Producers of fine chemicals, beset with fierce competition and sluggish demand for their products, are largely holding the line on price increases this year. To revive their depressed margins they are setting up new divisions and building new plants and research facilities to focus on high-value pharmaceutical ingredients, and to capitalize on the rapidly growing custom manufacturing business. Players in the industry are also showing a new attentiveness to customer needs.

In terms of profit margins "2001 was one of the worst years fine chemicals has had in quite a while," says Phil Calderoni, an analyst with SRI Consulting, Menlo Park, Calif. "We foresee a recovery in 2002," he adds, "but right now there's still a lot of pressure on these companies." Much of that pressure, Calderoni notes, is from low prices due to sagging demand in a slow economy. Prices are also being kept down, he adds, by the recent consolidation within the pharmaceutical industry, which is giving a smaller number of customers greater clout in the marketplace. Manufacturers of fine chemicals are also facing competition from low-cost producers in Asia, Calderoni says, even as their margins are eroding from the escalating costs of developing new drugs and of operating on a global scale.

The fine chemicals sector includes compounds used as active ingredients or intermediates in the pharmaceutical and agricultural chemical industries. Some analysts also classify electronic chemicals, flavors and fragrances, and photographic chemicals as fine chemicals. The pharmaceutical and agricultural portion of the fine chemicals market has worldwide revenues of about $85 billion a year, according to SRI. Growth in fine chemicals has averaged 3-3.5%/year over the past five years, estimates Calderoni, who predicts that this pace will accelerate to between 4 and 5% annually over the next five years.

The largest suppliers of fine chemicals include such familiar names as Bayer, BASF, Dow Chemical, Albemarle, Degussa, Sigma-Aldrich, Lonza, DSM and Rhodia. However, there are many small to medium-sized companies that offer one or two fine chemical products or services for a specialized market niche.

Difficult conditions have prompted some departures and cutbacks in the fine chemicals industry. Great Lakes Chemical, for example, announced in July that it was exiting the business. Eastman Chemical planned to leave the fine chemicals field in 2001 but then changed its mind; the firm nonetheless closed a major fine chemicals facility in Hong Kong early this year.

But most suppliers are opting to ride out the storm as they strive to cut costs and make their businesses more customer-focused. "Intense competition and slow markets have sent a clear message to fine chemicals manufacturers: Be more responsive to customers and more cost-efficient or be left out," says Peter Nagler, president of Degussa Fine Chemicals. Major players in the industry are heeding such advice in numerous ways. They are restructuring their operations, paring costs, shedding marginal businesses, and focusing on high-value products and services. They are globalizing their operations to match the global reach of their large pharmaceutical and chemical customers. They are also stressing stronger ties to their customers.

Among the reorganizations, Bayer has grouped its fine chemicals operations within the newly created Bayer Chemicals, one of four independent operating companies Bayer recently formed to better address specific market segments. (The others focus on healthcare, crop science and polymers.) Dow Chemical has formed its Pharmaceutical Services business to bring together diverse operations in contract chemical and biopharmaceutical manufacturing, plus the activities of two subsidiaries—Chirotech Technologies and Mitchell Cotts Chemicals —which it acquired in 2001.

Meanwhile, Lonza has separated its new-product services group from its technical services group in order to "reduce the cycle time to commercialize new products," says Gary Williams, president of the company's performance chemicals sector. And Sigma-Aldrich Corp. carved out a separate division for fine chemicals in 2000, a move the firm says helped boost its annual revenue growth in the sector from 7% to 12%.

Economizing is also widespread in the industry. Bayer, for instance, has just completed a round of cost-cutting in its fine chemical production, manufacturing and R&D operations. The moves included the closing of some of its plants in Leverkusen, Germany. BASF, meanwhile, says it shuttered a "less efficient" Vitamin E plant in Wyandotte, Mich. earlier this year and has concentrated production of the product in a more modern facility at its Ludwigshafen, Germany headquarters. And Degussa, citing the economic slowdown as a factor, closed part of its orthoesters manufacturing unit in Mobile, Ala. this year and shifted production to Europe.

Companies are also eliminating what they regard as peripheral businesses. In one such move, Sigma-Aldrich Corp. decided in April to divest its diagnostics division to focus on what it calls its "core capabilities."

