Changes at Shell.

First off, I am a "Shell Brat", my father worked for Shell Canada for over 33 years and retired in 1982. I was also fortunate to work at Shell for two summers during my high school days in the 70's. During my first year I was helping out in the mail-room, and the second summer was spent washing dirt in their geological warehouse. Shell holds a special place in my mind and strongly influences my perception of the oil and gas industry. That is why it is with extreme disappointment regarding The Royal Dutch Shell group, who just purchased the outstanding shares of Shell Canada, have announced that the CEO of Shell Canada will be retiring and the new CEO will be the CEO in their Houston operation. The time when the decisions and understandings that Calgary may have had on Shell Canada will now cease to be a factor.

In my thesis that was the precursor to this blog. I suggested that if the producers were not willing to move toward a more innovative footing, the loss of their independence would be the result. That Shell is the first is disappointing, and I can not determine which producer would be next, nor can I provide any of the cause and effect analysis that proves my thinking. It would only seem reasonable with Houston's focus moving away from the Middle East, Russia and China, that Canada would lose its independence and stature, as Houston asserted its influence.

Technorati Tags: Genesys, Plurality, Governance

Annual Report Season

Canadian Natural Resources Ltd have filed their 2006 annual report. Within its financial statements there is a small qualification of managements opinion on internal controls. But first lets go back to 2005 to see what they wrote.

The accompanying consolidated financial statements and all information in the annual report are the responsibility of management. The consolidated financial statements have been prepared by management in accordance with the accounting policies in the notes to the consolidated financial statements. Where necessary, management has made informed judgements and estimates in accounting for transactions that were not complete at the balance sheet date. In the opinion of management, the financial statements have been prepared in accordance with Canadian generally accepted accounting principles appropriate in the circumstances. The financial information elsewhere in the annual report has been reviewed to ensure consistency with that in the consolidated financial statements. Management maintains appropriate systems of internal control. Policies and procedures are designed to give reasonable assurance that transactions are appropriately authorized, assets are safeguarded from loss or unauthorized use and financial records are properly maintained to provide reliable information for preparation of financial statements.

PricewaterhouseCoopers LLP, an independent firm of Chartered Accountants, has been engaged, as approved by a vote of the shareholders at the Company’s most recent Annual General Meeting, to examine the consolidated financial statements in accordance with generally accepted auditing standards in Canada and provide an independent professional opinion. Their report is presented with the consolidated financial statements. The Board of Directors (the “Board”) is responsible for ensuring that management fulfills its responsibilities for financial reporting and internal controls. The Board exercises this responsibility through the Audit Committee of the Board. This committee, which is comprised of nonmanagement directors, meets with management and the external auditors to satisfy itself that management responsibilities are properly discharged and to review the consolidated financial statements before they are presented to the Board for approval. The consolidated financial statements have been approved by the Board on the recommendation of the Audit Committee.

And for 2006

Management is responsible for establishing and maintaining adequate internal control over financial reporting for the Company as defined in Rule 15(d)-15(f) under the United States Securities Exchange Act of 1934, as amended. Management, together with the Company’s President and Chief Operating Officer and the Company’s Chief Financial Officer and Senior Vice-President, Finance, performed an assessment of the Company’s internal control over financial reporting based on the criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on the assessment, management, together with the Company’s President and Chief Operating Officer and the Company’s Chief Financial Officer and Senior Vice-President, Finance, has concluded that the Company’s internal control over financial reporting is effective as at December 31, 2006. Management recognizes that all internal control systems have inherent limitations. Because of its inherent limitations,internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

Management’s assessment of the effectiveness of the Company’s internal control over financial reporting as at December 31, 2006, has been audited by PricewaterhouseCoopers LLP, independent auditors, as stated in their report presented with the audited consolidated financial statements.

Well who would have thought, sounds like a systems related argument that has been discussed here many times. I'll let you know of whom's head I see rolling down 5th Avenue first.

Technorati Tags: Genesys, Governance, Call-to-Action, Failure

Capabilities and Governance, Conclusion

Langlois' et al's theories have taken us a long way in terms of researching the optimal organizational construct for oil and gas. I have suggested, and the industry concurs with me, that greater recognition of the Joint Operating Committee as the organizational construct provides value within the industry. Through this review, Langlois has taken us down some roads that we otherwise may have travelled on our own. I am certain that we would have discovered many of the same pitfalls that Langlois discovered and noted in his many papers. The use of "production" costs and "transaction" costs as clear classifications of costs managed by two "sub-organizations" either the Joint Operating Committee (production costs or market) or Military Command and Control Structure (transactions costs or firm).

