MANAGEMENT & ECONOMICS: Time running out for E&P's e-business operations

For all the hype surrounding e-business in exploration and production (E&P), do most industry executives really get it? Almost every company has launched Web sites, both internal and external, with much of the current attention focused on cost-effective e-commerce and e-procurement - buying and selling over the Internet. We're now beginning to hear talk about "using the Web" to connect industry experts and to work more collaboratively across traditional boundaries. New e-ventures pop up every week.

Despite all the commotion, there is serious doubt that many E&P executives are re-examining their businesses through the lens of the new e-business economy. Few understand how radically the landscape is shifting, or how to gauge competitive position in a global marketplace increasingly dominated by the Internet (see table).

According to Geoffrey Moore, Silicon Valley marketing guru and venture capitalist, six "remarkable transitions" are effectively shifting power away from the old economy's "trusted source of value creation."

From P&L to market capitalization

For the first time, many oil company stocks have remained relatively flat while their profits and cash flows have grown enormously. According to recent data, traditional oil company shareholders gain about $20 of market capitalization (mkt cap) for every dollar of earnings. Yet Enron shareholders, by contrast, are getting over $50. Market capitalization, it seems, is a far more meaningful metric than earnings alone.

Consider Cisco's market capitalization: a whopping $180 per dollar earned. One of the largest high-tech companies, Cisco, provides an interesting comparison with one of the energy industry's largest companies, Exxon.

Cisco has a market cap of $481 billion on sales of $19 billion and earnings of $3 billion, while Exxon has a cap of $281 billion on revenues of $212 billion and last year's earnings of $13 billion. Exxon, whose earnings are four times greater than Cisco's has little more than half of Cisco's market capitalization.

The markets understand that:

Commodity prices in the petroleum industry are highly volatile.
Oil and gas companies have a poor record of performance over the long term.
There is little future in the usual consolidations and cost-cutting programs aimed primarily at boosting short-term profits.

The markets are looking for innovative companies with radically new business models, and are rewarding them handsomely. To date, Web-based initiatives in E&P have primarily focused on reducing transaction costs through e-procurement systems. While these certainly have a role to play in the industry, like so many other industry initiatives, they will have far more impact on short-term profit and loss (P&L) than on long-term competitive advantages.

In other words, from an e-business perspective, e-procurement is more of a distraction than an innovation that will build future shareholder value. That's why, despite all of the recent "e-sizzle," oil and gas industry efforts in this area have gotten a "big yawn" from investors, reflected in flat E&P stock prices.

Savvy investors in the new e-economy understand that e-procurement is like electricity: everyone will have to have it to stay in business, but it will never be a long-term differentiator. New models will have to be developed by oil companies willing to look beyond today's obsession with P&Ls and find ways to create value that will be sustainable for years to come.

From assets to information

As Moore says, "the more information you have, and the better (and faster) your analysis, the greater the probability you will make winning investments." The Internet is a powerful force in enabling more profitable decisions, because it's all about connecting people with information in real time.

"Twenty years ago, 80% of the market capitalization of US public companies came from the value of "hard" assets, with 20% from intangibles. Today, the reverse is true. For the most part, however, this remarkable change has missed the petroleum E&P business. Consider-ing oil and gas in the ground as part of this industry's assets, I suspect our ratios today are roughly the same, if not, in fact, more asset-intensive than before."

If the petroleum E&P business were more like the high-tech industry in which product shelf life is measured in months rather than years, what companies would now be on top: The ones who managed information and knowledge most effectively, who made the right decisions most rapidly, who more efficiently monetized reserves, and released lower-return capital to higher-return investments - not the ones who owned the most reserves or had the largest associated cash flows.

Value creation in the petroleum E&P industry of the future will focus on the knowledge-intensive activities of finding and managing oil and gas reserves and their associated risks. Therefore, any move toward the new economy will require a new petroleum E&P business model, which must include ways of shedding assets and gaining more value from knowledge and intellectual capital.

From products to services

"All products have benefits, to be sure, but it is the benefits, not the product, that you want to buy," says Goeffrey Moore. Moore notes that "even the most product-centric of companies ... are now assigning their best and brightest to the task of differentiating on services." Hewlett-Packard, he says, is a good example. HP's corporate strategist recently announced that "the company's future does not lie in computers as much as in computing." HP "recognizes that computer power delivered over the Internet is an anonymous commodity ... and what will differentiate it in the future is the services attached to it."

