When BP revealed its thirdquarter results in October 2009 – around $1.5 billion or almost 50 per cent higher than market expectations – the company’s share price rose by 5 per cent to a 16-month high. Against the backdrop of a global recession in which demand for oil has slumped, as has the price since its record high of $147 a barrel in July 2008, the results made impressive reading.
BP’s replacement cost profit, a measure that strips out the impact of oil price fluctuations, was $4.7 billion for the quarter to the end of September (excluding $200 million of nonoperating gains) – this was a notable fall on the $10 billion posted the previous year but way ahead of the $3.2 billion the markets had been forecasting.
A significant part of this was attributed to the company’s ability to cut spend, with BP estimating its operating costs were some $3 billion lower on the year in the first nine months of 2009. Most of these savings – around 60 per cent – came from a combination of renegotiating supplier contracts and implementing more efficient procurement procedures, as well as restructuring, simplification and operational savings. The rest could be attributed to foreign exchange costs and lower energy costs for its own use, the company said. Announcing its results, BP increased its cost-saving target for the calendar year from $3 billion to $4 billion; more than double its original target.
A key factor behind the impressive cost savings was a programme designed to use BP’s total buying power across entire regions. “Our whole focus has been to move to a better leveraging position,” says Dave Connor, who was appointed vice-president, procurement and supply chain management, in BP’s exploration and production (E&P) segment – the largest part of the business – in March 2009.
“We have 16 business units in the E&P segment alone and there is a tendency for each to negotiate for its services and materials individually. We’re using that as best we can, globally, regionally and locally, to get the best deal for BP.
“It’s basic procurement; you need to leverage your spend to optimise the deal. But it’s not easy as it involves working collaboratively with multiple partners, including national oil companies, and the timing is always a challenge. This is a journey that BP has been on for two years and we’re only starting to see the benefits of it now.”
Paul Yates, a senior manager in Accenture’s oil industry supply chain practice, explains that many oil companies tend not to use their global buying power to best effect. “You’ve got to bear in mind that the size and complexity of some of these projects would make the eyes of procurement folk in other companies water,” he says. “The individual purchase decisions are governed by individual project managers because ultimately getting the oil out of the ground is more important than the procurement savings. But if they can move to a model where they have got a co-ordinated approach across those assets and can manage global categories of spend as global categories, therein lies a major opportunity.”
On a practical level, this meant extending some contracts to consolidate regional agreements to renew at the same time, says Merv Swan, vice-president of BP global account management at Halliburton, an oilfield services company and a key supplier to BP. Suppliers were then invited to tender for larger pieces of work using the SORAC (schedule of rates and charges) system, a company-wide tendering platform that aims to give BP a common view of all its supplier bids.
“When you bid and implement SORAC-based contracts, a unique BP price book is created that requires great discipline in your business to be successful,” Swan explains. “It structures a complex bidding and contracting cycle and establishes a global standard that BP can use to evaluate or challenge bids while understanding regional differences. Upon award, SORAC also becomes a foundation for the new contract.”
The introduction of SORAC in 2008 was part of an attempt to reduce prices that was already under way when the markets crashed in October that year. “The change in the environment required us to take some fairly drastic action in 2008 and 2009,” says Connor. “We had to re-look at our baseline of what we were paying for our services and materials, then went back to our suppliers and asked them to look at their direct costs and their supply chain cost.
“The cost of raw materials, fuel and some services had come down so we expected to see that reflected in the prices we were paying. To a great extent our suppliers responded very well to that campaign and there were a lot of adjustments to pricing very quickly. If you look at the industry, BP and its suppliers reacted quickest to the changes in the market.”
Swan admits the first reaction was to resist such a move but this quickly changed with the economic downturn. “Over a few short months we were able to accept BP’s initiative, based on the trust that we had previously experienced with BP and this allowed us to endorse SORAC,” he says. “We understood that this was what the industry needed to be in a better place as a result of drastic market changes.”
Nigel Dodds, global account director BP, at global oilfield service company Baker Hughes, agrees that the initial approach didn’t meet a favourable reaction from service companies. “BP clearly had a business goal to drive deflation into its supply chain,” he says. “It went about that in a much more joined-up fashion. It had a strategic approach, it communicated that strategy and we knew very much where we stood. We were then able to respond accordingly.”
Now the process is complete, he says his company is in a much better position to plan for its own future in terms of staffing requirements, having been awarded a number of three-plus-two-year deals.
“BP was quite open in the post-tender negotiations to point out where there could be major variances in price that could give you another opportunity to amend your offer if you chose to,” he says. “We know whernahe we are price-wise; we chose not to go down to certain levels and we chose to go to prices in some places because we wanted to win that particular work.”
Connor admits that there was some tension with suppliers in the second half of last year. “We were reacting very quickly to the changing market and were expecting suppliers to look at their supply chain and take the appropriate action quickly, rather than wait until contract renewal or the next line of tenders,” he says.
