How to Manage Sourcing in Declining Markets – Will It Be Any Different in Oil & Gas This Time Around?

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Buyers often struggle to deal with radical short-term changes in their power and leverage position. One of the most dramatic problems experienced by buyers is an overnight fall in demand for their products/services. This normally leads to the immediate ‘knee jerk’ response of an immediate realignment in their sourcing strategies with suppliers.

The Oil & Gas industry is facing this problem today with the oil price falling from around $120 to a recent low of $46.6 (highlighted in a blog by Evan Kelly ‘Oil Majors Taking Ruthless Measures to Survive’). It is, however, a recurring problem—in 1998 the oil price fell to below $12 a barrel.

Oil Price Fluctuations

In 1998 a number of Oil & Gas companies asked me and my colleagues to help them with their sourcing response to this challenge. The emphasis in the industry then was (after having begun a brief flirtation with partnering relationships in the mid-1990s) on how to quickly improve leverage by the adoption of aggressive short-term cost reduction exercises.

Given this, and the highly fragmented approach to sourcing that many Oil & Gas companies then adopted (with decisions being made normally without any centrally coordinated Procurement or Supply Chain Management function), the obvious short-term solution was to end fragmentation and consolidate all similar spend into one bucket at the category level.

Once this had been achieved it was then possible to quickly organise RFPs with a small number of preferred suppliers—although the frequent lack of rigorous category segmentation methodologies and processes, or readily available and robust demand and spend management data at the category level, made this exercise somewhat hit and miss.

The speed with which some Oil & Gas companies were able to implement market tests using consolidated spend, and then implement aggressive cost-down strategies by awarding consolidated volumes over 3-4 years to the winning bidders, was quite phenomenal. In one case an Oil Major in one region was able to take over 40% out of its internal and external costs of sourcing within a 2-3 month period.

While this strategy was extremely successful in meeting, and some cases exceeding, the cost-down targets required by senior management it came at a significant price in relationship terms. Many ousted suppliers were shocked by their loss of contracts and by the breakdown in former partnership relationships. This led to heated meetings between some CEOs from buying and formerly supplying companies.

The upshot eventually was, of course, that as the oil price began to rise, and the power dynamics in the industry began to favour suppliers rather than buyers, these formerly disgruntled suppliers were very happy to teach the aggressive buyers a lesson. They either denied supply or priced aggressively when demand was high and supply was limited.

At that time, while assisting the Oil & Gas companies with the development of this emergency short-term strategy, my colleagues and I were concerned by this possibility. We explained that this ‘reactive short-term’ cost down approach should not be seen as the end of the process, but merely the beginning of the development of sourcing competence in their companies.

To this end we recommended that all of the major organisational sourcing weaknesses that were evident within these companies at that time should be eradicated, and a much more sophisticated and professional ‘proactive’ sourcing approach should be developed.

When benchmarking the Oil & Gas companies at that time 10 key weaknesses (that are also common in many industries) were identified:

  1. Excessive fragmentation of spend, with short-term project management and outsourcing philosophies dominating organisational sourcing thinking
  2. Lack of rigorous and robust current and future spend management data
  3. Lack of segmentation methodology to identify categories of spend
  4. Lack of cross-functional buy-in by Line managers to early engagement and a co-equal role for Procurement professionals in the sourcing process
  5. Lack of embedded performance management culture using rigorous and robust KPIs for all categories of spend
  6. Endemic maverick spend, with a lack of mandate for Procurement staff to be involved in the whole of the sourcing process pre- and post-contractually
  7. Lack of embedded and on-line processes/systems to manage categories of spend, and to undertake sourcing strategy development and/or supplier relationship management
  8. Lack of use of sophisticated power and leverage positioning analytical tools to develop sourcing strategies
  9. Lack of knowledge management, leading to staff reinventing the wheel
  10. Lack of fully competent staff, and especially in relation to the possession of ‘proactive’ sourcing skills

Our view was that in the future a more sophisticated and ‘proactive’ approach should be developed. This would seek to establish longer-term relationships with key suppliers (whenever feasible). It would also be based on the principles of ‘open-book’ collaboration, to improve value for money (not just cost reduction) for both parties to the relationship, and operate throughout the business cycle and any short-term movements in the oil price.

This would obviously require the removal of all of the structural weaknesses identified above, as well as the rigorous segmentation of spend at the category level to identify where a more ‘proactive’ approach to supplier relationship management can be adopted. It would also require the creation of a fully integrated and cross-functional category management process for all strategic sourcing, and the creation of a core team of cross-functional experts in managing relationships based on the principles of ‘open book’ collaboration.

