Successful alliances driven by processes, not discounts

J. Ford Brett, Valerie B. Craig, Kathryne E. Pile, David B. Wadsworth, Kathryn V. Brett
OGCI Management
Tulsa

John Aslakson
Gas Research Institute
Chicago

Many companies enter alliances without a full grasp of the economic potential such a relationship might offer. Many alliances rely too heavily on relationship issues and commercial terms instead of focusing on integrating their technical processes successfully.

Process-driven alliance (PDA) is the term adopted by a new Gas Research Institute report prepared by OGCI Management Inc. to represent a fundamentally different way to plan, execute, and evaluate drilling projects.¹ The term sounds academic but is not.

Not to be confused with the current industry understanding of the term alliance, PDA is much more than a change in commercial terms between organizations. Instead, process-driven alliances are the result of two or more parties that enter into an agreement with a common set of objectives which, through joint planning, execution, and evaluation, provide economic benefits to all concerned-often without regard for corporate boundaries.

The starting point for this report was GRI's Successful Drilling Practices studies (OGJ, Sept. 25, 1995, pp. 68-74), which find the most successful drilling methods in specific gas drilling regions.

In the Greater Green River basin study, 5 years of drilling performance data from every operator in the Moxa Arch were analyzed.² All organizations improved at a fairly steady rate except for one major operator, which significantly increased its performance by integrating its technical processes. This improvement made formerly uneconomic plays profitable.

The data clearly demonstrated that of the 30% of reduced drilling costs, 39% of the reduction resulted directly from many small improvements attributable to the alliance and planning. The major operator credited this dramatic improvement to integrating technical processes among the alliance partners.

Findings

The interviews in the PDA study revealed great variance in the way companies measure-or do not measure-their projects' success. This lack of quantified value restricted OGCI's ability to make quantitative or statistical comparisons of success between organizations. Even with a lack of quantifiable values, the analysis revealed some new findings:

• Process-driven alliances add demonstrable real value by reducing costs and accelerating production. PDAs can also add stability if this real value is shared among all the partners.

• Good working relationships improve, but do not form, the foundation of successful drilling alliances.

• Seven factors contribute to successful alliances. Documented successes range from 12 to 30%. Nevertheless, a few conditions exist that can reduce the impact of even the most well-planned relationship.

• Independent operators naturally use some elements of PDAs because of their size. The scope of independents' projects is sometimes too limited to take full advantage of a PDA.

PDAs create stability

The long-term viability of any drilling relationship hinges on its ability to create real value and achieve stability.

The operator can benefit by discounted prices, and the supplier can benefit from long-term contracts. Reshuffling responsibilities or signing long-term contracts alone does not necessarily add any real, substantive value.

Without improvement in the drilling process, however, the industry as a whole is no richer. This is much like dividing up a pie. Sometimes with a conventional alliance, the partners merely change the size of the slices of the pie. But slicing the pie differently does not create more pie, i.e., more value. Only increasing the size of the pie creates additional value.

Of the four findings in this study, the most central is that process definition and linking add demonstrable real value by reducing costs and accelerating production. In other words, the most effective way to form an alliance is through a detailed description and improvement of the technical processes involved. The organizations in the process-driven alliance are linked together with a common set of technical processes, mutually defined bottom-line goals, and shared benefits.

Improving the technical process, not segregating individual companies' contributions, is the focus of the relationship.

To continue to succeed, the alliance must also be stable. All members must have incentives to remain in the relationship. If one party's profitability suffers as the result of the relationship, then the agreement will be unstable. Without stability, what appears to be an improvement may actually be only a shifting of profit from one partner to another.

Stability of any system or process must be defined in relation to disturbances. For example, a golf ball can theoretically rest on top a bowling ball, but it is not stable. At the slightest disturbance, it will roll off. Similarly, an alliance might add real value; however, if the partners find more profitable uses for their management time and effort, best equipment, and top personnel, then the alliance will eventually fail. An alliance is stable if the other commercial options available to the parties involved are less attractive than the alliance relationship.

