Winning in the age of commoditisation— three imperatives for GCC players

Today, GCC economies are highly dependent on commodities, with fossil fuel revenues making up 70-90 per cent of several GCC countries’ fiscal revenues.

Commodities such as petrochemicals and metals like aluminium and steel also significantly influence the remaining non-oil revenues.

In recent years, however, commodities have faced several headwinds that have impacted their ability to create value for GCC economies and regional companies.

First, the US shale revolution rapidly flooded the market with abundant oil supplies, which in turn depressed oil prices and created budget deficits in several GCC countries.

Second, China’s massive capacity build-up over the last decade in several materials such as chemicals and metals has created an oversupply situation and lead to the commoditisation of several products.

Finally, the global economic slowdown will ensure that overcapacity in several industries will remain in the near future. Naturally, this has strongly affected the profitability of several GCC companies in the region that play a major role in commodity markets.

While some may categorise these recent trends as ‘short-term cyclical challenges’, it may actually mark the onset of commoditisation — a shift that businesses and countries in the GCC must urgently prepare for. After all, commoditisation — the act of rendering unique, valuable processes, goods or services affordable and widely available — is often seen as the kiss of death for an industry, leading to slower growth, falling prices, and increasing competition.

In reality it need not be a death sentence. But surviving it, or even benefiting from it, can entail drastic measures such as rethinking strategy, repositioning the company in the industry’s value chain, and overhauling its operating model.

For various reasons, many businesses facing commoditisation often fail to respond with anywhere near the required boldness or speed — some may not even recognise or acknowledge the challenge, let alone succeed at crafting an effective plan to address it.

Based on this it is clear that to emerge as winners in this age of commoditisation, GCC companies must act before it’s too late. In particular they need to understand that they can gain a competitive edge in commoditised markets by following three imperatives:

• Cost-based advantage
Companies should evaluate their portfolio to understand their position on the supply curve and how it can be improved. For example, in energy intensive industries like aluminium smelting, access to cheap energy can be a big source of advantage. Some companies — such as Qatalum, an aluminium manufacturer in Qatar — have built capacity in the region based on relatively lower energy sourcing cost and positioned themselves in the first quartile of the supply curve. As a result, they enjoy healthy margins in the commodity metals industry. Companies should also evaluate the evolution of the cost curve. If the cost curve as a whole is getting flatter, then the value may be shifting to other parts of the value chain. Companies should accordingly allocate investments in other parts of the value chain.

• Advantage based on market imperfections
Market imperfections arise when it is difficult to predict where supply meets demand – which makes predicting prices tricky and often leads to price volatility. Players that are able to detect and react to search imperfections can generate significant value for themselves through market arbitrage. For example, asset-backed trading with commodities like oil and refined products can bring additional value to the company. This is what oil giant Saudi Aramco is achieving by trading in the refined markets space. Their trading arm enhances the system’s balance of refined petroleum products to optimise and support their downstream investment portfolio — in the kingdom and overseas. This helps the company better capture trading opportunities and create more value for its products.

• Product differentiation
The overhaul of products’ characteristics and value proposition can be a highly effective way to confront commoditisation. It is an effective way for companies to differentiate products and extract additional value. For instance, over the last few years, Saudi Arabia’s petrochemical company SABIC has continually increased its innovation spending to increase the number of its patent-protected products. This will allow the company to extract more value for its products. However, product differentiation requires capabilities in innovation that may be relatively harder to find in the region, but can be overcome via global partnerships. One example being the petrochemical company Sadara, a JV forged by The Dow Chemical Company and Saudi Aramco, to add further value to Saudi Aramco’s petrochemical products.

Many companies will instinctively lean towards creating a cost advantage, often putting less emphasis on exploiting market imperfections and more emphasis on re-differentiating their products. But there is significant value to be gained from all three sources, depending on how the industry evolves.

Companies that have built the capabilities necessary to exploit market imperfections can succeed with relatively modest capital expenditures and a moderate level of risk, making this an attractive option under the right circumstances.

To come out as a winner in the age of commoditisation, the above three imperatives need to be considered by GCC companies dealing with commodities to ensure a competitive advantage and continue to capture value from products.

Bjorn Ewers is partner and managing director at BCG Middle East