Daniel C. Coolidge
Unocal Corp.
Lafayette, La.
A recent survey of petroleum industry contracting strategies indicates that alliances between operators and service companies had a success rate of nearly 75% (See Part 1, OGJ, Sept. 25, p. 58).
Sole supplier alliances (between an operator and one supplier or service company) had a higher success rate than integrated service alliances. (One supplier or service company provides all or most of the services for an operation.)
Moreover, alliance activity is increasing along the U.S. gulf coast. Many operators and service companies plan to continue with alliance-type contracts.
To determine the current trends and characteristics of alliances between customers (producers) and suppliers, a survey was sent to 200 petroleum industry personnel located in the Gulf Coast area. The survey population was divided into 100 producers and 100 suppliers.
Half of the producers were major integrated oil companies (Amoco Production Co., Mobil Exploration & Producing U.S. Inc., Shell Oil Co., etc.) and half were independent producers (Apache Corp., Enserch Corp., Meridian Oil Inc., etc.). Seventy different producing companies were polled. A few independents and most of the majors were sent more than one survey to different office locations (Houston, New Orleans, and Lafayette, La.).
Of the 100 suppliers, 70 were small to mid-sized service companies (Camco International Inc., BJ Services Co., Enterra Corp., etc.), 10 were major integrated service companies (Halliburton Energy Services, Schlumberger Well Services, Baker Hughes Inc., etc.), and 15 were drilling rig contractors or consulting/engineering firms (Diamond Offshore Drilling Inc., Pride Petroleum Services Inc., Cliffs Drilling Co., etc.).
The survey was designed to determine how the petroleum industry defines an alliance and what they have experienced with their agreements.
The response rate was 55.5% (111 out of 200). A total of 54 customers, or 49% of the total responses, were divided between 28 major and 26 independent producers, which corresponds to 25% and 24% of the total responses, respectively. A total of 57 suppliers, or 51% of the total response, was divided among 42 service companies, 8 major integrated service companies, and 7 rig contractors/drilling consulting firms, which corresponds to 38%, 7%, and 6% of the total responses, respectively (Fig. 1). The percentages of responses of each type of company closely match the percentages of those surveyed.
Of the 111 responses, 88 companies (79%) had participated in at least one alliance program. The other 23 companies (21%) had no alliances or did not choose to label their agreements as such. Of the 88 companies that participated in alliances, 37 (42%) were producers, of which only 3% considered themselves as suppliers (some drilling groups consider themselves as internal suppliers), and 51 (58%) were suppliers, of which only 2% considered themselves as customers (turnkey drilling consultants).
The range of accuracy in this survey is within +5%.
About 20% of the respondents provided detailed comments to elaborate on their experiences with petroleum industry alliances. The results of the survey were compared in terms of the overall response and the most common types of exclusive arrangements reported, the sole supplier and integrated service alliances.
Survey results
The average success rate for all the alliances surveyed was 73% (68% for customers and 75% for suppliers). The most successful for both customers and suppliers were the 24 sole supplier alliances, which had an average success rate of 88% (82% for customers and 92% for suppliers).
The 17 integrated service alliances had an average success rate of 71% (60% for customers and 75% for suppliers). The average success rate for the customers with integrated service alliances is not statistically significant because of the low response rate.
In almost every case, alliances, and especially integrated service alliances, seem to be slightly more successful for suppliers than for customers.
Failure rates
In contrast, the average failure rate for all the alliances surveyed was 7% (5% for customers and 12% for suppliers). The highest average failure rate reported was 20%, which included one of the five customers with an integrated service alliance (not statistically significant). The average failure rate for suppliers with integrated service alliances was 8%. The failure rate was also 8% for the sole supplier alliances (9% for customers and 8% for suppliers).
These data suggest that producers significantly increased their chance of failure by forming an exclusive relationship. Without an exclusive relationship, however, the failure rate for suppliers was greatly increased.
Control
Surprisingly, only 53% of the respondents (62% of the customers and 47% of the suppliers) said their alliance relationship was one-sided. Almost all indicated that the customer (producer) was in control.
Customers with sole supplier alliances believed they had more control than those with integrated service alliances, or 73% and 60%, respectively. Suppliers with integrated service alliances viewed the customer as more controlling than those with sole supplier alliances, or 67% and 54%, respectively.
Customers with integrated service alliances take more risks by forming these types of agreements and therefore, they should have more control in their alliance.
Incentives
A performance incentive program was included in 49% of the alliances reported. Overall, 49% of the customers offered a performance incentive, but to only 37% of the suppliers. Performance incentives were more common in integrated service alliances, where 67% of the suppliers and 40% of the customers reported having incentive programs.
Incentive programs were somewhat less common (46% of the suppliers and 45% of the customers) with sole supplier alliances. Only 21% of the suppliers without an exclusive agreement reported having a performance incentive.
Several customers reported that they were eliminating their performance incentives because their programs were difficult to manage or were a constant source of controversy.