Do energy companies still need to own and operate production platforms or would it make more sense to purchase "contract to produce" services? Do they need to own computers and software, or could they simply access the necessary technologies over the Internet for a fee? To create maximum shareholder value, therefore, petroleum E&P companies must move from purchasing products to contracting for services. This means, of course, that they must be willing to integrate more tightly with outside service providers.

From vertical to virtual integration

Vertical integration is based on the idea that competitive advantage, and therefore sustainable future earnings, can be created more effectively by doing almost everything yourself. In contrast, value creation throughout a virtually-integrated system is such that, even though all the participants share the profits, the "total pie" is much larger than if only one or two vendors dominated the market. "Virtual value chains scale much faster and are more cost-competitive than vertically integrated ones," writes Moore.

A good starting point for re-visioning the virtual E&P value chain of the future is distinguishing between what is "core" and what is merely "context." According to Moore, a particular activity "is core when its outcome directly affects the competitive advantage of the company in its targeted markets. Any behavior that can raise your stock price is core - everything else is context."

In the age of the Internet and virtual integration, is operating a mature field on the Gulf of Mexico shelf still a core activity? How about owning and operating a petrochemical plant? The answer is yes - only if it boosts the company's stock price. Today's investors are rewarding those corporations who identify their core and virtually integrate with other members of the value chain to provide their context.

Cisco is an excellent example. Of its two dozen manufacturing plants, only two are operated by Cisco, the rest are run by partners. Customers cannot tell the difference. The most challenging task for executives today is to determine what activities are truly core, and how to allocate the majority of the company's intellectual and financial resources to them. They won't figure that looking backward. As Moore observes, in technology-enabled markets, what was core yesterday is likely context today.

From command and control to self-organizing systems

A change in the management model must go hand-in-hand with the transition from vertical to virtual organizations. Command and control just doesn't work, Moore says, when the people "don't belong to you." The most difficult leap for traditional managers is realizing that, "the value chains of companies that inter-operate to make up an open architecture market are self-organizing systems."

Even though E&P companies have made progress in alliances and partnerships, few, if any, have perfected the business alignment and collaboration required for the new model to work effectively. They resist the self-organization that occurs naturally in any living growing ecosystem. The biggest challenge for executives is to stretch their management models sufficiently to accommodate virtual integration. They must understand that, by integrating with partners whose core is an oil company's context, the market "pie" can be enlarged enough to generate additional cash flows and to create the necessary economic alignment.

Oil and gas may be one of the slowest industries to adapt to the age of the Internet because of this entrenched resistance to change. Companies that "break out" first will enjoy a significant competitive advantage, since others may drag their feet for years.

From money to time

While most energy companies still focus on optimizing P&L, companies like Enron have envisioned potential new markets and invested at whatever rate is necessary to ensure leadership in their targeted segment. Says Moore, "In the trade-off between time and money, time wins hands down ... no short-term profits could ever match the lifetime value of ... the market leader position. It is this principle that underlies the fundamental shift in stock market valuations over the last half decade."

The traditional formulas no longer hold in emerging Internet-based markets where being first can almost guarantee long-term competitive advantage. Oil companies, oilfield service providers, and technology suppliers are leaping into cyberspace, forming new dot-com ventures almost every week.

The stakes are high. Will new market leaders emerge from all this e-sizzle, or will too many of these Internet ventures turn out to be ill conceived and poorly managed? I suspect many industry "firsts" will end up e-fizzles, like too many of the other dot-coms, because they will fail to alter the underlying business model.

The long-term market leaders, I believe, will be the first virtual oil companies, the ones willing to forego short-term profits to re-invent the entire petroleum E&P value chain.

Today, the petroleum E&P business is stuck in the old economy of Moore's six categories. Oil and gas companies still depend primarily on improving profits to drive shareholder value. They are asset intensive, purchasers of products, vertically integrated, heavily weighted toward command and control, and unwilling to take a short-term P&L hit to capture emerging market leadership.

How will the energy industry move to a new phase of growth and value-creation? Who, besides Enron, will break out early and re-invent the current petroleum E&P business model? If executives and their management teams would take Moore's six transitions seriously and apply them to their businesses, I'm convinced they would be able to craft appropriate strategies for the age of the Internet. eSizzle would not become eFizzle. The race is on. Only time will tell whom the long-term winners and losers will be.

Author

Since January 2000, Robert P. Peebler has been Vice President of Halliburton Company's eBusiness strategy and ventures. For eight years prior to that, he was President and CEO of Landmark Graphics Corporation.