I would like to end this research of Professor Langlois with the note that I will be writing more about his theories as we progress. I have added him to the stable of excellent research that is being conducted by Dosi, Perez, Romer, Winter and Schumpeter. Recall that Langlois is a recipient of the Schumpeter Prize, a well earned attribute. In closing with this final entry on Capabilities and Governance I want to highlight some of the salient quotations. They are;

"The organizational question is whether new capabilities are best acquired through the market, through internal learning, or through some hybrid organizational form. And the answer will depend on (A) the already existing structure of capabilities and (B) the nature of the economic change involved." pp. 21

and

"If a profit opportunity requires a configuration of capabilities different from what already exists in the economy, the Schumpeterian process of creative destruction may be set in motion." pp.21

and

"More generally, we are worried that conceptualizing all problems of economic organization as problems of aligning incentives not only misrepresents important phenomena but also hinders understanding other phenomena, such as the role of production costs in determining the boundaries of the firm. As we will argue, in fact, it may well pay off intellectually to pursue a research strategy that is essentially the flip-side of the coin, namely to assume that all incentive problems can be eliminated by assumption and concentrate on coordination (including communication) and production cost issues only.

"Either way it boils down to the same common-sense recognition, namely that individuals - and organizations - are necessarily limited in what they know how to do well. Indeed, the main interest of capabilities view is to understand what is distinctive about firms as unitary, historical organizations of co-operating individuals." pp. 17

These last quotes of Langlois reflecting to me the role that industry needs to help define and develop. A process of coordination that will be an inherent part of the software development process. A coordination process that industry can and will benefit from without the perceived costs of loosing any competitive advantage. A process that can evolve with the shared cooperation that comes from an enhanced competitive understanding. One that will identify the key competitive criteria as the producers land base, and the capability to explore, produce and exploit these much needed energy resources.

"In a world of tacit and distributed knowledge - that is, of differential capabilities - having the same blueprints [or software] as one's competitors is unlikely to translate into having the same costs of production. Generally, in such a world, firms will not confront the same production cots for the same type of productive actively." pp. 18

"This in turn, implies that the capabilities may be interpreted as a distinct theory of economic organization." pp. 18

And industry can then achieve many of the promised benefits.

"... while transaction cost consideration undoubtedly explain why firms come into existence, once most production is carried out within firms and most transactions are firm-firm transactions and not factor-factor transactions, the level of transaction costs will be greatly reduced and the dominant factor determining the institutional structure of production will in general no longer be transaction costs but the relative costs of different firms in organizing particular activities." pp 19

"If by contrast, the old configuration of capabilities lies within large vertically integrated organizations, creative destruction may well take the form of markets superseding firms. History offers many examples of both." pp. 21

These changes are needed, and based on my current marketing, much desired. People know intuitively the time is now to proceed in these directions. A time to realize many of the benefits that are promised through their Public Petroleum Data Model, Royalty Simplification, Petroleum Accountants Society of Canada and Canadian Association of Petroleum Land-man and other standardizations.

"If however, change is autonomous - if change can take place in separate subsystems without greatly affecting the way those subsystems are connected together - then markets, which can take advantage of specialized and decentralized knowledge, may be at a relative advantage. Here the issue of standards enters the picture: for standards are typically ways of fixing the connections among subsystems so that change is channeled in autonomous directions. Langlois and Robinson (1992, 1995) call this kind of structure a modular system." pp. 22

"But more quantitative empirical studies also suggest that differential capabilities, and therefor production costs, are significant variables for explaining the boundaries of the firm. In Graham Walker and Donald Weber's (1984) empirical study of the make-or-buy decision, the most important explanatory variable turned out to be the indicator for differential firm capabilities, that is, for production costs." pp. 22

Technorati Tags: Capabilities, Governance, Langlois, Military-Command, Genesys, Software, Strategy

photo courtesy David Sifry

Revised Final Research Report Abstract.

Preliminary or "Peer" review of the Final Research Report has been completed. The purpose of the peer review is to capture many of the attributes and issues that the industry sees in the report and to assimilate it here. Therefore I am submitting this Revised Abstract as a precursor to approaching the appropriate decision makers in industry. The results of the peer review include the following points.

