Tag Archives: Oil & Gas

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

KONICA MINOLTA DIGITAL CAMERA

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….