Lubrizols Additives business, which in 2008 had revenues of $3.5 billion, or 70 percent of the companys total, began braking for the downturn in the years final quarter. Its goal now for 2009 is to deliver an operating income as good or better than last years $427 million, by defending margins and reducing costs. The road has been bumpy – volumes fell 24 percent worldwide in first-quarter 2009 versus the same quarter in 2008 – but the business segment is fighting to do just that.

Late in May, LubesnGreases sat down for an exclusive interview with Dan Sheets, the new president of Lubrizol Additives and a 25-year veteran of the company, at its headquarters in Wickliffe, Ohio. A graduate of Penn State and vocal fan of the Pittsburgh Steelers football team (awkward in a town that loves the Cleveland Browns), Sheets spent his first 16 years at Lubrizol in its coatings and specialty chemicals areas. In 2000, he moved to fuel additives, then into engine additives, and in 2005 became vice president of sales for the entire Additives business. He stepped into the role of Additives president this past September.

The position of Lubrizol and the other addcos is somewhat unique, because of what additives companies do in the value chain, Sheets remarked. Ive looked but not seen another industry where suppliers play such a vital role. We have to understand the chemistry and also understand the application; to formulate, test, get approvals, certify products and in some cases enable our customers to get product licenses. Yet, at the end of the day, we dont sell the finished product – we help our customers go to market and capture value.

Sheets emphasized that Lubrizol needs to be rewarded for this leadership, even in the face of todays reduced demand. In operating this company, two things I know to rely on every year. First, well spend about $100 million in capital expenditures, to maintain an asset base that has a replacement value of $4 billion. It takes nearly $75 million of that just to keep operations running and for environmental, health and safety initiatives. Tens of millions more go to support market demand growth with new product manufacturing facilities, such as the new polymethacrylate unit that we recently installed at our Painesville, Ohio, plant. Second, we spend another $150 million annually in R&D. So we need to make a certain level of return, to make sure were recouping those investments.

In the face of slack demand though, the business has postponed some expenditures ear-marked for expansion. Plans to build an additive plant in China, originally announced in March 2008, are being reevaluated. That announcement was based on demand we were seeing at that time, which was growing 1 to 2 percent a year. With any capacity expansion, risk number one is supply and demand, he said, and the current outlook is simply not favorable. Its critical that we not build plants that sit idle. Meanwhile, we are doing some debottlenecking at our plants in France and Texas, Sheets pointed out. These are all good investments. We still want to build in China, and we will do it. But we first need to revalidate the best timing.

Looking at the various additive companies, were unique because were publicly and broadly held, Sheets continued. With things as they are on the credit scene now, the cost of capital is climbing. And we need to be able to assure our investors that any project will make money for the shareholders. Our board of directors has approved the investment in a new China plant – but the timing must be right to provide a sufficient return.

Growth through acquisition is another leg in Lubrizol Additives strategy. In mid-May, the company indicated it was casting an eye towards acquisitions, but Sheets declined to say if something specific is on the anvil. I will say that we are looking for things that are complementary to what we do.

Meanwhile, two smaller businesses – AMPS specialty monomers and ADEX explosives emulsifiers – have joined the segment, moved from Lubrizol Advanced Materials (formerly the Noveon business). Both products are legacy Lubrizol businesses, the corporations Chief Operating Officer Steve Kirk told LubesnGreases, but at the time of the Noveon acquisition, anything that wasnt purely additives was categorized under the Advanced Materials business. Clearly the two products align better under the Additives segment; for one thing, they are manufactured in Additives facilities. For another, Sheets is very familiar with the AMPS products and market, having worked in that area for so long.

Additives again expects to spend about $150 million this year on research, product development and testing, with about half of that for required product testing. We spend about $5 million a year just in screening new components, Sheets observed. You cant keep using the same old chemistry, because the pace of change has accelerated for lubricants used in automotive, heavy vehicles, drivetrains and industrial applications. Not just performance, but also environmental, health and safety, and emissions regulations are keeping pressure on additives.

Due to technological demands and specification changes, most of the R&D spend goes for automotive additives, versus industrial products. One recent venture is the roll-out of the HyperZDP System, a highly stable antiwear additive technology that meets reduced phosphorus requirements for engine oils while delivering strong protection. Lubrizol Additives expects this chemistry to be the cornerstone of its additive pack for ILSAC GF-5, the new engine oil specification slated for market in 2010.