Alliance formation
Alliances are largely customer driven. Overall, 60% were initiated by the customer, 31% were formed through mutual agreement, and 9% were initiated by the supplier. The percentages of responses were very similar for each type of alliance.
Customers initiated 54% of the sole supplier alliances and 59% of the integrated service alliances. About 38% of the sole supplier alliances and 35% of the integrated service alliances were formed through mutual agreement.
Overall, the suppliers did not directly initiate very many alliances. The suppliers do influence their customers, however, by providing information about successful alliance programs with other customers.
About 51% of the alliances were formed by competitive bid, 17% were arranged by management, 9% were a natural progression of an existing business relationship, and 23% were formed by other methods. The percentage of alliances formed by competitive bid was basically the same for each type of alliance studied.
Management was responsible for arranging 29% of the integrated service alliances, 13% of the sole supplier alliances, and 8% of all others. Thus, company management has been twice as likely to arrange sole supplier alliances, and three times more likely to arrange integrated service alliances than all other types. This control can be detrimental to the success of the alliance if there is no ownership or acceptance with the operational personnel of either party.
The rate of alliance formation activity was increasing in 68% of the 111 total responses, and only 3% reported a decreasing activity level.
The highest level of activity reported was in the 24 companies with sole supplier alliances, where 88% reported their activities as increasing and none reported decreasing.
As for the 17 companies with integrated service alliances, 76% reported an increasing activity level, and 12% reported a decrease in activity. Of the 22 companies that reported having no alliances at the time of the survey, 23% said their activity level was slightly increasing, but 77% did not see a change in their activity level (or they had no alliance activity).
Overall, alliance activity is increasing, especially in the companies with sole supplier alliances.
Life cycle
The primary term or length of the alliance contract was more or less evenly divided: 1 year or less (35%), 1-2 years (29%), and 2-5 years (33%). The remaining 3% committed to terms longer than 5 years.
The sole supplier alliances tend to have the longest terms; 38% had commitments of 2-5 years, compared to only 29% of the same in integrated services alliances.
Also, integrated service alliances tend to have the shortest terms. About 47% committed for only 1 year, compared to 25% of the sole supplier alliances.
One possible explanation for these short terms is that integrated service alliances involve more risk, and, therefore, customers want to review progress annually before committing to longer terms. In any case, most customers are not likely to commit for more than 5 years, and only 36% of those surveyed committed to more than 2 years.
The actual alliance life cycle or duration differs somewhat from the primary term or length of commitment. About 21% of the sole supplier and 35% of the integrated service alliances lasted for only 1 year, but 50% of the sole supplier and 30% of the integrated service alliances lasted up to 2 years.
Also, 25% of the sole supplier and 35% of the integrated service alliances lasted 2-5 years. Overall, only 4% lasted for more that 5 years (one sole supplier and one nonexclusive alliance).
There are two possible explanations for these short alliance life cycles. First, because customer/supplier alliances are relatively new to the petroleum industry, it may be too soon to establish a larger frequency of long-term relationships. Second, these alliances may be periodically re-evaluated and put out for bid, and a different supplier may be awarded the alliance because of more favorable terms and conditions, or the customer was not completely satisfied with the previous partner.
Reasons for forming alliances
The reasons for forming alliances varied greatly between customers and suppliers for the various types of alliances. Cost reduction was not included as a survey option because the intent was to identify other important reasons.
Of the 88 total responses with alliances, 37 were from customers (producers) and 51 were from suppliers. The primary reasons for forming customer/supplier alliances were to improve communication or efficiency and to increase the quality of products and services (Fig. 2). Most customers also formed alliances to share risks or resources and to gain technologies or expertise. Most suppliers formed alliances to satisfy their customers and expand their market share.
Similar to customers, the suppliers formed alliances to increase efficiency and quality. They were less interested in sharing risks and resources, or gaining technologies, and more interested in complementing their product lines or neutralizing their competitors, however.
In terms of the actual number of responses, improving communication or efficiency was an important reason for 26 customers (70%) and 28 suppliers (55%). Only 22 of the suppliers (43%) formed alliances to increase quality, even though 23 out of 37 customers (62%) believed that quality improvement was important.
The most surprising difference was that 35 of the suppliers (69%) believed that alliances have become necessary to satisfy their customers, yet only one of the customers (5%) agreed.
This wide difference in opinions suggests that the customers have not accepted that alliances are necessary or that suppliers misunderstand their customer's true intentions.
Nineteen customers (51%) and 14 suppliers (27%) believed that sharing risks or expenses was a good reason to form an alliance. Similarly, 18 customers (49%) and 13 suppliers (25%) believed resource sharing was another important reason.
Contrary to alliance trends in many other industries, gaining technology was not the most important reason for alliances in the petroleum industry.
Sole supplier
Sole supplier alliances were formed primarily to increase communication or efficiency and to increase the quality of products and services (Fig. 3). There were a total of 24 sole supplier alliances reported, which comprised 11 customer and 13 supplier responses.
