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SPECIAL REPORT

 ALLIANCING: A PARADIGM INTRANSITION, GETTING THE INCENTIVES RIGHT
By Peter D. Loftspring

 

Part One: The Alliance Paradigm - An Overview

Editor's Note:

This series of articles is based upon a paper presented by Mr. Loftspring at

 the "Partnerships, Contracting & Strategic Alliances" Conference presented by the Strategic Research Institute in New Orleans on February 26-27, 1997

 WHAT EXACTLY IS AN ALLIANCE?

One of the most misunderstood and misused terms in the modern commercial vocabulary is the term "alliance." Not only does the interpretation seem to vary significantly by industry, but often many members within an industry view the meaning and purpose of an alliance relationship differently. Interestingly enough, it is likely that this nebulous connotation tends to give alliances much of their strength and, unfortunately, if improperly structured and implemented, much of their weakness. Just as Lewis Carroll's Humpty Dumpty in Through the Looking Glass observed, a word means: "just what I choose it to mean -- neither more nor less," so the definition and consequently the nature of any particular alliance varies according to the unique personalities of the entities entering into these arrangements. Indeed, the departure from traditional delivery mechanisms for the provision of goods and services in favor of outsourcing and strategic alliances that deliver total solutions provides fertile ground for the development and evolution of new and different paradigms. This paper explores these developments based on experiences gleaned from the examination, negotiation and documentation of numerous small and large alliances in the rapidly changing oil and gas industry by one of the world's largest oilfield service companies, Halliburton Energy Services, and its sister company, one of the world's largest engineering and construction companies, Brown & Root.

From the outset, a concept that appears troubling to some, perplexing to others and exciting to many should be addressed: the ownership of an interest in minerals by a "development partner" that is responsible for supplying the goods and services required. While much debate over the potential for both conflicts of interest and "undesired" competition has arisen of late within the industry, this concern overwhelms and potentially clouds the much more important motive for such arrangements - a new organizational model that provides tremendous commercial advantage to those able to implement it properly. The significance of these new arrangements is not in the meager potential for re-allocating mineral ownership or in the arrival of a new competitor (competition between producers that routinely partner and compete with one another all over the globe is nothing new), it is about evolving the very fundamental tenets of the process utilized to analyze, design and perform development, production enhancement and abandonment efforts. It is about organizing relationships to enhance the synergy available when companies pursue common goals - alliancing is first and foremost about aligning interests. The most basic, but by far not necessarily the most desirable, way to align interests is for each member to have a similar equity interest in the undertaking. Far more alluring are meaningful and lucrative incentives that give each member of an alliance the motive to invest scarce resources to assist the mutual effort of achieving higher overall value. Equity is thus a means - facilitating, aligning or both - not a desired objective. With this in mind as merely one potential alternative for a successful alliance, the following discussion examines the evolving industry trend toward utilizing this powerful business strategy.

 DEFINITION - A FRAME OF REFERENCE

 

Webster's New Collegiate Dictionary defines the word "alliance" as an "association to further the common interests of the members." While this definition is broad enough to describe virtually any commercial enterprise, the more common use of the term tends to refer to a loosely organized collection of companies that does not involve a formal legal entity (e.g., corporation, partnership, limited liability company, etc.) to accomplish its goals. In practice, the structure and composition of alliances vary widely. One reason for the possible confusion over the use of the word "alliance" is that the term can be used quite conveniently to describe two common forms of association that are closely related.

 SUPPLIER/SUPPLIER ALLIANCES

 

On the one hand, an alliance between suppliers of goods and/or services allows entities with different kinds of expertise to organize in such a manner that "skill gaps" are covered. Thus, a more competent, smoothly functioning, synergistic organization can be marketed to those requiring the complement of skills offered. Significant value can be achieved by reducing the inefficiencies that result from dealing with separate companies for individual pieces of an overall project. Properly organized and focused, the alliance can accomplish a broad range of goals including joint technology development, product integration, cross-product endorsement, equipment configuration optimization and integrated customer service and support. Just as law firms and accounting practices bring together divergent specialties to meet a broader spectrum of their customers' needs, these alliances allow the pooling of resources that, after several years of close cooperation, can deliver higher quality products in a more timely and efficient manner. Unlike these professional joint ventures or partnerships that rely on distinct expertise to resolve interrelated problems, however, alliances between suppliers of goods and services are able to build upon each other's ability to design, construct and implement compatible processes, procedures and equipment that provide integrated solutions to ever changing problems.