"What does the industry get."

I am asserting a revised business model then what exists in the marketplace. Investment capital is unavailable for the software developments purposes. Looking at the long-term aspects of this software solution I have concluded it requires a strong revenue stream. This revenue stream starts with the subscription deposits noted below.

"Sticker Shock"

The costs mentioned in the Final Research Report are the total project costs to develop a Canadian oil and gas application. These development costs are amortized over the overall number of producers that subscribe to this development. Ideally this should be the industry at large. Discussion of these initial upfront costs being subsequently equalized over the industry is something that I would support. These costs are allocated over the life of the development, with well over half the costs being incurred in the last fiscal year of development. This provides a decision / stage gate point in time over the 4 cash calls.

"The Joint Operating Committee is the appropriate organizational construct."

This involves moving the "Accountability" framework, consisting of the "reporting", "regulatory" and "compliance" sub-frameworks, over to the "Financial", "Legal", "Operational Decision Making" and "Cultural" frameworks of the Joint Operating Committee. This re-alignment of the oil and gas producers organizational focus will have the material effect of increasing the scientific and engineering capability to a higher overall industry capacity. This is based on much of my current research in Professor Langlois, Dosi, Perez and others. This will also facilitate a faster speed of implementation of corporate policies. These concepts are proven in my research noted on http://innovation-in-oil-and-gas.blogspot.com. These concepts have substantial support from the academic community, as noted under the calls to action in the Final Research Report. And it can now be said has tangible industry support.

"The myriad of permutations and combinations of a facility."

Review of the Partnership Accounting module reflects how this system could be built to accommodate the needs of the industry. How this has been handled in the past is poor. I suggest in this research report that the methods and means are at our disposal to provide the CO&O Farm-in / out, Pooling, Lease and associated mail ballots, AFE's etc. The Partnership Accounting module will have the influence on the accounting either through a strict application of the chemical makeup of the product produced, or the legal agreement, or any point in between these two extremes. This is the nut that is being cracked through the development of this software.

Review and comment on the competitive landscape.

CGI was granted a production accounting development on a shared basis between a number of the senior producers. This applications delivery is now in excess of 14 months late and is rumored not to be able to meet its requirements. The limited scope of the application and focus on the linking to each and every ERP vendor makes this a still born project in my opinion. I am also concerned with the level of expectation that these developers would therefore be available to this project. This project will hire the necessary people to make the application function in the market as expected. The people therefore who are coming to this clean slate approach, I will ensure are the best available. I also have methods and means that I can use to increase the overall capacity of the development community in Calgary.

There is now a definitive mindset in the industry regarding the packaged applications provided by SAP and Oracle. There is a general agreement that the oil and gas industry is poorly understood and represented by these vendors and their offerings. It is also agreed that these vendors consider the Canadian oil and gas industry as a niche market, not worthy of any new development investments.

IBM has now sold Qbyte, their oil and gas solution in the market. 140 producers use this solution. Many feel they were buying IBM, and hence no one ever lost their job recommending IBM. Many producers feel the current offering, which will not be supported by the purchaser in this transaction, will have ripple effects throughout the industry. These ripple effects include having an ERP system that is not supported is inconsistent with the requirements of Sarbane's Oxeley. It also makes the demand for IT services during the next 3 years seriously over subscribed.

I want to highlight the point I made in the Final Research Report regarding the copyright I hold. This is a unifying point for the industry to rally around. I am only licensing one company to develop the software and there will not be this scattered or "Venture Capital" approach to developing many solutions at the same time. All the energies of the development community and energy industry are focused on getting it "right". I can state this as no developer will be able to develop alternative systems based on the joint operating committee without a license from myself. This will disable the Venture Capital approach through the fact that Sarbane's Oxeley and general prudence would not permit producers’ employees to use a system from a pirated venture.

Development needs.

The four stage-gate cash calls are calculated on the basis of 10 subscribing producers to this offering. (Based on the minimum budget of $87.7 million.)

* Deposits of $1,000,000 ($100,000 per producer) on or before February 28, 2007
* $10.6 m / # of subscribing producers ($1,06,000 per 10 producers). Due September 30, 2007
* $19.6 m / # of subscribing producers ($1,96,000 per 10 producers). Due September 30, 2008
* $57.5 m / # of subscribing producers ($5,750,000 per 10 producers). Due September 30, 2009

An additional request for 4,000 sq. ft. in the downtown core to September 30, 2008 is required.