Sharing risks or resources, and gaining technologies were important to customers. Customers generally formed their alliances for increased quality more so than suppliers did.
Suppliers, however, believed that alliances were necessary to satisfy their customers. As expected, suppliers were interested in entering a new market or expanding their market share.
Integrated service
The reasons for forming integrated service alliances were largely affected by the supplier's viewpoint (Fig. 4). Twelve of the responses were from suppliers, and only five were from customers.
Not surprisingly, 11 of the 12 suppliers formed integrated service alliances to enter a new market or to expand their market share. Eleven of the suppliers believed that alliances were necessary to satisfy their customers (although none of the customers felt the same).
The other reasons for forming integrated service alliances were very similar to those discussed earlier: improving communication or efficiency, increasing quality, gaining technologies or expertise, sharing risks, and sharing resources.
Unfortunately, the low customer response rate on integrated service alliances does not provide enough details for statistical significance.
Sharing risks or resources has been a key selling feature for suppliers that offer integrated service alliances in international areas, because most of these alliances include the major service companies that can usually afford some additional exposure.
Risk sharing is one of the primary goals in the lead-contractor type of integrated service alliance, which is somewhat complicated and can be very controversial for a rig contractor. A customer may have to commit all or a significant portion of his work for his supplier to justify the expense of sharing risks or resources, especially those which provide desk engineers or accept penalty clauses for poor performance.
Sharing risks or resources may be less important in the Gulf Coast area because resources are more available, and natural gas prices are more volatile, which can complicate risk sharing agreements.
A major problem for integrated service alliances is that most customers are excluding some portions of their service work from their integrated partner because they feel the supplier lacks competence in a particular service area or product line or because they have been unsatisfied with their prior service history.
Also, most producers have difficulty justifying a comprehensive integrated service alliance. Many are trying to decide the best way to structure their integrated service alliances so that each partner is completely satisfied with the agreement.
Performance measurements
Customers and suppliers measured the performance of their alliances differently (Fig. 5)(Fig. 6)(Fig. 7). The performance measure used most often was decreased costs or expenses.
In fact, 30 customers (81%) and 24 suppliers (47%) measured cost reduction to evaluate the success of their alliance. Increased efficiency, which includes lower administrative expenses, was the second most common measurement.
Quality improvement was not measured as much as expected, considering that 23 customers (62%) said they formed alliances to improve quality, but only 14 (38%) actually measured their performance.
Profitability or increased net revenue was not measured very often, and it was used mainly by suppliers. Increased production was rarely measured; only 12 customers (32%) and 8 suppliers (12%) measured production as a performance indicator.
The performance measurements of sole supplier alliances varied greatly between customers and suppliers (Fig. 6). All 11 customers measured cost reduction, and most measured increased efficiency and quality to evaluate the performance of their alliances.
Suppliers preferred to measure their market penetration or increased revenues. Surprisingly, less than one-third of the suppliers measured cost reduction and increased efficiency or quality, even though these were the primary reasons that customers formed the alliances.
Some customers measured increased profitability or production as a performance indicator, even though determining their effects on the alliance can be difficult because of outside variables.
The two most common measurements for the integrated service alliances were cost reduction and increased efficiency (Fig. 7). Other common measurements included increased quality, profits or net revenue, and increased production. Customers primarily measured decreased costs and increased efficiency. Increased quality was measured only by the suppliers.
These customers possibly rely on their suppliers to monitor their own quality improvement. Suppliers preferred to measure profitability over gross sales revenues. They also measured increased production, which was probably linked to a performance bonus incentive. Surprisingly, only four suppliers (33%) measured increased market penetration, even though it was the primary goal for eleven (92%) of them.
Other findings
While a performance incentive program may offer some motivation for suppliers to obtain their customer's goals, it did not seem to greatly affect the success rate of the 64 successful alliances studied. In fact, only 42% of the 64 successful alliances included a performance incentive compared to 67% of the 24 unsuccessful alliances.
Also, several customers mentioned they were discontinuing their incentive programs because the programs seemed to create problems or were difficult to manage properly.
Performance bonus awards were most often included in integrated service alliances (Fig. 8). The major service companies were more willing to share risks and resources in integrated service alliances, and, thus, they should have received more rewards.
Slightly less than half of the sole supplier alliances included performance bonus incentives, possibly in exchange for increased discounting or penalties for poor job performance. Only 19% of the nonexclusive alliances provided a performance incentive. Only 25% of the rig contractors reported receiving a performance bonus, and most felt that incentive programs were not very useful for motivating their crews.
Also, most rig contractors viewed alliances as a means for their customers to "beat down" their day rates and force them to share risks. In general, rig contractors were not in favor of forming alliances (at least not formal alliances). Instead, they preferred to have informal, long-term contracts or to turnkey their drilling services to give them more effective control of their costs and risk factors.
Copyright 1995 Oil & Gas Journal. All Rights Reserved.
