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Check with seller Interviews with executives in the chemical industry to assess the financial impact of innovation Almenno San Bartolomeo

Published date: March 1, 2021
  • Location: Almenno San Bartolomeo, Bergamo, Italy

How technology and market familiarity affect financial returns




The return rate of innovation investment projects also varies with the familiarity of chemical companies with the market and technology. Because we examined 35 chemical innovations using externally available data, we were unable to estimate their total financial impact. However, we can assess the financial impact of innovation through interviews with chemical industry executives. We explored two areas with them. First, we discuss their experience and expectations about IRR, including success rate, typical cost and expected sales. Secondly, we discuss the extra profit (excluding competition of similar products) of innovative products relative to the products they replace; we call this extra margin "top margin". In determining the internal rate of return, we use the full return of the new project - excluding sales of similar products, because it can be assumed that if there is no innovation, these sales will flow to innovative competitors.




The highest profits - and the greatest variability in those profits - appear in the most risky categories (i.e., unfamiliar with the market and Technology). The highest profit and the lowest profit are those who are most familiar with the market and technology. Interestingly, comparing these two types of IRR returns shows the opposite pattern, with the lowest risk getting the highest return, as measured by IRR. This is because the internal rate of return is largely determined by the success rate and listing time. Again, it's important to note that success rates represent typical values; we recognize that there are some outliers in each quadrant.




We can observe the effect by quadrant




High familiarity with market and technology. Our research shows that the top edge of this quadrant ranges from 0% to 5%, which is the lowest of the four categories. However, the rate of return is very high, because development and capital investment are usually very low, the success rate is very high, and the number is usually large, resulting in an average internal rate of return between 18% and 23%. Often, these innovation investments are incremental to protect market share or to adjust existing products to drive further value.




Low market familiarity and high technology familiarity. Our interviewees said that compared with previous product types, this area can provide higher profits (10% higher than existing products). This may be because the entries here can bring about truly novel features that existing products lack. These investments usually provide high returns, in the range of 20% to 25%, because investment in development and capital is usually low.




High market familiarity, low technology familiarity. New technologies in the existing market usually get strong excess profit (10% higher than existing products), which is driven by novel features and understanding of market demand. However, due to the high capital requirements of new technologies and the long time to market, the return rate of such projects is usually lower than that of the first two types of projects, about 13% to 18%.




Low market familiarity and low technology familiarity. This type of innovation shows the highest level of risk, but has the highest profit potential (up to 60%). The low success rate and long-term framework in this area result in a typical return on investment of only 8% to 12%, barely covering the capital cost of most chemical companies (usually 9% to 12%). In fact, some of the executives we interviewed questioned whether these investments would have a positive impact on NPV.




In addition to the matrix framework, we compare the IRR range compiled with the database and find that the two groups of data show similar return range. Our meta-analysis of the database based on market segments (commodity, specialty, materials and nonpharmaceutical Life Sciences) shows that the innovation of chemical companies has strong average returns - 14% to 18%. In addition, the database provides further insight: it shows that market segments have a significant impact on financial performance. The internal rate of return of the commodity segment is only 6% to 10% (equal to or lower than the cost of capital), while that of other segments is much higher. Materials science innovation ranked first with 19% to 23%.


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