With oil prices hitting $60 a barrel in 2005, motorists’ and other buyers’ pain is most definitely the oil industry’s gain. The world economy’s lifeblood is currently five times more expensive than it was in 1999, producing windfall profits for the clutch of global mega-corporations that extract, refine and distribute it.
As the third biggest oil major (behind BP and Exxon Mobil), Royal Dutch Shell is earning its share of the spoils. In October, it announced the biggest quarterly profit in its 98-year history (more than $7 billion), despite the disruption caused by hurricanes in the Gulf of Mexico. Last year, only one other company in the world (Exxon Mobil, again) made more money than Shell, according to the latest Fortune Global 500 rankings.
But life at the company hasn’t all been happy drilling. The scandal over its reporting of oil and natural gas reserves in early 2004 forced the departure of several of Shell’s top executives, led to almost six billion barrels being deleted from its “proved” reserves category, and prompted a reorganisation of the Anglo-Dutch group’s governance structure.
More recently, an internal report obtained by the Financial Times questioned the company’s ability to manage large projects and an “over-reliance” on external contractors. (Shell says it won’t comment on leaked information.)
The man in charge of Shell’s global contracting and procurement function is Kees Linse, a tall, personable Dutchman based in its corporate headquarters in The Hague. Like a number of his peers in newly created CPO roles, Linse is not a career procurement professional. He has a PhD in physics and prior to taking the job in February 2003 spent 25 years in a variety of Shell businesses and roles, latterly managing a plastics joint venture with the German chemicals company BASF.
CPO Agenda caught up with him recently to find out how his mission to transform procurement is progressing.
What effect has the recent unification of the British and Dutch arms of the company had on procurement?
For us it’s more about culture than organisation. In May 2004, Jeroen van der Veer, the chief executive of Shell, started an initiative called Enterprise First. It was a drive to make sure that everyone in the company avoids blinkered, silo-orientated behaviour and puts the interests of the enterprise as a whole first and foremost. The three components of Enterprise First are leadership, accountability and teamwork – lead through example and clarity, stand up and be counted for what you deliver, and look for others with whom you can jointly create value for the company.
Procurement is, by its nature, an activity that has Enterprise First written all over it. It is about the total bottom line. It is about value creation for the company beyond your silo. It is about global leverage and global co-ordination. So this initiative has given a tremendous push to the way the company deals with the procurement challenge.
Has it changed the way people in the business engage with procurement?
Yes, it has shifted people’s perspectives very clearly. It has created an environment where there has been a natural preparedness of people to connect with procurement; to say, “We have a big issue, let’s work together to create the optimal value.” That has had a positive effect. You can already see the benefits of that coming through.
Shell, like the other major oil companies, has been making enormous profits lately as a result of the steep rise in world oil prices. What impact has that had on procurement?
Two main things. First, there is an enormous amount of money around in the industry as a whole. At a price of $60 a barrel, a lot of companies are pursuing investments which at $15 would not be attractive. So we’ve seen a tremendous rush on the market. That is not so positive from a procurement point of view, because what has happened in the past 18 months is that the contractors that construct wells and refineries suddenly found themselves in very high demand.
That has inevitably shifted the balance of power between us. And since capital expenditure represents a third of our spend, that can be significant. At the same time, the market for raw materials, particularly steel, heated up immediately – and there’s a lot of steel in an oilfield. Both of those factors pose enormous challenges for the buying community.
The second thing is that, with prices as high as they are, continuity of operations has assumed an enormous value. If production stops, as it did in the Gulf of Mexico during the summer, every barrel lost is worth four times as much as it was a few years ago. So the price people are prepared to pay for that crucial nut or bolt that keeps production going is extremely high. That also shifts the sentiment in the market.
Does that mean cost control has fallen off Shell’s agenda?
No, it’s not like we are making so much money that we can afford to be sloppy. The oil industry is too conscious of the cost factor, having been through previous cycles, and people are more sensible than that. But it has shifted the priorities in terms of how value is judged. If you have an oil production platform that is down and you need a small piece of pipe to bring it up again, then that can be worth 30,000 barrels a day to you. Whether it costs $20 or $30 is not really the issue.
So security of supply and speed of delivery have become much more important, and procurement has to cater for that. We are operating in a very different environment, and getting the lowest possible cost is not always the top priority.
However, you still need to keep an eye on your competitive position. When Total, Exxon Mobil, BP and Shell are all in the position where profits and costs are both rising, it may be tempting to take your eye off the ball. But the company that keeps its eye on the ball will come out of this period in much better competitive shape for when things change again. The guy that drops it now will pay for it later.
Where you are able to do, as a procurement organisation, to give Shell competitive advantage in this situation?
