Supply Chain

Supply Chain Management (SCM) is critical for capturing and retaining the buyer's fair share of the learning and scale benefits generated by high-cost resource strategies. Scale benefits are derived by loading assets more effectively. Learning benefits accrue from executing projects and services more efficiently over time. Since these benefits are first realized by 3rd party service providers, buyers must establish service agreements that anticipate and provide for a fair allocation of risks and benefits.

The SCM capabilities needed for capturing scale and learning cost benefits through more productive supplier relationships have evolved in other industries over the last twenty years. Leaders realize significant cost benefits -­12-20% in the first years, 3-5% per annually thereafter. The common principles are well understood:

1. Supply chain widely viewed as a "value creating" function, not a "service".

2. Senior executives communicate with a "single voice" to strategic suppliers.

3. Sector strategy formation and implementation organized around markets first (not projects, businesses or regions)

4. Sustained and frequent focus on executing category strategies, especially disciplined supplier selection processes

5. Transaction systems that make compliance to preferred contracts easier than non-compliance

6. Supply chain is viewed as an essential stop for developing commercial skills for high potential managers.

7. Data management tools that make monitoring progress and launching new initiatives less daunting.

8. Clearly defined metrics and performance measures to promote, and share, learning benefits

But how to get there? International upstream operators face unique challenges, especially in PSC environments where government regulations impact supply chain management. In Chevron's experience these environments can present some difficult challenges to supply chain optimization.

• PSC terms specify procurement processes that require everything to be bid out, which can limit innovation in supplier relations. Government approvals are required at every step, increasing cycle times, schedule uncertainty and running costs.

• Consolidation in the service sector has shifted market power from the IOCs to their suppliers. Transocean has a dominant share of the deep water drill ship market, leaving operators more dependent on this company. Schlumberger and Halliburton are highly focused strategically on NOC business and are less attentive than they

Steam Assisted Gravity Drainage used to be to IOCs. Further, some suppliers are declining to serve certain markets, such that market concentration is even greater.

• On top of the spike in petroleum related demand for materials and services, there has been a simultaneous surge in demand from the Chinese infrastructure build out which has contributed to a scarcity of steel and other materials.

CRA has observed that there are systemic challenges in the project nature of the upstream oil development. Bespoke projects make it difficult for SCM to establish a baseline for demonstrating value-creation. The positive incentives and focus created by project management make coordinating a single voice to a supply-market difficult. Finally, the fluid nature of project work makes it difficult to demonstrate the value of forming long-term relationships to suppliers.

Reformulating traditional projects into programs, as Chevron has done in Indonesia, coupled with thoughtful SCM strategies is the first step. Leaders are taking important additional steps to enhance their ability to execute these strategies. We see four consistent themes:

1. Strategic Alignment. Aligning SCM strategies with broader program and business strategies. Strategic Alignment convinces suppliers and internal stakeholders of executive management's commitment to changing the status quo of relationships and a willingness to drive change across traditional 'project' boundaries. Suppliers are adept at building relationships throughout client organizations; disrupting these relationships creates winners and losers within both organizations. Hence, linking to the enterprise's higher strategic goals establishes an environment where appropriate risks can be taken.

2. Organizational Integration. Engagement with a supply market on a project-by-project basis is by definition sub-optimal. Leaders use structural or organizational mechanisms to enable self-interested projects/businesses find common interest in working across boundaries. One approach is setting reporting relationships for SCM at the highest levels of the business. Another is empowering SCM leadership to select, resource, and manage cross-functional/project teams to execute strategies.

3. Process Discipline. Most organizations have adopted standardized procurement processes. The leaders, however, execute these supplier engagement processes with skill and consistency. The key challenge for upstream oil is maintaining a disciplined approach that meets the needs of a portfolio of projects with evolving needs. CRA has seen that good process execution usually trumps buyer scale (e.g. Exxon adopted Mobil's process, contracts & leadership team, Gillette's supplier pre-merger prices were better than P&G's). Strategic Supplier Selection Processes must address the full value of the potential relationship, and be seen as a fair and rigorous process to create competitive tension between incumbent and non-incumbent suppliers. Supplier Relationship Processes must incorporate robust metrics and material incentives to motivate capture and sharing of learning benefits.

4. Capability Development. Since much of the value from world class supply-chain comes from disciplined execution of its core processes, the capabilities of individual practitioners is critically important. In addition, the far-flung markets in up-stream oil make the quantity of skilled resources a concern. Leaders constantly work to improve their talent set and ensure that their best talent is applied against the most important opportunities.

There remains the problem of addressing government imposed procurement rules that frustrate SCM best practices. This will require an industry-wide education and engagement program with government and NOC officials that seeks to understand the objectives of the government rules, educates officials in best practices, demonstrates the value of these practices, and proposes approaches that meet the government's procurement objectives while allowing operators (and therefore governments) the cost benefits of global sourcing contracts. This process must maximize total value derived by optimizing the use of both global and local suppliers and ensure that this value is realized by operators, governments and NOCs.