1.

1.2

At its 2000 Chemical Analysts Conference DSM presented the outlines of the leading multispecialty chemical company it wants to become over the next few years. This transformation has already started, but major steps still have to be taken. This strategic direction was the product of an extensive corporate strategy dialogue, or CSD, as the process of rethinking the corporate strategy is called within DSM. The CSD is held roughly every three years. In last years CSD two main issues emerged which DSM has to address: First, the structural changes in the industry. The nature of these changes differs greatly from one business to another. In petrochemicals there is a trend towards global consolidation. Although DSM currently enjoys a healthy and leading position in the West-European petrochemical industry, it is clear that in the long run the maximum value of this business can only be achieved if it participates in this global consolidation. In chemical specialties, by contrast, there is a drive for size on the one hand and a focusing trend on the other. Both consolidation and specialization are taking place, involving mergers, portfolio restructurings and IPOs. Which offers opportunities for DSM.

The second main issue of last years CSD was the persistently low valuation of DSM by the stock markets. While it is flattering to be considered to be a value play with considerable upward potential by many analysts, DSM felt and still feels the urge to realize that value. In this respect it is noteworthy that the financial markets immediately responded positively to DSMs strategic plans. Before 11 September 2001 DSMs share price was up some 25% compared to the level of September 2000, when the new strategy Vision 2005: Focus & Vision was announced. This is in sharp contrast to the general climate on the stock markets in the same period and it also means DSM is outperforming the chemical stocks indexes. But DSM clearly aims for more than 25%. To address these issues of a changing industry structure and the appreciation of the investor community, DSM developed a coherent strategy, fully in accordance with the development of the chemical industry and the companys history.

1.3

The trends in the chemical industry are leading towards a structure with three clusters of chemical companies. At one end of the spectrum you have the large conglomerates, with sales of over 25 billion euro and a broad portfolio of products. Companies such as DOW, Dupont, Bayer, and BASF fall into this category. Due to the relative stability provided by their size, the broad variety in their portfolio and the liquidity of their stocks, the investment community accepts that their portfolio encompasses substantial volumes of cyclical commodities. At the other end of the spectrum there is a cluster of highly focused pure play specialists. Their size is limited, often not surpassing the 3 billion mark. Many of these pure play companies are the outcome of the ongoing reshuffling process. Companies such as Lonza, Givaudan and Novozymes are prime examples. In between these two groups a cluster of global multi-specialty players is developing. This cluster includes companies such as AKZO Nobel, CIBA, Clariant, Degussa, ICI, Rhodia, and Rohm & Haas with a size of roughly 5 to 15 billion in annual sales and a portfolio consisting predominantly of a set of chemical specialties.

In this arena a constant game of consolidation and specialization is going on, involving mergers, acquisitions, assets swaps and IPOs. Somewhat outside this chemical spectrum are the large global oil companies, which are relevant for chemicals as they increasingly dominate the petrochemical business, and the group of large global pharmaceutical and food processing companies, which are also consolidating. With its strategy Vision 2005: Focus and Value DSM embarked on a route to become a leader in the cluster of global multi-specialty players by readjusting its portfolio focus and size. In order to reach that goal DSM has to withdraw from petrochemicals and simultaneously boost its presence in chemical specialties. It is difficult to define what makes a product a chemical specialty. In DSMs opinion the most important characteristic is the ability to generate good and preferably stable margins. This can be based on a combination of several aspects, such as the absence of supply driven cycles, the resilience to GDP fluctuations, a high degree of intimacy between producer and customer, the innovative content of the product and so on.