Since that time there has been considerable improvement in the approach to category management and strategic sourcing by many Oil & Gas companies, and by some of their suppliers, as our benchmark data below indicates.

PSCM Index Scores by Sector

Despite this, when benchmarked using our PSCM Index methodology against world-class standards in category management and strategic sourcing, the Oil & Gas Industry still lags somewhat behind best practices in other industries. As the diagram shows, while the leading benchmarked Oil & Gas company is 4th overall (with a score of 78.7%), the average score of 52% places the industry as a whole only in 8th place.

This means that, while much has been done since 1998 by some Oil & Gas companies to remove the structural impediments listed above, many of these barriers still remain, and few companies have fully embraced the need to develop a more ‘proactive sourcing approach’ with key suppliers.

Because of this continuing lack of organisational and individual competence the fear is that many Oil & Gas companies will once again simply react to the current very low price of oil, and use the same ‘reactive sourcing’ strategies based on aggressive short-term cost reduction that were evident in the late 1990s.  This will have significant consequences for future supplier management in the industry, just as it did after 1998.

If the Oil & Gas companies do repeat themselves as the price of oil falls, it will be a very great pity and testament to the wasted opportunity in this industry during the ‘good’ years when oil prices were high. In this period the opportunity existed to segment categories to identify when it is sensible to work with suppliers to create continuous improvement in value for money using ‘proactive sourcing’ techniques.

It would appear that the industry (like so many others) may once again ‘miss the boat’. Karl (not Groucho) Marx once said: “history repeats itself; once as tragedy and twice as farce”. Here we go again….

Andrew Cox
Andrew Cox
Vice President,IIAPS
Andrew has undertaken over 25 years research into best practice in purchasing and supply, and was the Founding Professor of the CBSP, University of Birmingham Business School, where he established the world’s first MBA in Strategy & Procurement Management. In 1998 he was awarded the Swinbank Medal for Outstanding Services to UK Purchasing & Supply by CIPS. He is also a founding Director of IIAPS, where he is currently Vice President. Andrew has been a strategic adviser and consultant to a large number of blue chip companies and to major public sector organisations in Europe, Asia and North America, primarily in the area of external resource management and the business process alignment of business strategy with purchasing and supply chain management.

14 thoughts on “How to Manage Sourcing in Declining Markets – Will It Be Any Different in Oil & Gas This Time Around?”

  1. An excellent article indeed. I am not from the O&G Industry but would concur wholeheartedly with the view that the issues identified and particularly the weaknesses sit across industry as a whole. I have always been an advocate of proactive, strategic alignment and ensuring a constant dialogue at the highest level of partnering organisations; although not the sole ingredient, in my view this is fundamental to making the difference between success and failure.

    1. We could not agree more about partnering failures, however we also think it is linked to the lack of true cross-functionality in companies, and lack of understanding of how to create effective KPIs linked to value delivery in the supply chains that run through all companies. There is far too much silo thinking amongst disciplines and within companies. There are ways to resolve this but only by first benchmarking companies against what world-class thinking and practices,

  2. I find your industry ratings of Category Management and Sourcing Capabilities very interesting. If I understand correctly on average the top 5 are: 1. Retail 2. Automotive 3. FMCG 4. Industrial 5. Pharma while the bottom 4 are all various forms of Public Organizations and utilities. In general I agree, but always feel automotive often gets more credit than they deserve just based on their size and leverage. Certainly as you point out Oil & Gas in general have room for improvement.

    1. Good point about automotive Bill. Our own view at IIAPS is that companies tend to do better in or benchmarking exercises not just because of scale but also out of necessity. If you are 90% outsourced and compete on price then managing external suppliers is of strategic importance. IN or experience it is these types of organisation that tend to do more than others when it comes to implementing best practices.

  3. A great blog. The industry in the UK has done some good work through the Oil & Gas UK supply chain forum with some common routes to market and contracting principles.

    Business will be business during the good times and the bad times, but the point that sticks out for me is your reference to ‘CEO speaking with CEO’, compounded by the fact that in many organisations across the industry, the procurement and supply chain function is still seen as a Contract or PO processing and materials handling function. It is not as bad as it was in the late 90s because there are some good professional PSCM people out being supported by CEOs and MDs that get the true value that the PSCM function brings. We just need more of them.

    It will be a painful couple of years but the oil price will recover and the better times (not necessarily the ‘good times’) will last probably for the usual 10 to 12 years with a scare in the middle, before we go through it all again. A bit like a cyclical spring clean for the industry where you dispose of some of the things you don’t use and store away the things you might use. You certainly shouldn’t move to a smaller house for two years and hope the big house is still there when you get back.

