Supply chain management: Why pursue single-source supplier relationships

Operational, safety integration key aspects

Wade G. Boudreaux
Danos & Curole
Marine Contractors

Financial and economic forces tend to oppose each other [3,639 bytes]
Oil and gas activity and its effect on operational costs of oil and gas firms during a "boom" period. [3,641 bytes]
Anticipated annual average spot price (1997 dollars) of WTE crude oil [9,022 bytes]

The concept of supply chain management is nothing new to major oil and gas companies. Many firms have formed strategic relationships (alliances) with certain suppliers of resources to gain a competitive and cost advantage. The main strategic objectives behind forming strategic supplier relationships are financial and economic.

Financial strategy in today's oil and gas industry is to cut costs. This approach is a product of the 1980s oil bust. The industry's inability to predict or control the future of commodity pricing for crude has brought about a new attitude in managing costs.

The main costs are labor and equipment. The outsourcing of these resources, an attempt by the industry to dilute capital risks, has created a multi-billion dollar service industry from big drilling companies to small labor providers. Companies such as Schlumberger, Global Marine, and Tidewater have emerged as corporate giants.

The economic factor involves limited resources. During the recent oil boom in 1997, day rates for a jackup rig on the open market exceeded $80,000. Oil and gas firm spending skyrocketed due to high equipment costs, yet most of the global fleet of drilling rigs was utilized. Firms had to pay the higher prices due to the lack of available equipment.

The same held true for human resources. The lack of skilled oil and gas workers sent labor rates up. Still, there weren't enough personnel to go around. Price wars created a employee's market as workers began to call the shots. Along with increased profit came high employee turnover as competition sought these vital resources.

This type of market caused dramatic increases in revenues for all companies in the industry. Even though revenues surged, costs also increased dramatically. Oil and gas operators wanted as much profit as possible, just like suppliers. Due to the scarcity of labor and equipment, operators began looking towards strategic relationships with their suppliers. This reinforced the concept of strategic alliances and ESRs (enhanced supplier relationships).

Opposing forces

Financial forces, which seek to push costs downward, are derived from earnings expectations of major shareholders of oil and gas firms. The economic forces, which seek to push costs upward, are derived from the scarcity of resources vital to oil and gas firm operations.

This scarcity allows outsource (contract) firms to capitalize on excess demand for their products and drive prices up. This of course means higher costs for outsourcing (operator) firms in times of heightened industry activity.

Activity in the oil and gas industry is mainly dependent on the price of crude. If, under normal circumstances, the price of oil increases, then the quantity of available resources vital to sustain the demanded level of activity will decrease in the near term. This decrease in labor and equipment signals an increase in activity for all firms in the industry, both operating and contracting.

In this scenario supply chain management and alliance building becomes most important to oil and gas firms. There is one drawback. It is also most beneficial for service firms to sell to the highest bidder on the open market. Likewise, it is of greater benefit for outsourcing firms to not have fixed rate alliances when industry activity is depressed. They need to get the lowest possible costs for equipment and labor, which are now available in a growing excess supply.

It is for this reason that it is virtually impossible for alliance building to be a part of both the customer and supplier's short-term supply chain strategy. Alliances must be part of both firms' long term supply chain strategy in order for alliances to pay off and reap lasting rewards. Enduring, integrated and enhanced supplier relationships help to create a safe haven where the two opposing forces (financial and economic) can meet and work together for optimal solutions for both firms.

Source alliances

Single source alliances are where one firm services all the resource needs for an outsourcing firm in a particular service sector. An example of a single source alliance is Company A, providing all the skilled labor services needed to operate Company X's shorebase facilities on the Gulf of Mexico. An example of a multiple-source alliance is Company A, providing all production operator skill sets for all of Company X's Gulf of Mexico shorebases, with Company B providing all welding services, and Company C providing crane operating services.

The main drawback of single-source alliances is that the outsourcing firm may not have other suppliers to fall back on if the alliance partner fails to perform or goes out of business.

The key is in the selection process. Business objectives of both firms must be in line with one another for a long-term agreement to take place. Each firm must know one another's business, view the relationship as a win-win strategy, and establish trust and camaraderie among key players.

There should not be any objections or differences in opinion about the main goals or controlling factors of the alliance agreement once the final documents are signed and the program is set into motion. Oil and gas firms and suppliers generally will have years of mutual work experience and a firm knowledge of each other's company and management before entering into a formal alliance.

Single source benefits

In today's oil market it really makes little difference when an alliance is formed. No one can accurately predict what the price of oil will be in a month, much less in a year.