Instead of a supplier either spreading its resources too thin to develop new areas of related expertise or investing in technologies that cannot be integrated effectively, numerous examples in many industries have demonstrated that collaboration among several suppliers to provide a broader skill set ultimately allows each company to specialize in ways that complement the others; thus the expertise of the overall group of suppliers is enhanced. From a customer perspective, reliability and dependability are enhanced because a single source of supply is capable of managing an entire project and bringing the appropriate resources to bear on most of the problems encountered. The inevitable problems identifying which supplier caused a particular problem within a complicated system are almost entirely eliminated because the members have worked together to design and develop compatible systems and those problems that do arise can be left to the alliance to resolve.

 SUPPLIER/CUSTOMER ALLIANCES

 

The other common form of alliance is based upon a close-knit relationship between one or more suppliers and their customer(s). Unlike the simple contractual relationship that exists when a supplier or supplier/supplier alliance is merely contracted with or hired by its customer, the supplier/customer alliance creates an organizational framework in which optimal solutions for total project value enhancement (not just cost minimization) can become the focus of the collective effort of the members. Not only are organizational inefficiencies wrung from the delivery process, but, if structured and incentivized appropriately, significant additional benefit for all of the members can be realized. Most notable examples of this form of alliance are found in automobile manufacturing, computer hardware production and major offshore oil and gas development projects. Rather than specifying detailed criteria in a request for quotation or delivery specification, the customer need only define general project goals and provide basic information from which more detailed design work can be produced. The members of the alliance work together to analyze and negotiate acceptable commercialization requirements (costs, rates of return, net present value ("NPV"), measurement criteria, incentives, risk allocation, etc.) as allies not as adversaries. Under this scenario, the customer works with its suppliers toward solutions to project problems as an integral member of the alliance for the duration of the project. The parties are thus able to share their skills and expertise beginning with the early stages where potential design problems giving rise to later re-work can be minimized or eliminated. As the project continues toward implementation, all members of the alliance benefit from the improvements and innovations which inevitably arise as experience is gained.

The customer benefits as organizational efficiency, better communication and economies of scale lower the cost to deliver the required products and services. At the same time, the supplier(s) is able to eliminate costs and uncertainties associated with overproduction, wasted marketing efforts, project bidding and inefficient utilization of resources. Combined, the members are able to take advantage of an enhanced relationship built on close cooperation and trust both for the initial purposes of the alliance and, experience has demonstrated with successful alliances, for any future projects undertaken. As long as both customer and supplier(s) stay abreast of market developments and maintain leading positions in their respective core competencies, the alliance will retain its commercial advantage on future projects.

 COMMON ALLIANCE COMPONENTS

 

In either "alliance," conventional notions of self-interest must be re-examined. In the supplier/supplier alliance, each company benefits by being better able to compete in the marketplace against other similarly qualified companies to offer the best possible quality for a given price (commonly referred to in terms of "value"). Similarly, in the supplier/customer alliance the need to continually investigate and analyze suppliers for the source of best value is also reduced (not necessarily eliminated). Under both alliance forms, the combined operations permit each member to gain broad advantages from the synergy provided by a close cooperative relationship with the other alliance members. Meanwhile, each member retains the necessary market incentives to remain competitive and stay current in its own niche because it must compete for other business outside of the alliance. In fact, if aligned correctly, a supplier/customer alliance may actually encourage the use of third party suppliers that compete directly with a member, where appropriate, if the overall value is thereby enhanced (it should be noted that although this concept generally meets with skepticism upon first consideration, incentive scenarios discussed in later articles in this series in which the "replaced" alliance member has more to gain from the resultant overall project savings clearly demonstrate the viability of this assertion - interestingly enough, it is generally the "replaced" member's knowledge of its core competencies and those of its competitors that leads to the recommendation for and enables the alliance to effectively implement the replacement).

