After two years of pressure on earnings from rising base oil costs, 2019 holds promise for some lubricants marketers and distributors. Why some rather than all? The upside belongs to those that make the right moves to regain growth momentum.
To begin charting the path toward success, its critical to note several powerful market developments and disrupters on the horizon. These complicating factors are:
Impact of electric and autonomous vehicles on the automotive lubricants market
Expansion of regional automakers and their genuine oil brands
Industrial performance levels and government restrictions of toxic substances
Vessel General Permit compliance for marine vessels
Yet the lubricants business remains attractive. The formula for success is getting past certain challenges to capture areas of significant growth. For this purpose, we examine the most important industry trends: value chain consolidation, margin compression and the changing marketer-distributor relationship. This analysis identifies the obstacles, sources of new growth and strategies and enablers that can deliver value.
We also need to consider metrics that allow us to judge success. These measurements help navigate near-term recovery as we look toward investment opportunities on the 2040 horizon.
Companies investing in emerging and growth countries to build brand presence and distribution needed a framework to navigate complex and dynamic markets and competitive issues. Jagger Advisory developed the marketers gross margin as a key metric for this purpose. We define gross margin as the marketers net revenue from direct and distributor sales, less the cost of goods sold, which includes base oil, additives, packaging material and manufacturing costs.
Today, the total global gross margin for all lines of business is $31.5 billion with an average unit gross margin of $0.82 per liter, based on total market size of 36.4 billion liters of finished lubricant products. By 2025, Jagger Advisory predicts that the global marketers gross margin will grow by 23 percent. This will come mainly from ongoing volume growth of premium and synthetic lubricants in the consumer and industrial businesses, as well as cost efficiencies generated by industry consolidations. Regionally, Asia-Pacific and the Middle East will contribute 60 percent of that growth.
Strategically speaking, marketers need to aggressively continue the momentum in trading up to higher-value products and achieve geographic diversity to mitigate volatility and deliver reliable new value.
Consolidation: Obstacle or Opportunity?
Have no doubt about it-consolidation in the global lubricants business is accelerating, and it spans supply chain operations, marketing, distribution and both business-to-consumer and business-to-business trade channels. Can marketers and distributors gain from it? Trends are working against that, namely flat to declining product demand in North America and Europe combined with more competition. As such, sales synergies and margin growth are considerably more elusive.
Playing the role of an industry consolidator drives down costs. Companies that go this route realize benefits immediately. Marketers are integrating along the supply chain to try to capture more value. They are moving into adjacent businesses, such as digital and non-digital services, and testing new business models. For example, Shell LubeChat is the first artificial intelligence-powered chatbot for B2B lubricants customers and distribution. Also, Fluid Vision Technologies LLC provides automated industrial fluid condition monitoring technology. Whats more, the application of Industry 4.0 automation and data exchange technologies could bring significant maintenance cost savings, though such activity is still in early stages.
The Specter of Margin Compression
Theres the normal business cycle of margins driven by rising and falling cost of goods sold. Theres also the longer-term impact of competitive pressures, which compress average margins as certain product categories become commodities. We see an inflection point, which occurs after 2025 in the consumer sector. Thats when unit margin compression accelerates by way of increased penetration of national oil companies, independents and private-label players, as well as moderation of volume growth through the impact of electric vehicles.
Brand extension is one powerful tool marketers can employ to capture more margin from their synthetics portfolio by targeting niche customer groups. For example, in North America, ExxonMobil has 12 brand extensions for Mobil 1, including the Mobil 1 Annual Protection (designed for a 20,000-mile or one-year oil drain interval) and Mobil 1 Truck & SUV brands. Shell does, too, for its entire Shell, Pennzoil and Quaker State portfolio.
In the commercial market, Chevron has eight brand extensions for Delo 400. Of course, not all marketers can go this route. It depends on their sales and marginpotential, required technology and marketing investment and added operational complexity.