Contact Information

Paul D. Cox
403-467-7971
Access my email address through the profile on this blog.

Technorati Tags: Development, Reference, Research, Strategy, Proposal, Genesys, Call-to-action

Photo courtesy troels

Capabilities and Governance Part II

Revisiting Langlois and Foss' "Capabilities and Governance: the Rebirth of Production in the Theory of Economic Organization" article. There were a number of other worthwhile points that I would like to comment on. In the last entry I discussed mostly the Governance attributes of the article, I would now like to focus on the Capabilities. I unfortunately need to quote extensively from the article and will probably violate the fair use doctrine of Dr. Langlois' and Foss' copyright. I have been in contact with them and will make them whole based on their determination of these writings.

Previously I wrote my opinion that the energy industry had developed as a competitive resource, and asserted that I thought there was a need to develop an industry-wide based capability. Today many of the companies that are of size in oil and gas are also the respective Chairmen of the joint operating committees for the properties they have interests in. This requires each producer to develop the capability to conduct those operations primarily through in-house staff. With the move to a stronger innovation mindset the industry would need additional capabilities and capacities, particularly in the science and engineering areas. This has become evident in today's marketplace. I have suggested in this blog that a pooling of the industries resources would enable a greater overall industry-wide technical capability. One that would eliminate the need for the high level of capabilities that each producer currently holds in its "siloed" corporation. The reason that companies would do this is to ensure that the company was able to continue to conduct all the operations they are involved in. The average engineering and geological work necessary for a barrel of oil increases annually and this trend is rapidly accelerating.

Today, this has already begun with a large portion of the industry operates on the industry wide capability basis. The large engineering firms are employed and indeed do the majority of the bullwork for the producers. What I want to assert is; with the industry transformed from "transfers" to "transactions" as discussed here, capabilities need to be expanded further to reach the potential of the industry. This to enhance the producers production profile under the revised organizational construct, the Joint Operating Committee. This thinking is consistent with Langlois et al.

"However, a new approach to economic organization, here called "the capabilities approach", that places production centre-stage in the explanation of economic organization, is now emerging. We discuss the sources of this approach and its relation to the mainstream economics of organization." pp. 2

I also want to assert that in dealing with the Joint Operating Committee's four frameworks (legal, financial, cultural, and operational decision making) leads me to Langlois' definition of production costs. And the regulatory, administrative and compliance frameworks lead me to what Langlois' describes as "transaction costs".

"The legacy of this "path-dependent history, we will argue, has been a tendency (albeit an imperfect tendency) to respect an implicit dichotomy between the production aspects and the exchange aspects of the firm or, to put it another way, between production costs and transaction costs." pp. 5

In my May 2004 proposal I successfully asserted the joint operating committee is the appropriate organizational construct for innovative oil and gas producers. And in particular I noted Dr. Wanda Orlikowski's Model of Structuration, which is based on Dr. Anthony Giddens Theory of Structuration, that software defines the organizational construct. Therefore, within the Model of Structuration, I have asserted the existing software applications define, support and constrain the hierarchy. And I went further to state that SAP is in fact, the bureaucracy. Langlois notes in his paper that Economists neglected organizational changes as benefits, and I would assert for the same reasons that they have been neglected by management, through their choice of their ERP software solution.

"Seldom if ever have economists of organization considered that knowledge may be imperfect in the realm of production, and that institutional forms may play the role not (only) of constraining unproductive rent seeking behaviour but (also) of creating the possibilities for productive rent-seeking behaviour in the first place. To put it another way, economists have neglected the benefit side of alternative organizational structures; for reason of history and technique, they have allocated most of their resources to the cost side." pp. 6

In my previous entry reviewing of Langlois et al theory, I noted how the transition from "transfers" to "transactions" could benefit the energy industry and provide enhanced performance through essentially defining new boundaries of the firm, and division of labor. From the Langlois et al article, the dovetailing of the governance issues meet the capabilities issues. And they go on further to suggest

"One of the important goals here is to bring the capabilities view more centrally into the ken of economists. We offer it not as a finely honed theory but as a developing area of research whose potential remains relatively untapped. Moreover, we present the capabilities view not as an alternative to the transaction-cost approach but as a complementary area of research." pp. 7

Here we have further evidence of the point that I have made in my thesis. That software defines the organization. Or as I like to say SAP is the bureaucracy. The definition and implementation of the bureaucracy is what SAP does best, and may I assert is the primary reason for its success. We have now come a long way from the SAP styled organization in oil and gas to a point where new and better means of organization are not luxuries but necessities. The demands and constraints of the industry to produce more with less have only begun to be heard. Will SAP continue to support the petroleum producer in the near future? From what I hear through my current marketing efforts, apparently not.