What the company needs to do is operate effectively and efficiently. Our role is to make sure that we constantly support the whole activity in the most efficient way. Procurement at Shell is not like procurement at Volkswagen or Wal-Mart, where supplies come in and are either assembled and sold on as part of a finished product or sold over the counter. The repetitiveness of what we do and the degree of standardisation in what we buy is far lower. Our main activity is finding, producing and refining oil, and our supply chain – and hence our job – is to support that. It’s a very clear challenge.
Newspapers recently reported that the Sakhalin 2 natural gas project in Russia had doubled in cost. What is your view on that from a procurement perspective? Is your heavy reliance on local suppliers a factor?
That’s a very sensitive issue for us, because when you go from $10 billion to $20 billion the world pays attention. So it’s not something I can really comment on. But what I can say is that we are learning lessons from this experience, in terms of how the connection between procurement and projects can be optimised. We are definitely learning from that.
Local suppliers are not the issue; it’s far more complex than that. Local content always takes a lot of management and a lot of effort to get it right, but that is definitely not the issue behind the cost overrun. And, by the way, I firmly believe that an emphasis on local content development can have enormous value to a company such as ours.
Aside from the current oil industry isues you’ve talked about, what are the key priorities for Shell procurement?
We have four priorities at the moment. The first is category management; we set that up company-wide in a very structured way with one business process about two years ago. The second is a whole effort around our capital expenditure. As I’ve said, it’s a very important area of spend for Shell and we have a focused effort to make sure we manage our capital projects in an optimal way and connect them into our category management approach.
The third one is around systems, which is really the infrastructural counterpart of the first two. We are investing in our SAP system and a data warehouse so that we can get full transparency over our spend. We are also working on a contract management system so that we have full transparency over our contracts. If you don’t invest in these systems, you can end up doing what I call “event management”, where every contract is seen as a one-off event and you go from one project to another, until you come back to the first one because it needs renewal. That can produce a short-termist view, particularly when you are under pressure from stakeholders. There are always those who say, “Never mind the infrastructure, tell me what you saved this morning.” Of course you need to pay attention to that, but if you jump on that bandwagon, you will find that over time you will have to run faster and faster just to stand still.
The fourth priority is people. We are trying to manage people as one Shell-wide procurement population. One way we do this is through an extensive distance learning programme, which enables us to connect people all over the world for the same quality and amount of training. We are also working on succession planning and talent management across the function. The objective here is to expand the skill pool in such a way that we have a proper succession pipeline up to the most senior jobs. At the moment we quite often have to bring in people from other parts of the business to fill senior contracting and procurement jobs.
Category management has been around for quite some time. Were you late in adopting it at Shell or have you taken a different approach?
The concept itself has been around for quite a while, but introducing a company-wide single business process for category management is a different matter. You can have people who focus on a specific commodity category and then try to optimise it, but that is very different from having a category management process that everybody in the company follows for everything they buy. The main categories in our case are things such as drilling bits, rigs, rotating equipment, hardware, software and services.
To me, however, category management is not just a process – investigating the market, identifying suppliers, setting up your strategy and going out to tender. There is always a danger that it becomes process orientated, whereas what you need in the end is to be content orientated. If you are buying rotating equipment, for example, my question is not are you following this process, because I expect that you do; my question is this: in rotating equipment, what is the brilliant idea that makes us more competitive than anybody else?
So it’s about moving from a process and compliance structure into looking at what it is in a particular category that really makes the difference. If you do that in every category, then you make a difference across the board.
How difficult have you found it to make that transition?
The biggest difficulty initially was to get good spend coverage. Currently, about three-quarters of our spend is covered by category management. The next step is getting every category manager to run their category in the way I’ve just described. That may sound obvious, but in practice some categories – transport or maintenance, for instance – are complex and require a lot of analysis before you can make optimal decisions. So you need more strategic thinking managers to get your category strategies right. We have a lot of very good buyers in Shell, but we don’t have that many good strategists.
What about low-cost country sourcing and the related issue of corporate social responsibility?
For us, there are two elements. One is that clearly, like everybody else, we want to look as widely as possible for our supply base. For example, we have suppliers in India, offshoring in the Philippines, a large IT capability in Malaysia, and an office in Beijing that actively looks at Chinese suppliers. There is enormous potential in low-cost countries, although given that services forms a large part of our spend profile, we are only likely to benefit from this in a minority of categories.
The second element is that, by the nature of our operations and our geographical spread, we have enormous local content requirements. Our partners in the remote places where we operate expect us to use local suppliers. It’s often explicit in our contracts. But that is not confined to countries in, say, Africa: in the US there are legal requirements about using suppliers owned by women and minorities. That automatically brings in our corporate responsibility role, because we have a large footprint in the countries where we operate and we do have influence over the development and use of local suppliers.
People often don’t realise how extensive Shell’s role is on this and the positive effect it has on the people we work with. And, as I said earlier, I am convinced there is real value to be had here. I see local content development as both an obligation and an opportunity.