Industry participants expected the median price of WTI crude to be around $20/bbl in 1998 and 1999. Forecasts were strongly supported by global supply/demand data complied by various sources. Today, many forecasters are predicting oil prices to be as low as $12-14/bbl throughout 1999.

Most forecasters, however, expect an upward trend in oil prices over the next 7-10 years. It is this long term trend in industry growth that makes alliances and supply chain management appealing. Remember, the goal is to decrease "total cost of ownership" by forming strategic, life cycle partnerships with selected vendors across each supply segment. The long-term positive results are derived from:

Mutually beneficial revenue and profit objectives
Learning of and integration into one another's business
Routine adjusting, improving, and sharing of creative solutions to make the relationship more effective and efficient.

The main benefits of a single-source supply segment relationship are:

Cost savings and improved profitability
Improved safety performance
Optimized service output
Continuous improvement.

Cost savings, profitability

Reducing the number of vendors can greatly reduce the administrative and supervisory hassles of contracting multiple companies to do similar types of work. With many alliances, the contact for the outsourcing company will be given a "point person" in the supplier company who is accountable for managing the entire account. Having one company to deal with instead of five, and one person to deal with instead of twenty, lends itself to effective time and administrative resource management, thus reducing costs over the long term.

Retaining a solid employee base is essential in a labor alliance. Turnover costs are a major expense in the oil and gas industry and can be reduced if one firm is putting a greater amount of its resources into recruiting, hiring, training, and managing the skilled labor needs of a more significant account. In a multiple supplier situation, less importance may be placed on meeting these needs. Higher skilled or more experienced workers may be transferred to larger accounts.

Shared marketing resources can be a means to divide the costs associated with selling the product or service of the outsourcing firm. This maintains profitability and the need for contract personnel.

Price leveraging will allow the operating company to benefit from a "volume-rate discount." Contractors have a greater incentive to reduce costs and accept a lower profit margin if they will not have to add much additional overhead to take on the account.

A universal safety training program developed by fewer parties will keep all personnel within "standard operating procedure." One firm better manages this program. Safety performance is a top priority with most oil and gas firms. Firms striving to standardize their safety program will do better when fewer, more involved suppliers are controlling parts of it. The synergy comes when the best aspects of both the operator's and the contractor's programs are combined to produce a more effective system.

Innovative practices can be employed and tested to develop unique solutions to safety problems more effectively with a single-source supplier.

Optimized service output

Identifying customers is the first step in understanding how the operator-supplier relationship can best be structured for optimal service output. The end customer is not always an internal manager or another executive-level supervisor.

By sharing responsibility, aligned firms can work to better identify the true customer so that his/her needs are more completely met. In a multi-vendor situation, political forces sometime disguise the true customer and force the operator and vendors to work against each other. Usually the end customer loses.

Focusing on meeting needs is the next step. Once the true customers, both internal and external, are identified, streamlined processes and workflows can be used to meet deadlines and work toward service-based goals in addition to cost-related objectives.

Defining performance standards can be better accomplished with a single-supplier system. Customer expectations can be captured and a set of rules, governing the handling of each customer situation, can be developed. The result is a clear vision of what is expected from every employee in handling the end user, and an optimal level of service can be achieved for each customer.

Continuous improvement

Standardizing operating practices is the first step. This will encourage "process thinking" across the outsource sector and result in constant examination of how work can be done better, safer, and more cost effective. Sharing best practices is one of the greatest benefits of a single-chain alliance. The barriers of information flow are eliminated and inter-supplier secrecy and competition is stopped. Best work practices can be shared freely, resulting in an ever-improving operation, rather than an environ ment of secrecy and self-interest.

Economies of scale can be developed through improvements in billing efficiency, reduction of paperwork, and other redundancy removing measures. The use of technological integration such as electronic data interchange (EDI) can be justified in an alliance situation, ensuring fewer errors in data processing and reducing work times. Administrative staff reductions can take place as fewer people are needed to run the operation.

Creating measurement opportunities can be achieved through regular meetings to discuss issues and opportunities between the supplier and operator. The ownership on the part of the alliance companies can lead to new, innovative performance measures and standards.

A typical cross-functional alliance team will act as if they are managing a separate company.

It is in this light where creativity and success measurement will lead to ultimate, long-term benefits that make the relationship worthwhile.

The benefits of forming a single-source supplier relationship center on one underlying theme - aligning the business objectives of two firms to increase all levels of performance and operational efficiency in a particular supply-chain sector. It is by this alignment of business objectives and sharing of risks that the "total cost of ownership" can be decreased.