There also are good differentiation opportunities on the industrial side, and were pursuing these too, Sheets said. For example, on the industrial side, we have a new clean-hydraulic fluid product that dramatically reduces varnish in the system. It allows more uptime, and requires less time offline for cleaning. The financial investment for this kind of product tends to be lower than on the automotive side, but the opportunities are no less significant for our industrial lubricant customers.

Lubrizol can do this research because it is deeply involved in the lubricants industry, he said. We differentiate ourselves not on size, but on the depth of our technology and the breadth of our technology. We cut across more end-use areas than the others.

Nevertheless, when deciding which products deserve attention and resources, some opportunities are more attractive than others, and so are some customers, Sheets conceded. We want to know, will they work with us? Were not trying to chase every piece of business. Instead, we want to find out where we can add value to the relationship. The best customers are the ones that are more differentiated, with a strong brand, and who will take a value message to the market.

In fact, not all the marketers understand the complexity of lubricants, that its a highly engineered material, he went on. Generally, we want to steer away from the low-cost/low-value approach. Technology is valuable and industry has to value it. Customers who want volume only are welcome of course, but its the customer with a value message we want to work more closely with.

This emphasis on value is key to preserving margins. Having raised prices last year in response to rapidly increasing material costs, the company is determined not to give back too much this year. We had two price increases in the first half of 2008, and we have provided price relief in 09 to our customers, Sheets firmly stated. Are we back to where we started? No, and were starting to see an uptick in our raw material costs – crude, natural gas, petrochemicals. Our customers are facing the same issue with their end users.

Cost control measures also led Lubrizol in February to lay off about 170 employees, from a total workforce of around 6,900. Less than 25 percent of the cuts came from Additives, Sheets said, and morale is extremely good. Every other week, he meets with different groups of employees to hear their views. Mostly, I hear theyre happy that Lubrizol is doing OK, that were investing in the business. In the first quarter, there was a sense of uncertainty, but now they see were moving forward.

And weve not had a hiring freeze at Lubrizol, he pointed out. We actually have hired when weve seen longer-term growth opportunities, such as overseas. We now have about 100 PhDs with the company, and another 120 with masters degrees.

Additives in fact hopes to attract more top scientists, says Doug Barr, head of Wickliffes chemical synthesis labs. This is the molecular engine of our business, where we come up with new chemistries driven by technological needs, he explained during a brief tour. Originally built in 1972, the labs are halfway through a much-needed upgrade which will be finished next year. The renovated workbench areas are modern, airy and sunlit, and separated from scientists offices with glass partitions.

The modernized labs are appreciated by both current staff and potential hires. We were trying to recruit the same people and graduates as other industries, particularly pharma, and the outdated labs didnt help, Barr said. The new labs help us to compete for the top people.

A short stroll away are the mechanical testing labs, where processes are hammered out and performance tests run on products. Lubrizol operates some 150 test stands worldwide; over 90 of them are in Wickliffe, including three engine test stands for the new Sequence VID fuel economy test and one for the current VIB. Driveline and axle test equipment also crowd the space; housed in a separate building nearby are heavy-duty diesel test stands, each in its own cell to dampen noise and vibration.

Pete Kampe, mechanical testing manager, points to stands for automatic transmissions, dual clutch transmissions and continuously variable transmissions. He expects all three to be in heavy use in the coming years, as auto makers shift through their powertrain options. This is another area where R&D spending probably will grow.

Automatic transmissions can look like a horse race, said Sheets. Which transmission technology will capture the market? More and more, its looking like well have multiple types and geographic divergence. Five-, six-, seven- and eight-speed automatics will be used in North America and elsewhere, while CVTs are preferred in Japan, and dual clutch transmissions are winning out in Europe. In fact, we have to place bets on all of them, and have to be ready in case one of them does win. For now, its looking like fragmentation is what well end up with, with a high degree of specialization and different fluid types. Separately, these may not be as large a fluid market, but each one is complex. Well have to factor that into our pricing and development processes.

On the flip side, Im excited about the changes in the industry. We see substantially more change and complexity coming. Weve accepted that challenge and made the commitment to be there for our customers. Were working to solve problems – but need to get paid for it and earn a return on our investments. Its important that the industry understands theres more to it than product in a tank car. We have made commitments going forward, to support our customers, and we will deploy our substantial people and physical assets to help our customers win in the marketplace.