07 May Setting Business Goals in the Digital Era
Boards in oil and gas must now take into account the wave of digital change that is impacting the sector, and help shape appropriate goals for management.
The Pressure on Boards
Boards in oil and gas can no longer ignore the wave of digital change sweeping through industry after industry. From media and entertainment, to cars, to banking, new digital technologies are overturning business models, creating vast wealth and upending the established order. The exponential growth rates of the underlying circuitry (data, analytics, communications) and the rapid descent to near zero cost almost guarantee that digital innovation will impact sector after sector. We have gone from a time of technological constraint, where only the richest companies could afford to own a dedicated super computer installation, to technological abundance.
Capital markets are woke to this wave of change too. Capital markets want to know what oil and gas companies are doing to react to the wave of digital change, as a precondition to securing new financing. Perhaps not all the financing, but capital is now wise to the possibility that their investment may be stranded should business models unexpectedly shift. It’s happened in all of these other industries, and it stands to reason that capital faces a new and unquantified risk caused by digital in oil and gas.
As I’ve pointed out in earlier articles on this blog, there are already a few examples of business model disruption happening to the oil and gas value chain. For example, companies like GasNinjas deliver fuel directly to the car, which makes the retail station obsolete. Automakers are experimenting with shared car business models, where the user of the service does not own the car, and does not purchase fuel, and therefore does not visit convenience stores.
In the upstream, oil and gas explorers are moving their data to the cloud, which opens up the possibilities of separating the data from the owner of the asset and from the reservoir itself. This move enables “exploration as a service” as a new way for small resource holders to pool their data and access high end data interpretation and analysis services. The IEA estimates that bringing such digital innovations to the upstream could add a further 5% to global reserves, or the equivalent of about 500 billion barrels of oil equivalent.
Waiting and hoping that rising prices will reverse these trends is not a good strategy. Some oil and gas companies have concluded that the industry is now into permanent oil abundance and that prices are never returning to their heady days. Those that exploit digital to substitute technology for labour will also reset their cost structures permanently, allowing them to price acquisitions more shrewdly. Next generation workers will not even want to work in the industry if its information tools and practices are a throwback to the previous decade.
Nose In, Hands Off
I like this phrase – nose in hands off – to describe the Board’s role. The Board should let managers manage, but should take an interest in the companies activities. One of those activities is setting goals for the year, or years to come.
Depending on cultural norms, management will set goals for the business year, which Boards then endorse, whereas other Boards may be a little more directive with management. Certainly shareholders should expect Boards to challenge management to make sure that managers are not myopically focused on the activities of the day and oblivious to the changes happening around them.
Unfortunately, this is all too common, particularly in the upstream segment of oil and gas, where change happens very slowly. It takes years of patient work to move an innovation from lab bench, to one or two pilot sites that run for a couple of seasons, to commercialisation in the global marketplace. In one of its clever sector comparison studies, McKinsey estimated that it takes typically 30 years from idea inception to 50% market penetration for some innovation in oil and gas. Compare this to 5 years or less for the telecommunications industry.
Goals for a digital future should not be randomly generated, but should be cohesive and mutually reinforcing. Here’s a simple framework that I like to use with Boards to stimulate their thinking on appropriate goals for management.
Don’t tell anyone, but technology is actually the easy part of digital. The hardest part by far is all the soft stuff – securing the talent to drive digital, creating fertile conditions for digital adoption in the field, training the workforce on digital concepts, rewarding early adopters who show the way. This first dimension of the framework looks at how companies are approaching talent for digital.
The biggest worry for Boards is that some new business model will pop up from nowhere, and start to displace the incumbents before they have enough time to react. Recall that one woman’s margin is another woman’s target: which parts of the business model look ripe for targeting? Business model pressures have emerged already in retail and mobility, but there is also opportunity in:
- construction (where margin on margin is common)
- upstream data (where cloud computing could cluster data more effectively)
- field services (where collaboration could optimise service delivery)
- carbon management (using blockchain to track carbon)
- financing (using crypto currency to transform funding and fractional ownership)
This dimension looks at potential business model shifts and their impacts.
The oil and gas industry is very innovative in some respects and thoroughly traditionalist in others. The way the industry contracts with its suppliers, its approach to royalties, the ownership of assets and how they are commercialised, has not materially changed for many years. For example, the upstream oil and gas sector devotes 85% of its innovation budget to just three of the 10 possible innovation levers (better faster extraction, better handling of water and emissions, and improvements to product quality).
This dimension of the framework looks at the approach to innovation, resourcing of innovation, and allocation of innovation investments.
With digital racing off madly in all directions, it’s not entirely clear which digital innovations look like they will have the biggest impact on oil and gas. Waiting for the future to arrive is one tactic, but another would be to experiment and monitor those that appear to have take up already. These include:
- Cloud computing – key to leveraging the distributed compute power
- Blockchain – fundamental to transforming business relationships
- Artificial intelligence, analytics, machine learning – better business decisions
- Internet of Things – puts all machines on the network
- Autonomous – automates human routine work via robots
- Augmented reality – enables deeper understanding of assets and work
This dimension of the framework looks at what could be disruptive to the industry as a whole (oil and gas, its suppliers, customers and regulators) and seeks to learn about them in an intentional manner.
There are four foundations that need to be in place for digital innovation to be fully successful. I reckon most companies in oil and gas have some of these foundations in place today, but the foundations may need shoring up to support a digital future. The foundations include:
- ERP – the big backbone systems which are themselves embracing digital
- Data – the feedstock for digital innovation
- Cyber – more digital means more attack points to be reinforced
- Infrastructure – enabling all the devices and cloud means better telecoms infrastructure
This dimension of the framework looks at the reliability and stability of the critical foundational elements for digital.
Putting the Framework to Work
In the annual business planning process, management will set out its goals for the year. These will include the usual elements – health and safety objectives, expansion and growth spend, optimisation and margin improvement, acquisitions and divestitures, people and talent targets, social outcomes, financial commitments. What’s generally not included are specific goals related to digital.
I would add the Framework to the planning cycle to provoke management into thinking about digitally enabled change. The framework needs to be pushed down the organisation – it won’t do to have just a handful of millennials in the home office dreaming up new uses for blockchain. It has to be real for the front line too. Ideally, the front line pulls digital into its business, rather than head office pushing digital onto the front line. With management now embedding digital goals into the plan, the Board can then play its proper role to review and challenge management in the planning cycle.
Boards should be looking for these kinds of goals that signal that digital is being treated seriously by management:
- Management messaging to the organisation and markets about the importance of digital for the future
- Front line employee engagement, being shown, not told, of how digital is impacting the industry
- Development of a digital strategy for the organisation
- Measureable business improvements attributable specifically to digital change
- Funding for a portfolio of small digital experiments in key areas
- Regular monitoring and awareness of emerging new and disruptive businesses
Investing in the foundation (ERP, cyber, data, infrastructure) with an eye to the future
In time, digital will not be something that needs to be added to the management agenda – it will be deeply embedded in how management thinks about the business.