1.4

First and foremost, in order to be successful as a multi-specialty player a company has to aim for leadership in every business segment it wants to operate in. This drive for leadership was already part of DSMs strategy before the start of Vision 2005: Focus and Value, and it has remained an essential element for the future. The second aspect that is of vital importance to be a successful multi-specialty player is a coherent portfolio. It is especially through a coherent portfolio that a multi-specialty player can outperform pure play companies and generate added value over a simple addition of separate business entities. This coherence is reflected in for example a focus on specific end markets as well as in the technologies applied. DSM keeps this coherence in mind when looking for acquisition candidates. Over the years DSM has learned the value of growing the business concentrically, as the companys recent history clearly shows. Which means DSM will only enter new business arenas on a large scale if it can bring in-house-developed knowledge and skills to the table.

The third essential prerequisite for being a successful multi-specialty player is innovative power. DSM always has been highly dedicated to innovation and R&D and annually spends about 250 million on R&D, mainly in the realms of Life Science Products and Performance Materials. The past efforts in this respect have laid the foundation for some fine and very profitable business positions of today. To name just a few examples: - Recently a new grade of Arnitel, which, like Stanyl, is an in-house-developed engineering plastic, was approved for the production of airbag covers in cars. This grade outperforms the competition in a combination of required features such as temperature resistance, ability to tear open at the required speed without fragmenting, and ease of production and application in different shapes and colours. Leading car manufacturers in Europe and the USA are applying this product now.

1.5

- Dyneema, the strongest fibre in the world, 15 times stronger than steel and 40% stronger than Kevlar, was developed in DSMs laboratories. At the moment markets as far apart as offshore towing & anchoring and bullet resistant vests & armours are using Dyneema in rapidly increasing volumes. Demand is increasing so fast that despite firm investments in new production facilities DSM can hardly keep up with market growth. - In the biotechnology part of its business DSM can point to a successful product such as Phytase, an enzyme aimed at a better digestion of feed by livestock, reducing both feed costs and the amounts of phosphates excreted. In the specialty business in particular, creative innovation is a key success factor. One of the best protections of the income stream is when products are patent protected. DSM enjoys this favourable position in a large number of cases. From the present business portfolio that will stay with DSM in the execution of Vision 2005: Focus and Value around 50% of sales are covered by patents on either the product itself or the production process. Innovation is also an area in which a multispecialty player has clear advantages. A larger company not only has more critical mass to support the expensive R&D programmes but can also bring into play the combination of various technologies and skills. More often than not, really creative innovation stems from a combination of disciplines. Pure specialists can take innovation a long way, but most of the greater breakthroughs are the result of bringing together different lines of thinking in order to create something really new. For DSM this is notably the case in the combination of skills in biotechnology and materials science.

The fourth essential element for success is cost control. Due to its history, broad layers of DSMs middle and top line management have been brought up with a deep awareness that controlling and reducing costs is essential for survival. This attitude, which comes less naturally to specialty businesses, often gives DSM a competitive edge. Experiences with specialty businesses acquired over time have provided ample proof of this. And given the fact that, sooner or later, many specialty businesses will show signs of what could be called commoditization, this sense of urgency relating to cost control that is an essential part of DSMs culture is becoming more and more important. In the next chapter by Henk van Dalen an update is given on the progress made with the Operational Excellence programme, which was started a few years ago to reinforce cost consciousness at DSM. The fifth point on the list of essentials for a successful multi-specialty player is stable earnings growth. At the moment DSMs earnings profile is still heavily influenced by the cyclical contributions of the businesses forming part of the Polymers & Industrial Chemicals cluster. A comparison between DSMs results for the first half of this year with the H1 results of last year clearly proves this. Which might blur the view on the earnings growth achieved by the specialty businesses in DSMs portfolio. On the following pages DSMs score on the points mentioned above will be discussed in more detail.

1.6

This chart gives an impression of DSMs present leadership positions in relation to the existing specialty portfolio. It is based on the 2000 sales figures, adjusted for the acquisition of Catalytica and the divestment of Engineering Plastic Products (which were effectuated as of 1 January 2001) and for the planned divestment of Petrochemicals. So it zooms in on those parts of the present portfolio which are relevant to the new DSM. Most of the business groups that will make up the multi-specialty DSM of the future are already among the top three in their markets.

