Jake Leslie Melville
Senior Partner & Managing Director
Related Expertise:Energy & Environment
Over the past decade, many exploration and production (E&P) companies have significantly improved their procurement and supply-chain-management practices and have achieved material gains in the efficiency of their dealings with suppliers. Many E&P players believe, however, that they still have much further to go. In particular they suspect that there remains considerable hidden “value leakage” in their transactions with suppliers. What is more difficult to identify is where, precisely, the problems lie and to what extent they are resolvable.
To gain their insights on this issue, we conducted a survey of a cross section of companies that provide services and equipment to the E&P industry. Casting a wide net, we spoke with drilling contractors, OEMs, and companies engaged in well services, marine services, and engineering, procurement, and construction (EPC). What we heard surprised us, and we believe that our findings have significant implications for the E&P value chain. Most suppliers and service companies believe that there is indeed value being lost at the interface between them and E&P companies. They think that some of the issues still result from flawed contract framing and setup by E&P companies, despite the E&P companies’ extensive optimization efforts on this front. But the suppliers we interviewed also stated that many of the problems arise because of the way that E&P companies execute and manage these contracts. Some of the suppliers mentioned poor contract management as an ongoing concern. Suppliers said that this holds particularly for the large, integrated E&P companies—ironically, the players that have invested the most in their supply-chain structures and functions in recent years.
We believe that the challenge of value leakage is one that E&P companies can address, but it will require them to rebalance their focus in their supply-chain efforts. Specifically, they will have to assign less urgency to the design of ever-more sophisticated contracts and incentives and spend more time improving basic contract framing, supervision, and management practices.
Our discussions with industry suppliers identified 11 distinct sources of value leakage at the interface between E&P companies and suppliers. (See the exhibit below.) Value leakage in the contracting cycle falls into three categories: contract framing and setup, field operations and execution, and contract enforcement and administration.
Contract Framing and Setup. There are four sources of value leakage at the contract-framing and setup stage.
Field Operations and Execution. The following are the five sources of value leakage that we identified during the interviews focused on field operations and execution.
Contract Enforcement and Administration. Even when contracts have been well crafted, value is often lost through inadequate enforcement of the contract conditions.
In the course of the interviews, we heard many stories of inefficiency in the value chain. For sure, some E&P companies are more effective than others at managing their supplier relationships. Still, there is massive scope for improvement across the industry, and we believe that improving the interfaces between operators and suppliers is one of the biggest value levers the industry has for reducing costs.
There are several remedial and preventive approaches that E&P companies can take to minimize value leakage in their relationships with suppliers. We see the following as being the most critical:
Drive a commercial perspective into frontline decision making. Too often, decisions made by E&P companies’ frontline personnel are based solely on operational criteria, typically, with the easiest or most expedient solution prevailing. E&P companies should provide frontline staff with incentives that foster the adoption of an additional—a commercial—perspective. Frontline personnel should also be provided with the financial information they need to make optimized day-to-day decisions on cost-benefit tradeoffs.
Institute end-to-end contract ownership. E&P companies that employ committed end-to-end contract managers and management resources are considered by suppliers to be superior partners because they make it possible to have more candid and fruitful discussions about targeted outcomes and tradeoffs. To determine whether or not there is a positive business case for end-to-end ownership, E&P players should weigh the incremental cost of having dedicated personnel assigned to a particular contract against the potential corresponding gains in efficiency.
Restrict global contract standards to elements that are truly global. Standardization clearly has its benefits. But attempting to enforce standards that are poorly matched to a given locale is a recipe for value leakage. E&P companies should set global standards wherever possible but recognize that some unique situations require flexibility.
Learn from smaller, more agile players. Most large E&P companies have considerable scope for becoming faster operationally and accelerating their decision-making processes, and they can do so without compromising safety or integrity. Procedures are critical, but they should not exist solely for their own sake. Larger E&P companies should examine their operational and decision-making procedures and weed out those that fail to add value.
Form strategic alliances with suppliers to formalize joint approaches for tackling value leakage. This can be a very effective long-term solution that can deliver a host of benefits. Although implementation of strategic alliances can be quite challenging, it is a path well worth exploring. (See “Strategic Alliances in Upstream Oil and Gas: Getting Serious About Collaboration,” BCG article, April 2015.)
E&P companies are capturing—on paper—ever-greater amounts of value in their relationships with suppliers through increasingly sophisticated supply-chain practices. But they are behind where they should be in translating this contractually secured value into delivered value. The levers discussed above can help E&P players make the leap from the theoretical to the real and, in the process, take the performance and efficiency of their supply chains to the next level.
The authors would like to thank BCG's Maurice Berns and our panel of industry interviewees for their contributions to this article.