source: R&TD and Innovation in the EU - Economic Bulletin - June 1997 Article 2 chart 4, http:// www. cefic.be/Eco/eb9706b .htm 24We lack comparable data for Japanese chemical companies but as Figure 3 below suggests, R&D spending by Japanese firms is likely to have gone up during this period.
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CHEMICALS 65 Nonetheless, other trends point to the increasing international panty as well. Royalties and license fees paid by U.S. subsidiaries grew at an annual rate of 23 percent between 1986 and 1996 and stood at about $1.5 billion a year in the m~d- l990s. Royalties and license fees paid to American firms grew at 15.7 percent annually during the same period and stood at about $3 billion a year in the m~d- l990s. Thus, the United States is still a net seller of chemical technology, but its outflows are growing faster than its inflows. This is consistent with the fall in the relative share of U.S.-based companies in U.S. chemical patents, a figure that has fallen from 66 percent in 1970 to 55 percent in 1980 to about 52 percent in 1995. Dunng the same time, Japan's share increased from 6 percent to 12 percent to nearly 17 percent. Further examination of the structure of R&D reveals other trends consistent with this story. In real terms, chemical R&D has grown, but much of that growth has been in the drugs and medicines sectors (Figure 4~.25 R&D spending in real terms has remained constant at best in industrial chemicals and sectors such as paints and inorgan~cs. Indeed, the share of industrial chemicals (inorganic, or- ganic chemicals and plastics and synthetics) in total chemical R&D spending has declined from 43 percent in 1970 to 30 percent in 1995. To some extent, these trends reflect the increasing importance of drugs in the chemical sector and the concomitant decline in the share of plastics, fibers, and ~ ~ Chemcals and allied products ~ industrial chemcals 18.000 16,000 14,000 12,000 1 0,000 ~ 8,000 - 6,000 | ~ Mugs and n~dicines -~- Other chemcals 2,000 ~1: ~--a ~ o 1 1 1 1 1 1 1 1 1 1 1 ~oo a) oo oo a: ~oo ~a) ~ ~a) ~a, V ~-- - con ~ a) can en FIGURE 4 Company finance R&D expenditures ($ millions in 1992 constant dollars). Source: Our calculations from CMA, 1997 data. 25Figure 4 shows company financed R&D only but this accounts for the vast bulk of R&D spending in chemicals.
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66 U.S. INDUSTRYIN2000 organic and inorganic intermediates. For instance, the share of industrial and others in shipments, declined from 60 percent in 1980 to around 50 percent in 1995. But there is more to the story. With the maturation of the technology in polymers and chemical engineering, R&D intensity in the industry has declined, if pharmaceutical related R&D is excluded. In industrial chemicals it has hov- ered between 4.4 and 4.1 percent, while in the other non-drugs sectors it has declined steadily from 3.3 percent in 1986 to close to 2 percent in 1995. For drugs, the figure has risen steadily from about 8.4 percent in 1986 to well over 10 percent for the same time period, approaching 12 percent in barely two years. For the U.S. chemical industry as a whole, National Science Foundation (NSF) figures show that the "D" of R&D accounts for about 53 percent of the total. In industrial chemicals, however, the share of development tends to be higher and appears to have risen over time. Although changes in definition and coverage make precise comparisons difficult, the available data show that for company-financed R&D, the share of development increased from about 53 per- cent in 1989 to 62 percent in 1995. These figures point to the changing role of technology in the industry. Sim- ply put, there is a market for certain types of technologies. As noted in the dis- cussion of SEFs, chemical firms are much more willing than before to license their technology for profit. Moreover, many firms explicitly consider licensing revenues to be a part of the overall return from investing in technology. In turn, this readiness to license technology implies that generic or basic research will not be replicated as widely as it used to be. Instead, firms will license the ge- neric process technology and, as illustrated by the example of Quantum, focus on adapting and improving the technology to best suit their needs and those of their customers. Perhaps the most vivid example is the metallocene catalysts, which have been used in many of the most