Notable exceptions in this respect are parts of the engineering plastics business, some parts of the coating resins business and to a lesser extent some areas in food specialties, where DSM is only leading in a limited number of niche segments. That is one of the main reasons why DSMs acquisition strategy is aimed in particular towards reinforcing the market presence in these areas. In fertilizers and ACN, which are by-products of core businesses in caprolactam and melamine, DSM does not aim for leadership.

1.7

DSMs present positions in businesses that will participate in the future portfolio already have a high degree of coherence. This pie chart, which, like the chart on the previous page, zooms in on those parts of the present portfolio which are relevant to the new DSM, gives an impression of the present focus towards end-use markets. 70% of this portfolio is directed towards five end markets. Which is a fair amount of focus, and a clear proof that DSM has managed to create the necessary coherence in its portfolio to be able to benefit from the synergies derived from this coherence. The single most important end market is Pharma, which represents almost 25% of DSMs portfolio as defined above. This market is growing around 8% annually, has no supply driven cyclicality, and is moreover fairly recession proof. The processed food market takes about 15% of this portfolio. This market, too, is characterized by its immunity to cyclicality and recessions and shows a stable growth. Through acquisitions DSM wants to step up its presence in this market significantly. The businesses focusing on the pharma and processed food markets together make up 90% of the Life Science Products cluster. In the chapters by Feike Sijbesma and Bob Hartmayer these businesses are highlighted in more detail.

The Automotive industry is the end market for about 12% of DSMs current sales as defined above, and Electrics & Electronics accounts for about 9% of sales. DSMs sales to these two end markets are generated primarily by the business groups in the Performance Materials cluster. Together they represent about 60% of the present sales in this cluster. The chapters by Jan Dopper and Bernard van Schaik picture in more detail where DSM stands and how DSM wants to take this business further. Building and construction is the fifth end market for DSM, representing about 11% of sales in this diagram.This market is primarily served by the caprolactam and melamine businesses that form part of the Industrial Chemicals cluster, but a fair amount of Performance Materials also find their way towards this market. The remaining 30% of sales include for example the very interesting markets for Dyneema (the super strong fibre whose sales are rapidly expanding in applications varying from offshore towing cables to bullet resistant vests, helmets and armour plates) and the rapidly growing sales of a number of performance materials for the leisure and sports equipment markets.

1.8

Besides coherence in end markets, DSM can also show coherence in the field of technology. In the following chapters DSMs technological capabilities are discussed in more detail; the observations in this chapter are restricted to the importance of the combination of DSMs strong technological capabilities in both biotechnology and more classical fields of expertise such as materials science. Through the acquisition of Gist-brocades, DSM added a leading position in biotechnology to its already existing strong technological position in other fields. Biotechnological products today represent 15% of DSMs total sales, which makes DSM one of the leaders in this respect in the European chemical industry. Furthermore, the combination of biotech and other DSM expertise provides the key to new innovative successes. The potential value of this combination was recently highlighted by an unbiased source, namely in a publication by McKinsey last year. The following diagram is from this publication.

1.9

McKinsey# used this diagram to picture how biotechnology will transform the production of chemicals. Commercial applications of biotechnology today are mainly restricted to the production of fine chemicals and food additives. And indeed within DSM current sales based on biotech mainly relate to products intended for the pharma and the processed food industry. But looking ahead to the not so distant future of around the year 2005 and beyond, McKinsey expects biotech to enter the realms of among other things plastic additives, polymers pigments and coatings. Biotech materials might eventually take over 50% of the polymer markets and 15% of the market for base chemicals, says McKinsey. Although these figures may be too optimistic as far as timing is concerned, DSM certainly agrees with the direction indicated by McKinsey The same report mentions that chemical companies which already have strong operational skills and customer relationships in these markets are best positioned to achieve profitable growth through biotech. According to McKinsey there are clear advantages for first movers who can develop the technical leadership and the intellectual property reserves that might keep latecomers out.
#

The main building blocks of DSM in Vision 2005 are the Performance Materials cluster and the Life Science Products cluster. At present they seem unrelated from an end market point of view. But in the combination of these two mainstays lies the opportunity to be a first mover in the development of biomaterials and biologically driven processes. Indeed, McKinsey names DSM as one of the few companies which today are already well positioned for the development and subsequent production of these new classes of biomaterials and the development of biotechnological processes.