  4. A very good blog. Value engineering with the suppliers, rigorous & robust spend analysis/management (points 2 & 8), and good business intelligence around future demand always helps whether the price of oil is high or low.

    In defense of the operators though – short term reduction in Capex may be necessary in the present scenario considering the sudden drop in the valuation of development projects, driven by the price of oil. Unfortunately, with no significant change in the cost of capital, any sort of relationship with the suppliers may not be as helpful in the short term as a reduction in cost.

    1. We agree that cost reduction is essential, but my point was that there are ways of dealing with the ups and downs of markets other than using short-term aggressive leverage. I am not sure the industry has ever understood this because of the silo management and project-led KPIs that are used … it shows a lack of development of joined up value-driven thinking in my view.

  5. Very good and timely post, Andrew. What you also see is those companies who adapted the approach you’ve described, converted all their spend into commodity, if you like. Even highly complex and HSE sensitive services became commodities. A lot of suppliers are no longer interested to go outside of what they’ve told and paid to do. While “identify-group-leverage” works at the beginning and creates significant results, the law of diminishing results is there.

    Although a bit less than it used to be, the reactive short-term is still prevailing in Oil & Gas business. I hope this time around we are a lot smarter. Otherwise, the expertise drain might be inevitable as a result of low attractiveness of the industry for suppliers.

    It is like promoting STEM… but who wants to take a career of an engineer in Oil and Gas industry, if the industry lay people off, as the first thing to do when the oil price is down?

  6. Great article. As sourcing professional with a number of years serving the O&G business sector I would offer the following comments.

    The industry is “project based” where each project is treated as a “one off”. Due to regulatory requirements and the risk of “environmental damage claims”. From a supply chain perspective its very conservative and very risk adverse. As the “prime suppliers” offer their Customers technical solutions they stick with tried and tested technology. As such design engineers have substantial influence over source selection where Procurement is tasked with the role of “making it work”. Note Subcontractors are often predefined at the bid stage and are not subject to the scrutiny we would expect.

    The more enlighten primes are slowly moving towards integrated teams. As there is little “off project” development either at supplier or product level Procurement needs to be more proactive and dynamic in their role.

    Having said all that the rapid fall in oil pricing offers Procurement the opportunity to demonstrate its “value add”. However my concern is that many Procurement organisation’s have been used to a time of “feast” and will struggle to meet the needs of “famine”.

    1. Brian, Some great points here.

      I personally think that Procurement will never be able to add real value while it is only being performance managed on cost down initiatives.

    2. Brian, very good observation – Oil & Gas industry is project-based and the priorities are different than other industries, and it is mainly technology driven. Yet, projects are temporary, but assets (outputs of projects) are long-term.

      What is also a distinct difference in oil and gas is that we do not have huge inventory moving, compared to retail, nor have to be very flexible to accommodate demand fluctuations. What the industry cares about most is reliability and safety. Once projects are delivered, we want the facilities to be uptime as much as possible and safe. While this is a different game completely, but the fundamentals and basics would be the same, as in other industries.

      There is so much room to do things a lot better in projects and team integration is the first step. However, when times are tough during project execution, we tend to start spending all the professional and intellectual resources and energy disputing over who is to blame and protecting our positions, instead of focusing on things that are critical and important to the project. You can achieve it having trust, pulling in the same direction and sharing risks and rewards.

      Unfortunately, you do not see often.

  7. In many cases, it’s not the CEO to CEO discussion that’s the main issue. It’s more likely to be Technical speaking with Technical who after days, weeks or months of discussion without including PSCM people at the time, then get frustrated when the Contract/PO or Logistics Plan can’t be amended within 5 seconds for a number of reasons.

  8. Andrew, many thanks for sharing this interesting article. The 8over8 Team has been working with the global oil and gas industry for 14 years and we experienced the surge in category management initiatives particularly in response to the 2009 downturn. Our observation was that global oil and gas upstream players struggled to balance Local Content Regulation requirements and complex joint venture agreements with corporate category management initiatives-trying to leverage and enforce global agreements for supply in a market that is” capital project” project and” joint venture” intensive proved much more challenging in reality than the theory might predict.

    1. Spot on Clare,

      Of course how one resolves these issues is the $64k question. Our own view is that it is the failure of cross-functionality internally and externally that is the real issue. Unless companies understand that category management is an Exocet missile directed at current organisational silos they will constantly make these mistakes–and especially in a project-led industry.

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