significant process innovations in recent years because they provide greater impact strength and toughness, melt characteristics, and clarity in films than do existing catalysts. Total investment worldwide in metallocene research has been estimated at close to $4 billion (Thayer, 1995~. Commercially first used in the production of polyethylene in 1991, metallocene catalysts are being applied to a wide variety of polymers, exemplifying the inher- ent economies of scope in the technology. Several firms are active in this research area. Dow and Exxon are regarded as being ahead of the rest in polyethylene, while BASE, Hoechst, Mitsui Toatsu, Fina, and Exxon are also active in polypropylene, and Du Pont and Nova are developing alternative catalyst systems. Both Dow and Exxon have allied with other process innovators to combine the catalyst system with processing tech- nologies largely specific to the major polymers like polyethylene and polypropy- lene. For instance, Exxon has formed a technology joint venture, Univation, with Union Carbide, combining its Unipol technology with Exxon's catalyst (Chemi- cal Week, 1997a). Dow and BP have a similar arrangement.26 What is notewor
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CHEMICALS 67 thy is that both groups are actively trying to license their technology for commod- ity-grade but not specialty-grade polyethylene. This has encouraged other firms to develop complementary technologies. For example, BASE, Phillips Petro- leum, and BP are developing ways of using metallocene catalysts in existing slurry processes, many of which will be licensed.27 Interestingly enough, al- though SEFs are not among the major innovators, their role in improving pro- cesses in the past suggests they are likely to develop improvements and modifica- tions in metallocene catalyst-based processes in the future. They are therefore likely once again to play an important role as diffusers of new process technology. This willingness to license demonstrates that firms consider technology to be valuable but not necessarily the key source of competitive advantage. As docu- mented in Arora (1997), the metallocene licensing is only the continuation of the trend that began in the 1970s. In addition to companies such as Union Carbide, Amoco, Montedison (later through Montell, its joint venture with Shell), Phillips, Exxon, and BP that have been licensing their technologies for quite some time, a number of leading chemical producers such as Dow, Monsanto, Du Pont, and Hoechst are actively rethinking their traditional reluctance to license. For in- stance, Dow expects to earn $100 million in licensing revenues by 2000, while Du Pont hopes to reach the same target by 2005. Monsanto has licensed its acrylonitrile technology and is looking to license its acrylic fiber and detergent technology (Chemical Week, 1997c.~. Even Hoechst is reported to be contem- plating a reorganization of its R&D structure, with an explicit emphasis on licens- ing technologies developed in-house (Chemical Week, 1996~. As a result, tech- nological capability is more evenly distributed than ever before. A complementary trend is that R&D itself is being globalized. As Table 5 shows, American companies are directing a substantial fraction of their R&D spending overseas; in 1995 American firms spent $4.2 billion nearly a quarter of their total R&D budget on research overseas. We lack comparable figures for foreign firms but a recent survey found that, excluding biotechnology and pharmaceuticals, there were 42 foreign-owned chemical research laboratories in the United States, accounting for about $400 million in R&D spending and em- ploying more than 11,000 people. Counting biotechnology and pharmaceuticals, the aggregate figures increase to nearly $3 billion in annual R&D spending, or about 15 percent of the industry total, and more than 30,000 employees (Florida, 9971~28 26There are other technology sharing alliances as well in this area, including Dow-Idemetsu and Exxon-Mitusi Petrochemicals in polyethylene, and Dow-Montell, Hoechst-Exxon, Hoechst-Mitsui Petrochemicals, and Fina-Mitsui Toatsu in polypropylene. 27For instance, a spokesman for Phillips is quoted as saying that the company is likely to offer its proprietary metallocene LLDPE slurry technology for license (Chemical Week, 1997b). 28According to a recent news report, in 1995 Hoechst spent a majority of its R&D budget outside Germany for the first time in its history.