But even as they cast off outmoded plants and fringe businesses, fine chemical makers are investing in laboratories and production facilities geared to high-value pharmaceutical ingredients. Bayer, for instance, recently began producing pharmaceutical intermediates and APIs (active pharmaceutical ingredients) at Novochem, a new cGMP (current good manufacturing practices) facility in Murcia, Spain. Bayer has also expanded its cGMP facility in Leverkusen, Germany to include a "kilo" laboratory—one capable of producing small quantities of chemicals for early-stage testing. Sigma-Aldrich has just built a $55 million life science research center near its St. Louis headquarters. In 2000, the company also opened large-scale cGMP production units for air-sensitive chemicals in Sheboygan Falls, Wis. and Gillingham, U.K. And Degussa recently installed a new 4,000 sq ft cGMP unit at a facility in Edmonton, Alberta, Canada.

Sigma-Aldrich employs a system for running process optimization reactions in parallel on a benchtop-scale. "After these trials, we pick the optimum path and transfer it to our production unit for scale-up," says David Feldker, vice president for sales and marketing in Sigma-Aldrich's fine chemicals group.

The new and enlarged laboratories and plants are part of a strategy to offer fine chemical customers a complete package of services. These packages include contract research, preparation of samples for testing, process optimization and production scale-ups. "Ideally you want to be there when the customer first comes up with a new idea or a new molecule," says Hans Loose, group vice president for fine chemicals at BASF Corp. in Mt. Olive, N.J. The next step, he adds, is to help customers obtain the kilo-size samples they need for toxicological studies and develop a process they will use if the new compounds show promise. Loose says that BASF is building a new pilot plant for pharmaceutical process development in Minden, Germany; the unit will join a similar existing German facility in Ludwigshafen.

Bayer too provides a complete package of drug development services, spanning everything from initial sample preparation to production of commercial quantities. According to Frank Lueckgen, vice president of Bayer Chemicals in Pittsburgh, the company tries to give a fast response, usually in about a week, to inquiries about its ability to take on new projects. He says Bayer assigns teams composed of personnel from the company's R&D, production and marketing units to oversee its customers' fine chemical projects all over the world. "In this way," he says, "the customer always knows who is on the team and who is tending the project." One of Bayer's newest thrusts, Lueckgen says, is to offer its production services to "virtual" companies—small to medium-sized pharmaceutical or biotechnology firms that have come up with a promising compound but lack production facilities to make large quantities of the material.

Dow, meanwhile, is counting on its reorganization and its recently acquired subsidiaries to broaden its fine chemical offerings. The company's pharmaceutical services business includes capabilities for process development work and the manufacture of APIs and intermediates. It also includes the Chirotech subsidiary, which focuses on technology development, route selection and the earlier phases of drug development. "By putting these two components together, you get synergistic benefits across the whole pharmaceutical life cycle," says Gwin Bompas, commercial director for the Europe and Pacific region of Dow's pharmaceutical services unit.

Albemarle, which provides research lab to pilot-plant contract services in fine chemicals, also solicits feedback from its customers as part of its new business development. "We'll call on customers, not just to sell our existing product lines, but to see what other value we can add for them and what other products we can make for them," says Scott Martin, vice president of fine chemical services at Albemarle.

Developing new technologies to make syntheses more efficient is a high priority in the fine chemicals business. Degussa, for example, has just started up a new biocatalytic manufacturing process for making a non-natural L-amino acid at its cGMP facility in Hanau-Wolfgang, Germany. According to Nagler, the system, which produces a building block for a high blood pressure drug, "completes in one step what until now chemists laboriously prepared and synthesized in several steps." And Sigma-Aldrich is developing transgenics, which involves inserting foreign genes into plants, as a higher-yield alternative to fermentations in the production of pharmaceutical proteins.

Companies hope that such new technologies, coupled with their reorganizations, cost-cutting and the customer-friendly practices, will help restore the fine chemicals business to profitability. Some industry participants say they already detect signs of a recovery. "We're just now starting to see our phone calls picking up, a lot more inquiries coming in the door, and a bit less skepticism and caution in the marketplace," says Sigma-Aldrich's Feldker. A recent poll of his customers, he adds, shows that most plan to spend more in late 2002 than they did in late 2001.

While excess capacity, along with consolidation in the pharmaceutical industry, continue to be "disruptive" forces in fine chemicals, says Martin of Albemarle, he sees the trend as temporary. "There's still a lot of innovation going on" in pharmaceuticals and agricultural chemicals, he says, "and I believe that in the long term people are still committed to outsourcing to get their products to market faster."