Marketers also can re-balance their portfolio in favor of the commercial and industrial segments, where collectively the gross margin pool will grow, according to our projections, about 60 percent by 2040. The gradual growth of synthetics in the commercial sector, as well as the high-margin industrial specialties business for aerospace, automotive manufacturing, mining, transport and power generation customers, will hold significant opportunities.
Partners or Adversaries?
Whether marketers and distributors are partners or adversaries is an issue of cause and effect. As marketers have relinquished direct business to lower their support costs, the role of distributors has expanded to take on customer-facing supply chain and marketing functions. As such, marketers traded away customer intimacy for cost efficiency.
Savvy marketers have tested a wide range of national, macro and regional distributor models to forge networks based on marketer-distributor partnerships. Enterprise systems are the bridge for connections between customers, distributors and marketers. Some partnerships-but not all-have worked, reflecting local market complexities and the fact that one model does not fit all.
Now for the financial realities. These new macro-distributors, which handle all activities of a marketer, need growth to support financing. In many markets, there is no strong underlying volume growth. Macro-distributors have captured value by shifting more of their branded business to their own higher-margin private labels and by extending into niche product lines and services for trade customers. Today, the global average margin for distributors on all lines of business stands at $0.59/liter, substantially less than their marketing partners.
Once they achieve the scale of a national or regional platform, these macro-distributors should compete on equal footing with the oil majors for national and strategic account business, including direct supply to OEMs and their dealership networks. This is the end game-to take a larger piece of the value pie.
In response, marketers should strive for approaches that marry world-class customer offers and support with the strong logistical reach and supply assets of distributors.
Defining Success
In the face of these challenges, what will it take for lubricant marketers to win and deliver value? It boils down to a few must-have elements to get right as part of a regional or global strategy. Other than changing the portfolio balance and distribution model, what else can they do?
The customer offer. Standardize the customer offer globally to provide more consistency and reliability with less customer intimacy and flexibility. Cut supply chain and customer service costs by reducing product-brand variants-SKUs-and increasing minimum order quantities and lead time standards. Leverage global customer relationship management systems and centralize customer service centers.
Organization. Empower sales teams to respond to local market volatility, but with strong guard rails coming from regional enclaves of marketing, sales and technology. Leverage operating scale to lower cost of goods sold by consolidating manufacturing sites.
Marketing and technology. Align spending levels with business scope and scale. Ensure marketing investment supports the customer offer and defends key volume positions through business cycle events.
Pricing. Direct sales or marketing teams to drive mass and special pricing changes to derive critical speed-to-market in light of persistent market volatility, yet enforce strong discipline and clarity on the overall pricing framework.
In financial terms, what does winning look like today?
Leading multinational oil companies and global independents, which command about 50 percent of the market, deliver on average $0.40/liter of operating income (EBITDA) and exceed the market-average gross margin of $0.82/liter. The portfolio is geographically diverse with premium tiers that have a high level of capital efficiency. Lubricants organizations generally are regional enclaves and integrated with other downstream fuels, refining and chemicals businesses to share assets and resources.
National oil companies claim about 20 percent of the global market with home-country focus. They deliver on average $0.20/liter of operating income and fall below the market average gross margin of $0.82/liter. The portfolio is a broad, second-tier product mix with less capital efficiency and investment in their supply chain to become competitive global players.
Regional independents and private label players represent the balance of the market and are a fragmented group advantaged by low operating costs and speed-to-market, which generally offset a lower competitive price position. Operating income ranges widely, but with efficient distribution and the right product mix, these marketers can achieve operating income levels comparable to the majors.
As industry consolidation advances, leaders are rising to the challenges and extending their growth trajectory in spite of headwinds. These companies have become the competitive benchmarks by which we judge success. Some are finding rewards staying within their traditional comfort zone, while others will journey to new territory. Despite impediments, there is a vibrant upside to this industry.
Suzan M. Jagger, president of Jagger Advisory, has partnered with multinational clients across the energy industry for more than 25 years. Visit JaggerAdvisory.com or contact Suzan directly at suzan@jaggeradvisory.com.