Using plants as plants; an article by Rolf Bachman, principal in McKinseys Zurich office, Enrico Bastianelli, consultant in the Brussels office, Jena Riese, consultant in the Munich office, and Wiebke Schlenzka, consultant in the Hamburg office; The full article can be found at www.mckinseyquarterly.com/basic/usp100.asp.

1.10

Over the last few years, DSM has managed to achieve an impressive earnings growth in the businesses comprised in the specialty clusters Life Science Products and Performance Materials. Total EBITDA annually increased by 28% on average. Over the same period the EBITDA margin over sales of these two clusters improved by some 35%, bringing these ratios to 16% for Life Science Products and to 11.5% for Performance Materials in H1 of this year. A nice improvement, but the targets are higher and DSM will continue to work hard to further increase overall margins in these businesses. DSM aims to achieve an overall EBITDA of more than 18% of sales by 2005. Which means there is still a lot of room for improvement. In the chapter by Henk van Dalen some of the instruments that have been or are being put in place to accomplish this margin increase are presented.

1.11

DSM is not unique in its ambition to transform into a leading global multi-specialty player. Many analysts reports mention the risks of a corporate transformation of the kind DSM has planned. DSM studied and charted those risks carefully in the CSD executed last year before it embarked on this route. In the first place it is important to note that the transformation envisaged within Vision 2005: Focus & Value is a natural next step in a long track record of continuously adapting DSM to the new challenges of the market. The transformation process embarked upon is not a radical break with DSMs past, but a natural continuation of DSMs historical development. In 2002 DSM will celebrate its centenary. Sustainable development is often mentioned nowadays as an essential characteristic of the development of any company. DSMs impressive track record of the last 100 years shows that it has performed very well in this respect.

In the 100 years of its existence DSM has always managed to adapt swiftly and pro-actively to changing market demands. In the course of this evolution DSM developed an impressive range of competences and technologies. DSM also developed the managerial expertise and skills to execute the envisaged corporate actions in a responsible way. DSM has a solid managerial structure embedded in its organization. Now, in 2001, DSM is well equipped to transform itself into a leading multispecialty company in the coming years, as it has the right capabilities built into its genes. Although the impatient among the financial community may not like it, DSM prefers to focus strategically on the long term. More than the results of next quarter, the viability of DSMs businesses over the next 3 to 5 years is the main driver of our strategic moves.

1.12

In the period from 1995 through 2000 DSM managed to roughly double its sales, from 4.5 billion to the present 8 billion plus. This expansion was achieved first of all via aggressive autonomous volume growth. In these years autonomous volume growth averaged over 6% per annum and accounted for roughly half of the increase in DSMs top line figures. On top of that came targeted acquisitions, notably to reinforce the companys positions in Life Science Products. In Performance Materials DSM divested several businesses, in order to focus this cluster and improve its overall financial performance. These divestments on balance roughly equalled sales growth due to price increases. The portfolio transformation envisaged in Vision 2005: Focus and Value will require the same momentum of doubling the business in a time span of roughly 5 years, but this time the growth will be focused mainly on the two clusters Life Science Products and Performance Materials. Last year these two clusters generated sales of

more than 4 billion. In 2005 DSM wants these specialty businesses to generate 8 billion in sales, or 80% of the targeted overall sales figure of 10 billion. This expansion will first of all be achieved via strong autonomous volume growth of at least 6% per year on average. Autonomous volume growth will thus account for about half of the targeted increase. Just as in the last five years, the other half will be realized via acquisitions. Another important element of Vision 2005: Focus and Value is the divestment of Petrochemicals. DSM is confident that this divestment will be a success, for the following reasons. Firstly, there will be just one major transaction, without the handicap of dilution of management attention. The entity to be divested consists of one coherent set of businesses, not a vast array of several unrelated business units.

