Managing Director Christopher Monk, a leader in Protiviti’s Supply Chain practice, discusses some of the key findings from Protiviti’s recent study, Bridging the Gap Between Finance and Procurement, in the context of the energy industry and some of the challenges these organizations have been experiencing over the past several years. For more information, visit www.protiviti.com//CFOprocurement.
Yes, certainly, Kevin. Just to start off, the industry really fell off a cliff in the summer of 2014 and really didn’t come out of it until the spring of 2017. That was good news, obviously, for consumers with prices at the pump extremely low – the lowest they’ve been for over a decade – but obviously terrible news for the oil and gas industry as a whole.
However, a lot has changed since the rebound and particularly in the last six months, but we’re not entirely in the clear. When you look at oil prices, they’ve rebounded now to the mid-$60 range for the West Texas Intermediate, or WTI, but that was from a low of about $27 a barrel in January of 2016. That’s still more than about 40 percent less than the peak of $108 a barrel, which was in the summer of 2014.
We continue to face some risks and uncertainty brought on by things like supply and demand levels, interest rates, and foreign exchange. There’s a lot of news around some of the geopolitical risks and concerns, a lot of talk around disruptive technology and settling of the industry consolidation that I’ll talk more about here in a moment, just to name a few.
Coming out of all of that, we see a couple of macro trends going forward within oil and gas: Number one, continue to expect a little bit of the price volatility, still, over the next three to five years. Number two – and most relevant for this conversation – is, we expect to see an increased focus on cost, on profitability and on free cash flow. Interest-rates cost to capital will come up, so that will continue to be a point of emphasis for producers and energy firms. As the settling from the acquisitions and the investitures and the mergers take place, we will all start to see a differentiation in niche capabilities, which will drive specialties, but there’s still going to be quite an emphasis on the cost.
I guess two of the things I would leave with are number one, an increased use of technology – things like mobile, things like robotics, which will have a big impact on an organization’s ability to scale – and then finally, a war of the talents. That is, as the industry is rebounding and bringing back some of the talent that was let go, there is going to be considerable war for talent, and that will directly impact the supply-chain organizations.
Yes. There were a number of responses, many of them very drastic, albeit effective. Things like outright canceling projects, deferring any and all discretionary spend, and massive, massive layoffs, so that many across the industry and ancillary industries, suppliers and providers and the energy space, felt the implications of the layoffs.
In particular, there was aggressive targeting of price reductions and conceptions from the suppliers and extending payment terms. There was very much an aggressive renegotiation strategy that most firms took. Unfortunately, there was a lot of fat to trim, so to speak, when companies were accustomed to operating at north of $100 a barrel. There were also a lot of smaller companies that were not well-positioned to weather the storm. They had to restructure. They had to divest or, ultimately, they had to close their doors. Some of those responses, while effective, it’s now the time to look at what the sustainability of those responses are.
Yes, and one more point relative to the responses and the actions: Costs dropped drastically over the last couple of years; the costs to drill oil, in some cases, are more than 30 percent lower, but that level of decline was not sustainable, as I mentioned earlier. The supplier community was very understanding at first – very much willing to take concessions to reduce prices, to do whatever they could to keep whatever business they were going to hang onto. Now, we’re seeing cost-escalation pressure come quite rapidly, as the suppliers who were understanding years ago now look to recover some of those concessions, recover some of those margins that were lost and the concessions made during the collapse of the market.
So, without the ability to effectively manage this going forward, the reductions that were seen years ago will quickly erode, and producers will once again be faced with margin pressures as the top end of oil prices are nowhere near to where they will be in the levels in the past. Talk about $60 to $65 being the new norm in terms of prices. Beyond the costs aspects, capacity may also become an issue as producers look to ramp up, but they do so with a scaled-back workforce, which ties back in with the war-on-talent trend that I mentioned earlier.
So, when we think about what companies should do with moving forward with respect to keeping costs down or managing those savings that were achieved years ago, there are a couple of things: Number one is evolving from a strategic sourcing category management mind-set. Essentially, what that means is being a little bit farther-sighted in terms of the strategies around what are cost drivers, what are price drivers, or what are trends in a particular category or area of spend?
The whack-a-mole strategy, where you just go beat on a supplier for concessions, is effective in a short-term or isolated event, but now, take a broader perspective to understand not “What is my cost as a supplier?” but “What is the overall cost from a supply-chain perspective?” Thinking about longer-term trends, and really driving down the end-to-end supply-chain cost not just from an individual sourcing event.
Very much related to that is increasing the focus on supplier management. The level of collaboration, absolutely, is going to have to go up because to hit the margins that all parties want to make while dealing with cost at a $60-to-$65-a-barrel range as opposed to $100 to $105, it’s truly going to be a team effort up and down the supply chain. So, collaborative supplier management, supplier relationship management, working together and looking at not only the price but also at how do we drive performance to increase the overall value? That may be, rather than price reductions, things like innovation, improved efficiencies, etc.
Another strategy is around focusing on working capital. Strictly looking at it from a payment-terms perspective, obviously, inventory levels are area-focused, but in the past couple of years, the knee-jerk reaction was to push out payment terms from 45- to 60-, or 60- to 75-, or in some cases 90-day payment terms, which, again, yielded short-term results but not always to sustain the smaller supplier, so, really, beefing the working capital management capabilities.
When we think about the study that we did and looked at the difference on how finance views procurement versus how procurement views themselves, and then compared against both leading and lagging performers, there are a couple of interesting observations to note from that study. Number one, the study showed that 64 percent of energy companies we surveyed did not actively measure spending. This is a clear opportunity to improve the use of things like spend-analytics tools to really drive that mind-set and that focus on ongoing and active spend management. Number two, 91 percent of the industry respondents felt that 40 percent or less of negotiated savings actually hit the bottom line.
I’m going to say that again to let it sink in: Ninety-one percent of the industry respondents felt that 40 percent or less of the negotiated savings actually hit the bottom line. So, translated, we’re doing a whole lot of work to identify savings that really aren’t impacting our bottom line – a massive, massive opportunity. The good news is that there is the opportunity. The bad news is, it wasn’t one or two drivers that led to this. We saw a wide distribution of the reasons, which certainly makes it tougher to tackle but nonetheless a significant opportunity.
Finally, just to round out looking at what the EMP companies and producers will need to change in terms of the current way of thinking, number one talked about collaboration. This is with suppliers, but also internally, within the internal customers. On the external collaboration, it’s really a move from a price to a cost focus to sustain some of those previous savings. Then, third, something that I mentioned previously was looking at the use of disruptive technologies and digital and robotics or RPA (robotic process automation) as ways to drive efficiencies, to keep internal costs down but still be able to scale as they need to grow.