Value chain

Creating real value through linked technical processes can be described as a value chain. The operating partners' roles are integrated into the chain via a process description. Fig. 1 [20067 bytes], Fig. 2 [24194 bytes], Fig. 3 [25589 bytes], Fig. 4 [26947 bytes], Fig. 5 [23776 bytes], Fig. 6 [22670 bytes], Fig. 7 [28855 bytes] build a graphical representation of where real value is generated in any drilling alliance, illustrate the value chain theory, and demonstrate the concepts of real value and stability.

Fig. 1 shows the cash flow schematic for an operator's project. Assuming a well will achieve a given productivity (i.e., focusing only on the contribution of drilling costs to the bottom line), an operator can improve its profit picture by reducing expenses (Fig. 2 [24194 bytes]).

As shown in Fig. 3 [25589 bytes], the profit of the service companies, tangibles suppliers, and drilling contractor is similarly dependent upon each company's ability to increase revenue and decrease expenses. Their ability to reduce expenses depends on their ability to increase utilization of equipment and personnel and to reduce waste and loss. Fig. 4 [26947 bytes] illustrates that if expenses are relatively constant, increasing or maintaining profit depends on the terms of the operating contracts and on the ability to attract customers.

Thus, operator and supply/service company profit motives can be on a collision course (Fig. 5 [23776 bytes]). On a short-term basis, the suppliers and the operator are inherently at cross purposes. Operators would rather have equivalent service at a low price, and suppliers would rather have higher prices. In fact, viewed in this way the relationship is a zero-sum game: if one party wins, the other loses. This tension explains the source of the adversarial relationship between operator and supplier/contractor that can sometimes characterize conventional drilling business arrangements.

The GRI study found that about 50% of the alliances studied are driven by the structure of the commercial terms-not the technical processes. None of the commercial structure-driven alliances were able to demonstrate quantified improvements in performance.

The percentage shows that simply putting partners together does not address the fundamental issues of creating real value and achieving stability. Focusing solely on commercial terms is essentially cutting the same pie differently. The study showed that the goal of the most successful alliances was not to craft commercial relationships between the parties, but to create real value.

Real value is created only if supplier expenses are reduced or if the operator's revenue is increased, either by increased or accelerated production (Fig. 6 [22670 bytes]). For an alliance to create real value, it must increase the size of the pie. For a drilling alliance, this means either creating more value from the resource, creating the value at a reduced cost to society, or both.

The most successful alliances understand how joint process improvements reduce total system expense and cycle time required to bring new production on line, thereby increasing the net present value of the revenue stream. This can only happen with a detailed understanding of how technology can be applied to achieve these process improvements.

This real value is rarely created through a large breakthrough improvement. Usually real value is created through working within the technical and planning process to identify a large number of small efficiency improvements.

Creating value is not enough if the relationship is unstable. If the operator reduces expenses by improving the joint processes but does not share rewards with the suppliers and service companies for their increased efficiency, then the suppliers and service companies will see reduced profitability as the reward for their increased efficiency. Any service provider whose fee is based on time will make less per well as efficiency increases. Such relationships will be stable only if the service provider has no other, more attractive choices for work.

As one operator of a successful alliance related to the GRI team, "All partners must agree that an alliance is not a discount. Instead, they must recognize that the partners will make greater profits through incentives by reducing the operator's costs."

For a stable relationship, increased efficiency must be in every player's self-interest. This sometimes means that the benefits of the value generated should be shared with suppliers or the relationship will be unstable (Fig. 7 [28855 bytes]).

Alliances have the potential to create real value and stability. The only way for a structural change (alliance) to add real value is to reduce waste and loss in the system. Reducing suppliers by granting long-term contracts does not necessarily improve total system efficiency; the only reliable way to add real value is to integrate technical processes. Also, successful PDAs distribute additional profits among all partners. Without benefit sharing, the relationship lacks stability.

Integrating technical processes is the key that is missing in most alliances today. By fully understanding and implementing the full view of PDA, petroleum alliances can embrace real value and stability in their ventures.