How far down the road to world-class performance practice do you think you are as a function?
I think we are quite a long way down the road. Based on the contacts I have with CPOs in other companies, I’m very confident that we are among the leaders in terms of the issues that we are working on. By the end of 2006, I expect we will have embedded category management and have the quality of systems and a connectivity with projects such that our concern will be less about improving in those areas and more about ensuring that we can really drive full compliance and efficiency across the company.
You mentioned value creation earlier. What is your view on procurement’s role in this?
My view is that there is a tendency in the procurement profession to overreach, to say: “We create all this value by doing this for the business and doing that for the business.” I think we need to be very careful about this. When my business stakeholder decides they want to buy a certain service or item, it is because they are going to create value with it. The role of procurement is to get those requirements for the business out of the market in an optimal way.
For me, buying is the counterpart of sales and category management is the counterpart of marketing. I find that a helpful parallel because then the question about who creates value and where becomes more balanced. I see the value created by procurement as helping stakeholders to understand what the market can do for them, from an incoming supply chain point of view. That includes issues such as total cost of ownership and standardisation, but it is very supply market driven. It is up to sales and marketing to tell the company what the customer market looks like in terms of value.
So you think some in procurement are taking too broad a view of their potential role then?
Yes, and that is dangerous because it brings two fundamental risks. The first is that you reach too far and people will say: “What are you talking about? That is value that we create.” And that is never a helpful debate to have. The second risk is that the wider you throw your net, the harder it will be to prove the benefits or to quantify them. So I think a pragmatic and focused approach is required by procurement. That helps with how you organise yourself, it helps with how you use your resources, and it helps in giving clarity to your stakeholders.
As a relative newcomer to procurement, what has struck you most about the profession?
What has struck me is that procurement professionals generally are very focused, very sturdy and have a clear recognition both of their value and how they want to create it. Their stakeholders do not always make it easy for them and yet they stay with it. That is something to admire.
At the same time, aggressive stakeholders can make procurement people overly defensive and less assertive than they should be. They understandably want to keep their stakeholders engaged and satisfied, especially when compliance is an issue, but it can end up in a rather unproductive, vicious circle.
I think companies should be intolerant of non-compliance, and therefore the role of procurement should be much more of a given. That requires a willingness by top management to support that position, and a willingness by business stakeholders to play the game. But it also requires procurement to stand up and be counted. I think we have an opportunity to get a better balance than we have in the past. But procurement people need to ensure they don’t undermine that by trying to do everything and claiming that they create all the value.
SIDELINES: Kee Linse on…
Reporting into finance: My vision of procurement is one where you have a partnership with stakeholders and jointly create value. If you draw procurement too much into the business, that partnership turns into full absorption and then you don’t have the creative tension that you need to work in an optimal way. There are clear and legitimate requirements from both the business and procurement, and the two need to be managed in a balanced way. By having procurement as part of the finance organisation, you create just enough distance to make sure that the two are individually recognisable.
His lack of direct reports: Many people say that what counts is how many staff you have reporting to you, in terms of a solid-line relationship. At Shell, we have 2,000 procurement people across our various businesses, but in my team at corporate centre there are only 10. If I were concerned about that, I couldn’t do my job.
Having the right enablers: If you want real punch to the bottom line, you need a dual strategy. One is systems, processes and people. But that doesn’t create value – it’s rather like having a car parked in front of your house; it only becomes useful when you put gasoline in the tank and drive around. Our fuel is category management. You need the systems and processes, otherwise you have anarchy; and you need category management, otherwise you have no punch.
Outsourcing procurement: We haven’t looked at it in detail yet. I could imagine we would do it for selected categories that have a real commodity, repetitive nature where there is not much value that we can add directly, but definitely not across the board. Our major spend is on the supporting supply chain, and so our proximity to the business is a key element in how we work. Outsourcing will go against that. I am absolutely convinced that when you outsource, first make sure you fully understand the category. Otherwise, all you are doing is paying somebody else for the saving you should have made yourself in the first place.
Low-cost country sourcing: There is definitely an element of short-term, “quick fix” cost-cutting. I don’t think that is a big problem, but you have to invest in low-cost country suppliers to make sure you get the right quality, good logistics and security of supply. Overall, you make that investment because you end up with a larger supplier base and a more competitive supply market. That is a good economic principle, even though some people may not like it.
Royal Dutch Shell at a glance
- Founded 1907
- Operates in more than 140 countries
- 112,000 employees (2,000 in procurement)
- World’s fourth biggest company by sales
- Produces 3.5 million barrels (of oil equivalent) a day
- Procurement spend: $ tens of billions
- $15 billion annual capital expenditure
2004 financial results:
$268 billion in revenues
$18.2 billion in net profit
Four main businesses:
Exploration & Production, Gasa & Power (upstream)
Oil Products, Chemicals (downstream)
Interview by Geraint John