1.13

Secondly, DSM took ample time to prepare this divestment case carefully, before entering into any negotiations with third parties. The ringfencing of the petrochemical business took about six months from start to finish. But as a result a very clearly defined package could be put on the negotiation table. All aspects relating to the many ties between Petrochemicals and the surrounding DSM businesses are clearly defined in arms length, long term contracts. These contracts will provide the basis for a sound relationship with the new owner of the assets, which will remain intensely interwoven with the other activities at the Geleen site. Thirdly, DSM consistently refuses to be squeezed into a public time frame; DSM will refrain from any comment on the negotiation process until a deal can be announced. And last but not least, given the inherent quality of the business DSM has to offer, the company is confident that it will be able to get good money in return for this valuable set of assets and market positions.

The last point to be highlighted in this respect is DSMs financial strength. Financial strength is an essential prerequisite for successfully accomplishing the transition envisaged in Vision 2005: Focus & Value. An overstretched balance sheet not only directly affects the interest bill, it also hampers the possibilities of adapting the portfolio by innovation based on in-house R&D or via targeted acquisitions. DSMs current balance sheet ratios, shown below, are relatively strong even after the fully debt financed acquisition of Catalytica. It is fair to conclude DSM has the financial muscle to realize the goals of Vision 2005: Focus & Value.

Ratios at end of H1 2001 Solvency Gearing Interest cover 38% 71% 5.7

1.14

The implementation of Vision 2005: Focus and Value started with the acquisition of Catalytica Pharmaceuticals and the divestment of Engineering Plastic Products. However, autonomous volume growth will continue to be a major driver of the desired growth of DSMs core businesses. Against this background, the following projects have been started. Around the end of the year DSM expects to announce a new expansion of DSM Biologics in the form a new large scale fermentation facility for biopharmaceuticals and will also invest in the expansion of its therapeutic proteins position. The reason for the expansions is that the new capacity added in February is already sold out. DSM Food Specialties has successfully started the commercialization of LC PUFAs (Long Chain Poly Unsaturated Fatty Acids), which will serve as an additive to baby milk formula enhancing the development of babies nerve system.

The markets for super strong Dyneema fibre are expanding very rapidly. Production capacity of the Heerlen (Netherlands) plant will be increased by 70% in 2001 and the capacity of the US site will be doubled. Desotech will expand existing capacities in UV curable coatings for optical fibres by another 30% this year by building a new plant in Stanley (North Carolina), in addition to new plants built in The Netherlands and Japan recently. DSM Melamine is investing in a new melamine plant with a capacity of 30,000 tons and in a highly efficient, 100 kt plant based on a new technology which is scheduled to come on stream towards the end of 2002. The divestment of the Petrochemical business is well on track.

1.15

To support the transformation into a leading multi-specialty company DSM has also started a branding campaign: Unlimited.DSM. For DSM such a branding campaign aimed at the general public is quite a new phenomenon. Being a strictly business to business company, with no final consumer products in our portfolio, the need for broad public advertisement campaigns was never felt before. But studies undertaken as part of the CSD clearly showed a discrepancy between DSMs public image and reality. Although this did not affect DSMs attraction to customers, the need was felt to address this discrepancy. One reason was that a favourable public image will improve the companys ability to attract young graduates. Another was that DSM felt the retail stock markets appreciation of DSM would benefit from a better understanding of what DSM really stands for: a company that will not accept limits to its performance. DSM products can improve many consumer products, make them safer, healthier, stronger, more durable, and more environmentally friendly.

1.16

In conclusion: last year DSM embarked on a new phase in its ongoing transformation. From the commodity player of the eighties, via the hybrid chemical company of the nineties it is now transforming into a global leading multi-specialty player.