Successful PDAs

The findings of this study show that the integrated processes of successful alliances drive their relationships. This integration includes clearly and concisely defining the process, accurately and realistically quantifying each process component, identifying and prioritizing improvement opportunities, and jointly operating to achieve maximum results for the process. In addition, successful alliances analyze their processes in an ongoing manner, building feedback and improvement into the process maps.

Seven factors were discovered to be essential when creating successful process-driven alliances (see box). Table 1 [58809 bytes] demonstrates which of these factors were incorporated into each of the 17 alliances (which are identified by letters) studied. Interestingly, most of the alliances included two or more of these factors, leading to the conclusion that the tools and principles commonly associated with continuous process improvement have spread throughout the drilling industry.

Only 5 of the 17 alliances studied quantified the results of their alliances in any meaningful way. One major service company noted of a failed alliance, "We were never able to get our arms around how profitable we were for our operator. If they did have numbers, they never shared them with us. We had no documentation to prove our value and the value of the alliance."

Lack of performance evaluation complicated the task of correlating between an alliance's characteristics and its success.

For the study, levels of success were assigned based on interviews held with the partners within each alliance. This provided a method of relating the success factors to the "reported" success of each relationship. Those alliances that incorporated at least five of the success factors had a much higher chance of achieving what all parties considered to be success (Table 2 [45229 bytes]).

The strongest evidence of the power of PDAs is in the results of the five documented successful alliances. All five did the following:

• Incorporated goals linked to profitability

• Had a well-defined process

• Used quantitative performance measurement tools.

The documented improvements for these alliances ranged from 12 to 30% of total drilling-related costs.

Fig. 8 [27796 bytes] shows that alliances whose goal is to create real value through PDA improvements are far more likely to capture the maximum savings available through their operating relationships.

Changed commercial terms

Many of the drilling organizations interviewed contend that relationships are the critical success factor of an alliance. Typical quotes from the literature are, "The success of this alliance is based largely on trust, planning, and communication," and "The success of an alliance is based largely on mutual trust, constant communication, and the ability to work as a team."^{3 4} One operator interviewed for the study stated, "Relationships are the key to alliances."

The study concludes that this information is incomplete. Although relationships definitely contribute to success, improved working relationships alone are not a reliable way to add real value or stability to drilling programs. If technical process improvement is lacking, the success of alliances based on relationships is temporary. If partners cannot demonstrate the real value added to or stability created by an alliance, the alliance's continued existence is hard to justify.

This finding relates directly to the difficulty of quantifying the success of relationships. Team members may feel that morale is strong and that customer service has improved. Champions or advocates may be built into the system, but relationships are hard to measure. The partners cannot clearly identify the amount of improvement-if any-as a result of the alliance

A related issue is commercial terms. Without clearly defined, measured technical processes, organizations have no way to judge whether alliances improve the bottom line or are just a different way of working together.

The same applies to changing the conventional bidding process. Simply changing commercial terms or shifting the burden of cost and responsibility onto suppliers may provide temporary cost reductions to the operator. In the long run, though, it does not necessarily generate real value.

Conventional alliances fall short in several ways:

• They concentrate on managing people, not processes. Total system waste and loss may not be reduced.

• They are only as stable as the individuals involved; when key individuals leave, the alliances often fail. Even when the alliances are successful, their success cannot be reliably duplicated.

• They are often unstable because the mutual benefit of the relationship is unclear.

How can an alliance reliably create real value and a stable, long-term relationship? What is missing?

The missing factor is that the alliances are not driven by their processes. Although the partners may change commercial terms, shift responsibility to a supplier or contractor, or reduce the supplier base, these moves do not necessarily reduce total cost. By contrast, PDA partners accept common objectives and integrate their technical processes to provide economic benefits to all parties.

This relationship makes the most of the strengths each partner offers. The best person for any given task performs that task as efficiently as possible. Redundant or low-value tasks are eliminated, or the process is changed altogether to become more efficient. All parties benefit economically, usually through incentives, so they are financially motivated to find the best solutions.

Characteristics of failure

Integrating technical processes is the key to alliance success. However, process-driven alliances can fail if certain situations occur-notably, if the project scope is too small, if too many partners are involved in the alliance, if the process is not revised or changed over time, and if a clear exit strategy has not been developed.