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68 U.S. INDUSTRYIN2000 TABLE 5 Company Financed R&D Performed Outside the U.S. by U.S. R&D Performing Domestic Companies and their Foreign Subsidiaries All Industrial All Industrial chemicals and others Pharmaceuticals, chemicals and others Pharmaceutical ($ millions) ($ millions) ($ millions) (percent) (percent) (percent) 1985 843 444 399 1986 1071 579 492 12.36 11.56 13.45 1987 1243 625 618 13.16 11.68 15.09 1988 1548 855 693 14.30 14.42 14.14 1989 1532 609 923 12.83 9.47 16.75 1990 2007 720 1287 15.24 9.93 21.75 1991 2401 1009 1392 16.63 13.47 20.04 1992 2676 1045 1631 17.73 14.60 20.56 1993 2833 1318 1516 17.13 17.80 16.60 1994 2456 917 1539 14.83 13.22 15.99 1995 4194 1632 2562 24.19 22.87 25.11 Source: NSF/SRS, Survey of Industrial Research and Development (1995). Internationalization of R&D is not entirely new to the industry. The famous technology cooperation agreement in the 1930s between Standard Oil and I.G. Farben was based on bringing together U.S. expertise in refining technologies and German expertise in organic chemistry and coal gassification and liquefac- tion. The patents and processes agreement between Du Font and the British ICI also had a patents and processes agreement that lasted for more than a decade until the end of World War II. Similarly, in 1928 Shell Chemicals set up its petrochemical R&D unit in Emeryville, California, rather than in the Nether- lands or Britain. The international technology cartels that Solvay and Nobel put together in the nineteenth century in alkali and dynamite, respectively, show quite clearly that international technology cooperation has a long history in chemicals. This internationalization has gained strength in recent decades, reversing the frag- menting effect of World War II. Several forces are driving the current internationalization. Products now have to be customized to meet the needs of local customers. Different regions of the world appear to be becoming technologically specialized. Both factors reflect a division between basic or general purpose research not tied to specific appli- cations and downstream application and development research, which is de- centralized and globally dispersed. Fundamental research, on the other hand, is becoming geographically concentrated. Thus, many leading German firms view Germany as the best suited for fundamental research in organic synthesis, Japan for electronics chemicals, and the United States for life sciences.
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CHEMICALS 69 This separation between general-purpose research and research specifically tailored to products and applications has important public policy implications. Traditionally, R&D, including basic chemical research, has been privately fi- nanced. Firms were larger, had more diversified portfolios, and hence could better appropriate the benefits of the new knowledge they produced. Under the current competitive pressures in the output and capital markets, companies are moving their R&D toward more applied, product-oriented research. Yet, many industry analysts argue that a key challenge facing the chemical industry is the development of a number of new methods and generic technologies that can be used as critical tools and knowledge bases for innovation in many chemical in- dustry segments. For example, areas such as chemical synthesis or catalysis, as well as broad fields, such environmentally friendly products or processes require in-depth understanding of products, processes, and related phenomena before more specific problems and applications can be solved effectively. Similarly, although the life sciences have already witnessed several important scientific ad- vances, there is still a significant need for fundamental research to enhance new product development opportunities in areas such as drugs, biocatalysts, and bioprocessors. The development of computerized modeling techniques has also become a key challenge. Although molecular models have been used for some time in the pharmaceutical sector, their use is now expanding in areas such as organic chemicals, as well as new materials and processes. Chemical modeling techniques require greater understanding of the fundamental aspects of the phe- nomena that have to be modeled as well as the creation of simulators, which are inevitably general in nature (Vision 2020, 1996~. In fact, the need for more general tools and methods is not confined to the newest technologies and scientific disciplines. Basic research will also be key in the development of new processes, in the design and engineering of new plants, and in enhancing the manufacturing efficiency of chemical production. The plant design and engineering tools in use today have not changed much from those of chemical engineering in the 1960s. A more systematic use of computerized soft- ware engineering tools in the design and operation of plants is in its early stages. On many occasions new plants are still built almost entirely "from scratch," with little re-use of concepts, tools, or even equipment used in similar plants. Thus, another R&D goal is to develop "modularized" equipment or process structures that can be employed repeatedly in many plants of similar type or nature. A related issue is how to reduce the engineering costs of designing and con- structing new plants as well as the unit production costs in plants that produce at smaller scales than has been the tradition. As noted earlier, unit production costs in chemicals have been lowered typically by increasing the scale of plants. But today' s overcapacity problems imply that companies have to devise ways to ob- tain low unit costs of production even with plants of smaller scale. Advances in this area can come about only through a better understanding of process science