Unlike the traditional partnership made up of members with similar skill sets (e.g., accounting practices, law firms, advertising agencies, investment companies, medical groups and real estate developers), economy of scale is not gained merely by sharing commonly utilized administrative, support and other "overhead" resources. The alliance succeeds by tearing down conventional inefficiencies arising from the very manner in which the work is performed. The alliance members' main objective becomes the common benefit realized through productivity gains and cost savings, with little room left for bickering and blame assessment often found among traditional suppliers to a common project. Over time, the members' close communication, trust, familiarity with each other's personnel and a history of favorable past experiences contribute to well run and successful projects. Examples of potential improvements over traditional business methods are depicted in Exhibit "A."

EXHIBIT A

COMPARISON OF TRADITIONAL
 AND
 ALLIANCE BUSINESS METHODS

Aspect of Service

Approach

Technology

Information

Safety

Training

Environmental

Bid Process

 Service Company Selection

 Design

 Planning

 Post-work Analysis

 Accounting

Traditional

Most ideas are generated by the customer with little acceptance of ideas generated by the supplier.

The supplier brings new technology to the customer (whether or not they need it).

The customer supplies limited information to the supplier.

  The customer does not communicate long-term results to the supplier.

  The customer is reluctant to try new technology.

  The customer mistrusts information the supplier gathers.

  Roles and responsibilites are unclear.

The customer and supplier have separate programs and policies.

The customer and supplier have separate training programs and policies.

The customer and supplier are both concerned, but they have separate programs.

The process is inconsistent.

Supplier gets only limited input from the customer.

  The process is time-consuming and expensive.

  Personal preferences may create obstacles.

Criteria include

 - Low bid

 - Safety

 - Environmental

 - Personnel

 - Quality

 -Availability

The customer has only limited trust of the supplier.

  The customer is not accustomed to using the supplier's software.

  The customer performs all economic analysis.

  The customer is skeptical of the supplier's new design procedures and processes.

  Personal preferences can be obstacles.

Plans are developed independently.

  Customers consider only their needs.

  Customers seek only limited input from the supplier.

  The customer has final approval.

The customer rarely shares results, good or bad.

  A post-audit is used only for problems.

  Problems and solutions are not shared.

  Post-audit examines only short term results.

The supplier submits an invoice with the applied discount for each service.

  Customer is inconsistent with bids and in tracking cost.

  Invoice processing and review is time-consuming.

Alliances

Alliances and partnering promote teamwork. Companies work together proactively to generate ideas.

New technology and developments are pursued and shared by the joint customer/ supplier team.

The customer and supplier exchange pertinent data from all available resources, which opens communication and promotes teamwork toward continuous process improvement.

  Relationships are built on trust.

The customer and supplier share safety programs.

The customer and supplier share programs when possible, especially safety and environment training programs.

The customer and supplier use teamwork for continuous improvement.

  Bidding is eliminated for work within the scope of the alliance or partnering arrangement.

  Not bidding frees resources for continuous process improvement.

The selection process is eliminated, which gives suppliers and customers more time for process improvement.

  Teamwork is used to optimize designs; best practices are used, or new designs are created.

  The customer and supplier share in-house expertise.

  Teamwork is used to begin cost/benefit analysis.

  Teamwork is used to develop performance ratings.

  The customer and supplier share successes.

The team works to improve processes.

  The post-audit measures short-term performance and long-term economic success.

  The team works to improve processes.

  The post-audit measures short-term performance and long-term economic success.

  The team uses a simplified process for quick, fair payment.

  The team uses consolidated invoices.

  The team uses electronic funds transfer to speed processing.

 Next month: "Alliancing: A Paradigm in Transition"

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Copyright © 1997, 1998, 1999, and 2000 by Lewis G. Mosburg, Jr. and Ogden, the Invisible English Sheep Dog

"Lewis Mosburg's OIL & GAS NEWSLETTER"™ and "Lewis Mosburg's OIL & GAS PRIMERS"™  are trademarks of Lewis G. Mosburg, Jr.