28 Oct Scaling Up Is Hard To Do
The inability to scale up digital innovations in oil and gas is a significant impediment to progress. But there are solutions.
My good friends at Spartan Controls recently held an executive panel event to chew through the challenges of digital innovation. I was most fortunate to be invited to the panel, along with the CIO of Canada’s largest oil company, the global oil industry leader for the world’s most valuable technology company from Redmond, the CIO of a big North American midstream player based in Calgary, and the sector leader for a leading oil technology company based in Houston.
We were given carte blanche to focus our introductory remarks as we saw fit. I chose to highlight three messages from my book, ‘Bits, Bytes, and Barrels’. First, capital markets are now dominated by the very large digital companies (Alphabet, Amazon, Apple, Facebook and Microsoft), but the revenue leaders are still weighted towards other industries, including oil and gas. Talented young people are shying away from the industrials in favour of the digital giants and digital start ups, which sets up the industrials for some serious talent shortages in the future.
Second, I pointed out how digital companies exploit Moore’s Law (exponential growth), and Metcalfe’s Law (the value of networks) in tandem, and oil and gas does not. The oil and gas business model tends to create scarcity and high prices, whereas the digital business model is based on abundance and near zero cost. Finally, I presented a simple framework for thinking about digital, something easily sketched out on the back of a napkin and useful for getting the message across to others.
But one of the key takeaways was the problem of scaling up digital innovations. It was clear that the ultimate customers were serious about investing in digital, but were still struggling with moving beyond pilots and trials.
I have written about this problem already, since many technology entrepreneurs have asked me how to get out of pilot project hell, but the panel presented alternative insights that are worth sharing.
I took away four key messages from the event.
The Scale Mismatch
It’s very clear that the difference in scale between very large oil companies and very small digital companies or innovation start ups hamstrings mutual success.
With their multiple layers of management, tight procurement rules, waterfall design philosophies, and intergenerational masses of infrastructure, big oil companies inherently move slowly towards the future. There is virtually unlimited demand (for now) for fossil fuels, the industry is very mature, and the product is mostly undifferentiated. Capital markets thoroughly understand the business model and can easily rank one firm against another. Urgency is low.
Digital start ups, on the other hand, are lean and agile. The founder is often still coding. Decision making is practically instantaneous. Work methods follow new fangled theories and approaches, such as design thinking and Agile. These companies start out in the cloud, license lots of third party features, expect costs to fall precipitously, and scramble to achieve network mass as quickly as possible. Digital solutions need to be constantly changing to stay competitive, while avoiding the kill zone (straying too close to the markets of the digital giants).
This mismatch of scale is a permanent structural problem, and requires structural solutions. To be clear, a digital start up is not going to solve these structural features of the industry.
One solution to the structural problem is through market consolidation, where promising digital solutions are acquired by the large technology incumbents.
Large incumbents solve the scale problem as they are already at scale. Big technology companies know how to scale solutions to the market. They have the sales force to drive uptake, the product catalogues to deliver more complete solutions, the implementation teams to drive deployment, the integration known how to deliver interconnections, and the change management chops to overcome resistance. They provide trust to the market that the solution will work, in all situations, under pressure.
For the digital start up, selling out to an established technology player looks like an attractive answer to the problem of scaling up. Look at all that muscle that the incumbent brings to the party. But if the goal is to maximise value to the founders, selling out early surely isn’t the way to go. Certainly the founders might get a few million in deferred stock options, or perhaps a cash payment, but frankly, valuation is maximized with a steady monthly income and a couple of large customers. I note that there are no unicorns (start ups with a valuation of a billion or more) plying the digital oil and gas market, possibly because of this “sell out early” temptation.
Consolidation works for the customer and the consolidator, but arguably not for the consolidated.
The Corporate Accelerator
Another solution to scaling involves the creation of customer accelerator.
Years ago, I worked for Lafarge, a big manufacturer of cement, building products, and concrete Ready Mix, who had cracked the formula for scaling up innovations across their sprawling global business. Back then, mature businesses like cement and concrete no longer experienced big jumps in productivity through some clever innovation. Gains came from harvesting the hundreds of tiny improvements made at the various plants and figuring out how to deploy those changes to all the other plants. A 0.5% reduction in energy use at a single cement plant translated into big gains across the business if it could be replicated.
Lafarge ran a portfolio of pilots across a number of its plants, and constantly polled them to see what was working. Successful innovations were pushed through a central lab that figured out how to productize the innovations and enable them to scale out across the fleet.
It explained why a major company like Lafarge was cost competitive with mom-and-pop Ready Mix suppliers.
Fast forward to today, and industry leaders who are serious about scaling up digital will put in place their own internal digital accelerators. Dedicated corporate teams work with a portfolio of digital solutions to sort out scaling issues, promote change management, figure out deployment pathways, and measure value.
An example might be an oil field unit who trials a machine learning solution for detecting artificial lift issues. It’s piloted at the unit and achieves some success. The corporate accelerator pulls the solution in and replicates it to other pump problems, generalizing the solution, and redeploying it back into the original unit for additional testing and proving. The original business unit is the test ground because it was their innovation in the first place, and they are generally committed to its success.
Once the solution is proven out, the corporate accelerator then figures out the enterprise deployment strategy, to take the innovation across the full company. The enterprise strategy considers the impacts of Moore’s Law, the network possibilities presented by Metcalfe’s Law, the overall solution architecture, the pace and timing of deployment, the communications strategy, the migration approach, the implications for turn arounds, and the longer term sustainment strategy.
Digital start ups should look for companies that have this kind of internal accelerator.
The Oil Company Investor
Finally, there is an increasing interest among some oil and gas companies to run their own portfolio of investments in small promising digital companies. Shell has a venture fund that has invested in blockchain and visual data analytics. Suncor and Cenovus own a fund called Evok Innovations that behaves like a Silicon Valley venture fund. Repsol has a new ventures unit that has invested in a blockchain company called FinBoot. Those funds that take an active interest in driving scale are particularly attractive to start ups.
There is a compelling financial logic to this idea. The oil company investor can help shape solutions to better fit their needs. The oil company as investor lends strong credibility to the solution, and helps reduce resistance to internal deployment. And as an investor, the oil company stands to gain should the innovation become a unicorn (which will absolutely not happen if the innovation is purchased early by a technology incumbent), and can likely exit by selling their interest to a technology incumbent. Investors tell me that a start up has only a 1% chance of survival, but when a customer takes a very strong interest in helping the start up, the chance of survival grows to 30%.
So far, I’ve only seen very large oil companies stand up these kinds of investment funds. The recent low oil price environment constrains the capital budgets for many smaller oil companies, and their capital is vigorously deployed to maintaining the business basics (reserves management, production, infrastructure capital).
Digital start ups should get acquainted with these internal funds.
Scaling up digital improvements are quite possibly the biggest problems that oil and gas faces in addressing the opportunity from digital, but there are a few solutions to this structural problem.
Check out my book, ‘Bits, Bytes, and Barrels: The Digital Transformation of Oil and Gas’, available on Amazon, iTunes, Audible, and other on-line bookshops.
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