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70 U.S. INDUSTRYIN2000 and engineering to standardize the underlying structure of the processes as well as equipment and plant components.29 The questions that arise are who will carry out this basic R&D, and who will pay for it? The problem is serious because basic R&D is marked, much more than product-specific R&D, by high fixed costs and economies of scale. These costs can be amortized only if they can be spread over a very large downstream market or a large number of different markets. The chemical industry does have large and diversified companies, but in recent years these companies have been narrow- ing their product portfolios at the same time as the knowledge required is growing more complex and interdisciplinary. Reduced market opportunities for many chemical companies, caused by slower demand growth and increased competi- tion, have intensified the problem (see, for instance, Lenz and Lafrance, 1996~. In short, today the chemical industry is facing the classic problem of market failure in R&D. Basic and long-term R&D offer the potential for significant long-term benefits, but individual firms may not have enough incentives to ex- plore that potential. The solution will almost certainly involve industry-wide research projects in areas such as environmental technologies. Such agreements are already in place in the United States under the auspices of the Chemical Manufacturer's Association, and there are similar pressures in Europe, in envi- ronmental and many other chemical fields, coming from the European Chemical Industry Council (CEFIC) and the European Union itself (AllChemE,1997~. In- ter-firm joint ventures and university-industry collaborations will also be impor- tant parts of the solution (Vision 2020, 1996; Lenz and Lafrance, 1996~. Thus, wider collaborative arrangements will be key factors in providing new, critical enabling technologies that encompass many distinct product applications. Gov- ernments and public research agencies will play an important role in this respect, both in funding pre-competitive research and in improving cooperation in the upstream research. One possible future outcome is that the major investments in basic R&D will be concentrated in a few regions or countries, with the new knowledge then being diffused or transferred more broadly. In some cases, the concentration is likely to depend on the location of the first movers, those that are the first to make the investments in a particular research area. We argued earlier that different coun- tries or areas may become increasingly specialized in different research fields. It is likely that the United States will play a key role in this respect. The U.S. chemical industry has been the first to raise concerns about the need for funda- mental chemical research, a problem that Europeans are only recently beginning to discuss (AllChemE,1997~. As a result, the United States as a nation may well bear a large fraction of the fixed cost that is needed to advance basic research in 29For instance, Shinnar (1991) reports the example of ICI, which succeeded in building a new 500- ton ammonia plant that was competitive with traditional world class ammonia plants producing 2000 tons of ammonia daily.
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CHEMICALS 71 chemistry, particularly in key areas such as the life sciences, environment, and computerized modeling of products and processes, including software. Other countries will get access to this knowledge at marginal rather than average cost, but with a lag. This phenomenon has already been observed in the life sciences, where much of the basic research is being conducted in the United States, some of it by foreign-owned companies, with the results being used by companies from other countries. As a final note, one should not forget the lessons of the SEFs in the 1960s. The knowledge that flows from one country to the rest of the world is not just "in the air." The transfer typically requires intermediating institutions that carry the burden of moving the knowledge across locations. The SEFs had the right incen- tives to "sell the technologies" because they had no stake in the product markets and hence were not restrained by the fear of creating greater downstream compe- tition. Other intermediating institutions will probably play a very similar role in the next few decades. Small and medium sized research-intensive biotechnology companies have already acted as intermediating institutions in the early rise of the biotechnology industry, and the SEFs themselves are quite likely play this role again once new chemical process technologies become more standardized. Similarly, many independent software vendors specialized in commercial soft- ware for molecular modeling, process simulation, and the like are increasingly diffusing the computerized tools for more efficient automated chemical research . . ant engineering processes. CONCLUSIONS The evolution of the chemical industry has been driven by advances in tech- nology and by the institutions that have facilitated the growth of new markets. In addition to the conventional market growth in the form of demand from develop- ing countries, the evolution of the chemical industry has also been profoundly affected by the growth of a market for technology and a market for capital. When technology becomes widely available, albeit at a price, it ceases to be a decisive source of competitive advantage, be it for firms or for countries. Instead, com- petitive advantage must be sought elsewhere, in cheaper inputs or in closeness to markets. Similarly, a global market for capital gives shareholders the opportunity to look for the best returns, putting managements under pressure to cut costs and improve shareholder value. In the chemical industry, technological superiority was often a key compo- nent of competitive advantage, and the clear relationship between advances in chemistry and chemical engineering had led the market leaders to fund a substan- tial amount of basic research. Developments in the industry in recent years have weakened this incentive. These developments have tended to raise the payoff to applied, business-driven research relative to more basic and fundamental research. The industry has responded by forming industry-wide research initiatives in spe
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Representative terms from entire chapter: