Chemical manufacturing in India: A buzzing space

June 6, 2024

India's chemical manufacturing industry is a vital part of the nation's economy, projected to triple its global market share by 2040. The specialty chemicals segment stands out as the most robust, consistently showing a net trade surplus, driven by competitive labor costs and a favorable business environment. Ambitious entrepreneurs are seizing this opportunity by building B2B contract manufacturing marketplaces, providing R&D, quality assurance, and working capital financing to make SME manufacturers export-ready.

India's manufacturing industry in figures

The Indian chemical manufacturing industry is a vital part of the nation's economy, contributing about 7% to India's GDP. The country ranks as the 6th largest chemical producer globally and the 3rd largest in Asia: India is the fourth-largest producer of agrochemicals (following the United States, Japan, and China) and it produces roughly 16-18% of the world's dyestuffs and dye intermediates (the Indian colorants industry holds a 15% share of the global market).

The future looks even more promising: the Indian chemical sector is projected to grow by 11-12% annually from 2021 to 2027 and by 7-10% annually from 2027 to 2040. Doing some quick maths, this growth is expected to triple India's global market share by 2040. Domestic demand alone is projected to soar from $170-$180 billion in 2021 to $850-$1,000 billion by 2040!

EXIM dilemma

In recent years, India has consistently ranked third in chemical imports and fourth in exports, highlighting its crucial role in global trade. The country's share of global exports has been steadily increasing, driven by economic growth, rising consumer demand, and geopolitical shifts making India an attractive market and alternative manufacturing hub.

Still, India's chemical trade deficit is expected to grow from $9-$10Bn to $40-$42Bn by 2040. While exports are projected to grow to $140-$145Bn by 2040, imports are likely to grow to $180-$185Bn. Let's unpack why that is:

Within the three main segments of the industry - inorganic chemicals, petrochemicals and specialty chemicals - only the specialty chemicals segment is expected to be (and currently is) a net exporter. By 2040, net exports from this segment are projected to increase tenfold, from around $2Bn in 2021 to $21Bn. Conversely, the petrochemicals segment is anticipated to face a significant deficit, with a shortfall of $41 billion, nearly double that of the inorganic segment's $21 billion deficit.

As a matter of fact, India is deficient in multiple petrochemical feedstocks (namely: C1, C2, C3, and C7) and relies on imports for these - e.g. methanol (C1), ethylene (C2), propylene (C3), tuolene (C7) - to meet its requirements for intermediate and end products.

Similarly, while India has a significant domestic production capacity for some inorganic chemicals, it still relies on imports to meet the overall demand, especially for specialized or high-purity grades required by certain industries. Key imports regard fluorine, sodium hydroxide, chlorine and many more.

It's clear that ambitious entrepreneurs can jump on the chemical manufacturing opportunity in two ways: one, in building SC solutions solving for the import needs of chemical manufacturers in India; and two, in building SC solutions leveraging on India's large and growing specialty chemicals exports

Let's dig deeper into the second opportunity.

The specialty chemicals' B2B cross-border opportunity

As said, specialty chemicals stand out as the most robust segment of India's chemical industry, consistently showing a net trade surplus. India is becoming an increasingly attractive manufacturing destination due to several key factors, such as competitive labor costs and the ability to construct manufacturing units more economically than in developed countries play significant roles. Additionally, recent reductions in corporate tax rates have created a more favorable business environment. Strong tailwinds from China+1 and SC diversification strategies are also positively favoring the country. Indeed, sixteen subsegments of specialty chemicals excel in terms of market attractiveness and cost competitiveness, in agro, food, pharma, and more.

However, the specialty chemicals industry is not only large and growing but also highly fragmented. Most subsegments have only a few scaled-up players, with a long tail of smaller suppliers vying for market share both domestically and globally. The top 10 chemical manufacturers in India control less than 10% of the market, meaning there are 10000s of SMEs contributing to the majority of India's specialty chemicals production. For small suppliers (which are generally family businesses), demand generation is a critical value proposition, especially in cross-border trade, as SMEs mostly rely on word-of-mouth for their sales, which clearly does not work well in international trade. These players are continuously on the lookout for new opportunities (since their capacity is not fully utilized), and cross-border trade is attractive as it can offer better margins. These sound like some problem statements that a B2B marketplace solves. However, once discovered, the challenge shifts to servicing these buyers: many small suppliers struggle to export significant portions of their production. One key problem is long cash conversion cycles, which can be in the order of 60+ days. Figuring out logistics can be complex. Again, something that a B2B marketplace solves. Another hurdle is regulatory compliance: the chemical industry is heavily regulated, so ensuring regulatory compliance and quality for cross-border transactions is also key. And last: SMES lack R&D capabilities, much needed to serve the needs of international buyers looking for new partners for formulations.

On the demand side, international medium and small buyers of specialty chemicals often lack pre-existing relationships with cross-border suppliers and seek easier ways to find them, especially in international markets. This demand is substantial, driven by both the need to diversify supply chains away from China and the necessity to enter new formulations. On the other hand, large buyers are less likely to seek new suppliers - differently from other industries, large suppliers have already for the most part created diversified supply chains, and have a preference for long-term relationships with trusted suppliers. As a matter of fact, large buyers have procurement teams capable of conducting thorough checks and physical visits, often through local offices or representatives - a capability SMEs clearly lack. Hence, winning over large international buyers might be hard.

All in all, as hinted, this is an obvious space for a B2B contract manufacturing marketplace to be built. So what's happened to date, and what's happening now?

What has happened so far, and what is happening now

Ambitious entrepreneurs have not overlooked this opportunity and have already built startups in the space - no wonder, as margins can be very attractive. And VCs have also noticed and chimed in with capital to fund India's next B2B marketplace unicorn. It's been interesting to track the space in the past two years, which have seen quite a buzzing activity in both founding and funding (I could name 15-20 players).

Intriguingly, companies in the space have also evolved over time. Indeed, most players initially started on the distribution layer, connecting Indian formulators with end-application customers. These companies' main value add was the extension of credit - they effectively acted as (tech-enabled?) traders/distributors extending WC for suppliers. However, over time, it appears that every player has now moved upstream in the value chain, acting as contract manufacturers serving international formulators with an R&D + manufacturing service offering. This move is more than justified when we keep into account that SME manufacturers lack the resources to run R&D activities in-house and find themselves unable to fulfill the requirements of international buyers. So the managed marketplace expands their R&D muscle for product innovation, gets them quality-approved & ESG-adherent, and provides working capital financing to make them export-ready. R&D is usually carried out by the B2B marketplace on lease labs with researchers/scientists on its payroll. R&D activity run by these players can vary from re-engineering of off-patent molecules (reverse-engineering molecules whose patents have expired and that are currently sourced from China), import substitution, or product substitution (e.g. more sustainable molecules/components). Therefore, the "research risk" here is low. It's also crucial for these players to innovate on production processes.

Tech, differentiation, and right to win

So, where does technology come into the equation? One, in matchmaking suppliers with the chemical to be manufactured. Two, in streamlining complex supply chain operations (marketplaces manage high numbers of relatively high-value orders, that can be automated). LIMS (Laboratory Information Management Systems) can also be employed to gather lab info and data and provide timely updates to clients - this, however, can be purchased off the shelf: there's no need for a custom-built product. This begs the question: how can one differentiate in this space, in the absence of a true tech moat?

It's difficult to answer, and I currently lack to find strong arguments in favor of one player over the other, as many can currently boast a "right to win". Initially, R&D was a differentiation. But then, "when everyone has it, no one has it". What I have seen happening is that companies are now trying to verticalize on specific use cases (e.g. pharma, agro, etc) as a means to differentiate. Is the market deep enough to allow multiple players to reach unicorn status, though? Or is it going to be a war on who's capable of attracting the strongest researchers? Or, perhaps (as it happened in other instances) is the winner simply going to be the best fundraiser and executor? Time will tell. For now, I'll keep tracking the market and its evolution.

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