MANAGEMENT PERSPECTIVE HOW TO CUT COSTS 1990S STYLE

Phillip A. Ellis
Vice President Booz*Allen & Hamilton
Paris

Mark Gallion
Senior Associate Booz*Allen & Hamilton
Dallas

Continued weakness in the U.S. oil and gas industry is leading to yet another round of cost reduction.

In recent months, more than 15 large producers have announced significant plans to reduce costs. We expect this trend to accelerate during 1992 as low U.S. gas prices and $18-20/bbl oil prices take their toll on financial performance.

We suggest that the industry's approach to cost reduction during the 1980s will not be adequate for this next round of cuts. Instead, the 1990s style cost reduction will need to be more participative and thoughtful and will target nonpeople costs to improve organizational performance.

ANOTHER ROUND

Cost reduction is certainly not a new topic to oil and gas companies.

Most majors and independents have gone through several rounds of layoffs and reorganizations during the past decade. Those initiatives worked off the excess fat that built up during the 1978-82 boom, when $100/bbl oil price forecasts and natural gas shortages ruled the day.

Some of the initiatives were effective.

Everyone in the industry cites lower finding and lifting costs as proof that companies can continue to grow amid today's low prices. And it is true, finding costs and lifting costs have declined dramatically in recent years due to a combination of more disciplined portfolio management and new technologies (OGJ, Sept. 30, 1991, p. 42).

Overhead costs, however, are another story.

Since 1987, general and administrative (G&A) costs per barrel of oil equivalent have increased 14-18%/year for the 23 largest U.S. producers (Fig. 1).

It is now clear that the painful cost reductions of the 1980s failed to translate into sustainable savings for producers.

Given this situation, what can companies do differently in the 1990s to achieve sustainable cost reduction?

1980S COST CUTTING

Most of us remember the traumatic staff reductions of the 1980s.

Cost cutting was a semiannual event driven by a headquarters team of accountants, planners, and human resources staff. Organizations were paralyzed waiting for the much rumored announcements that usually included across the board staff reduction programs and a new organization chart.

Headcount reduction was the key measure of success.

Line managers went immediately into reactive mode to draw new lines and boxes, force-rank and select staff, and negotiate deals with other managers to meet headcount targets. Recently completed business plans were shelved as growth and profit became secondary objectives.

Once the cost reduction event was over, organizations often settled back into their old ways. Positions were eliminated, but business processes and work drivers were unchanged.

And there often was little accountability for continuously improving efficiency after the event. Costs crept back into the system as contractor and nonheadcount expenses increased.

Worst of all, employees that remained were demoralized, overworked, and alienated. This became a significant problem by the late 1980s as managers struggled-and mostly failed-to build employee commitment to implement total quality and employee involvement programs.

1990S COST CUTTING

Successful cost reduction programs of the 1990s must learn from experiences of the 1980s (Fig. 2).

Business strategies and line organizations must become the main driving forces behind cost reduction. Semiannual across the board events must be replaced by a continuous stream of targeted cost reduction opportunities that meet cost/value tradeoffs and position the company to achieve its business plan.

Cost reduction programs of the 1990s will challenge what companies do and how they do it.

For example, complex business processes-gas control, prospect generation, procurement, and the like-will be reengineered to take work out of the system. Low value added activities will be eliminated. Jobs will be redefined.

A horizontal "process" view of the organization will replace the traditional vertical and hierarchical views. Redundancies and other inefficiencies that build between departments will be eliminated.

Centralized staff functions will be held accountable for providing cost effective services to the line organization.

In many cases, nonstrategic functions such as accounting and information systems will be farmed out to service firms. The overall role of headquarters will be revised.

Accountability and authority for managing costs will be pushed to lower levels of the organization where detailed knowledge to make cost/value tradeoffs resides.

Senior management's role will be to convince the organization that cost reduction is a win-win situation because lower costs eventually can translate into growth. Employees will become participants in cost reduction through work teams, task forces, and employee involvement programs.

MANAGEMENT ISSUES

A number of majors and independents are implementing more progressive cost reduction efforts. Other companies will follow as it becomes clear that a new approach is required.

However, the transition to 1990s style cost reduction will force senior managers to face these issues:

What is the payoff? In companies with high and growing G&A costs, the payoff could be substantial. Low costs translate into competitive advantage in mature, declining basins. Our experience is that 1990s style cost reduction could yield savings of 20-40% of total expenses.
How do we get started? The keys to getting started are to build organizational commitment to the effort and set aggressive targets. Broad participation is a must. Insights from other companies and other industries are key in achieving the next evolution of G&A cost cutting.
How do I get employees to take ownership of costs? In most companies, a significant cultural change will be required to successfully implement 1990s style cost reduction. Our experience is that cultural barriers can be overcome if employees understand that the need for change is critical. Clear communication of the business drivers is a must. Furthermore, managers must demonstrate that broad employee participation is not only welcome but essential. Often the best way to break the ice is to launch a focused 1990s style program to achieve "step-change" cost reduction in one or more parts of the organization.

It must be appreciated that the new focus is on sustained cost improvement, not short term headcount reductions. Employees' loyalty must be won back with greater job satisfaction to ensure that they are committed to lower costs.