“So there was some surprise that BP was so proactive and at the front end of this initiative, but the way we handled ourselves with integrity and the collaborative nature of the discussions were received very positively. Suppliers are looking for long-term relationships and to expand their market share and want to work with us.”
He says another reason why BP was able to reduce spend so efficiently was because it continued to invest in the procurement function during the downturn. “We haven’t reduced the number of people in the global team and we’ve increased the number of people working in the business units,” he says. “We haven’t downsized; my organisation is flat on last year and we’re doing more with the same organisation because we’re doing it smarter. Employees are seeing a sense of direction and partnership and are being offered even more in the way of career development and training.”
This ranges from foundational training to a purchasing and supply chain management MBA programme, he says, much of which is run online because the participants are spread so widely around the world.
Yates at Accenture makes the point that with international oil companies in particular, even a small increase in the value delivered to the organisation by procurement would far outweigh any savings from cutting staff . “A lot of companies have been able to deliver some very substantial deals by taking advantage of market opportunities,” he says.
Another factor that has helped BP in recent months is its use of market intelligence. The refining and marketing segment’s dedicated team of analysts has directly achieved savings of $20 million over the past two years, and the E&P segment also set up its own team of six analysts in 2008 to help research in core categories, as well as buying in external data. “You want to move away from negotiating based on the current costs to what things should cost, and you can’t do that without a good deal of analysis of other people’s business,” says Connor. “For example, if we go to purchase turbines we need to know how the costs are made up and make sure that we’re doing a good deal for BP. In a very mature business relationship those costs are transparent to the operator and that’s what we aspire to.” Being able to manage inventory effectively has also been a priority for BP during the recession, largely due to its impact on working capital. “We have a very extended supply chain – the best comparison I could give you is the military,” says Connor.
“We tend to build up an inventory in countries to ensure we can perform as business units – you’re probably talking in our industry somewhere between $2 billion and $3 billion in inventory, which is mainly outside the UK – so what we really need to move to is setting up vendor-managed inventory in those locations and getting suppliers involved in the demand planning at the earliest stage possible. That’s a real focus area for us.”
The concept of working more closely with suppliers is a core part of BP’s future strategy as it seeks to extract further savings from the entire supply chain. “2009 has really been about readjusting the baseline, getting the costs back to where they should have been and doing some leveraging,” says Connor. “2010 and beyond will be moving to optimising our leveraging and managing our suppliers very proactively.
“We’re really starting to move to more efficient operations through supplier management, eliminating work that doesn’t need to be done and leveraging work through multiple businesses,” he explains. “You cannot only keep attacking suppliers’ margins; we need suppliers to reinvest in technology and people to give us reliable operations so we really have to look at total cost of ownership.”
This kind of strategy will be vital if BP hopes to maintain lower costs going forward, says Accenture’s Yates, with security of supply likely to become an issue again over the next 12 months. “A lot of the cost savings of the past year will have been driven by market conditions with a level of focus never previously seen in those areas,” he says.
“But if we see a return to growth you can bet your bottom dollar that the suppliers will be looking to get back to the old price levels, so your ability to do some of the more complex material – looking at costs across the supply chain and working with your key suppliers to identify opportunities to drive those out – is where you need to focus. There’s an opportunity there but there’s clearly a risk as well.”
For suppliers, the past few months have meant painful readjustment to both market forces in general and the demands of key clients such as BP in particular. But they remain keen to work for the oil company and optimistic about the future relationship.
“There’s no question our margins are deflated as a result of this particular change but that’s a reflection of the market,” says Swan at Halliburton.
“We’d rather have higher margins but there is also great maturity from BP to accommodate market cycles while building long-term value creation. SORAC is the first step in this.”
Dodds from Baker Hughes adds: “We want to be judged on performance, by our stated benchmarks and also against our competition. We would hope to be rewarded for excellent performance with additional work. BP has a very significant amount of work ongoing with more coming up in 2011 that will require a large amount of well services. This establishes a good basis but there’s huge potential for the future too for both companies.”
Nick Martindale (firstname.lastname@example.org) is deputy editor of CPO Agenda
Part of the family
When UK business Land Securities sold its commercial property division Trillium to Telereal in January 2009, the new business began a process of integrating the two procurement departments that is still ongoing.
“There are still effectively two procurement departments,” says Clive Dedman, head of procurement at Telereal Trillium. “In some of the areas on the Trillium side we have total cost responsibility, and in others the procurement department leads the negotiation but the actual contract itself is with the client.”
The business has also started to consolidate the two supplier bases. Dedman estimates each company had around 1,600 suppliers, with around 700 in common. “We are negotiating common prices so our business doesn’t lose any advantage or leverage for the combined spend,” he says.
Perhaps the biggest change, however, has been going from plc ownership to a privately owned family business in the shape of the William Pears Group.
“There is a much greater control over spend and cost centres but you also have a much more immediate decision-making route,” says Dedman. “In the plc environment you have all sorts of shareholders with different wishes and it’s often tricky to satisfy all of those.”