More to come on this interesting topic.

Technorati Tags: Genesys, Langlois, Reference, Research, Strategy

Capabilities and Governanace.

Continuing on with our review of Professor Richard N. Langlois, next up is his paper "Capabilities and Governance: the Rebirth of Production in the Theory of Economic Organization." Written by Langlois and Professor Nicolai J. Foss of the Copenhagen Business School. The title of this entry will take you to the Social Science Research Network to download the .pdf.

From the abstract of the document I would like to note how much of the work that Langlois et al are doing is applicable to the work being done here for oil and gas. I would suggest that oil and gas may become an excellent resource for this type of research. The abstract of this document states;

"However, a new approach to economic organization, here called "the capabilities approach," that places production centre stage in the explanation of economic organization, is now emerging. We discuss the sources of this approach and its relation to the mainstream economics of organization." pp. 1

Later in the document Langlois et al state

"One of our important goals here is to bring the capabilities view more centrally in the ken of economics. We offer it not as a finely honed theory but as a developing area of research whose potential remains relatively untapped. Moreover, we present the capabilities view not as an alternative to the transaction-cost approach but as complementary area of research" pp. 7.

And

"In sum, whether we see it from the perspective of the capabilities perspective or from the perspective of the modern economics of organization, there is an exciting theoretical frontier ahead." pp. 31

I can only concur.

A little review of Langlois' theories may help to assimilate the contents of this document. The market model requires "transactions" to occur between separate economic units. These transactions create "friction" in terms of the resources necessary to process the transaction itself. Typically these "transaction" costs were mitigated by industry forming companies that held the production and capabilities. This is referred to as the "transfer" model by Langlois et al. In the "transfer" model an employer only needed to tell his employees what needed to be done, there would be no transactions to process other then for the employee salary.

What happens as a result of this avoidance of "transaction" costs is that the industry needs to be defined and controlled through the traditional hierarchy's command and control structure. One of the key points that Langlois et al is providing evidence of is, transaction costs are used by the market to provide the oil and gas producer with what it needs in an entrepreneurial manner. The market is able to anticipate and make the determination of where the industry is heading and will work to anticipate and capture the future demands of the producer.

Langlois et al states that with the automation of transactions through the current Information Technologies. Transaction costs can be reduced to an immaterial level. This provides industry with evidence and a means to move from transfers within organizations, to transactions in markets.

It is at this point that I want to assert how damaging an economic model it can be when an industry is based on "transfers" instead of "transactions". In Calgary a few years ago many of the Drilling suppliers found their capacity utilization hit 100%. However, the market demand may have been at approximately 125% of capacity. Based on the history of the ups and downs in the market, the drillers were very hesitant to invest to increase their capacity. Recall that surplus capacity in any industry can become one of the largest fixed costs of a firm. Hence the producers who were needing the increased drilling capacity commissioned and paid for drilling rigs for their exclusive use. The drilling contractor would operate the new rigs for the producer on the basis of the producer's needs.

Why this type of "transaction" should be avoided is based directly on the Langlois et al theories that we have learned to date. The driller and his competitors, and most importantly the new drillers seeking to enter the business, seeing a new dynamic in the capacity increases and utilization, lost all incentive to take a risk in the market. Bringing a new rig or new technology to the marketplace would be too risky for any new player. What the producer signalled to the entire industry is that the hierarchies would now micro manage a drilling division due to the investment in drilling rigs. These types of "messages" are what Langlois et al is speaking about. The wrong message is being sent to both the competitive supplier side and the producer side. If producer A is willing to buy his own rigs, then producer B will have to do the same to have his wells drilled. The supplier marketplace, seeing that it is now possible to defer the risk and capital costs of new capacities to the industry will sit back and await the time for a producer to ask for the next great innovation. This is how the western capitalist marketplace begins to take on characteristics of the former Soviet Union.

In this scenario of market "transfers" it has become very difficult due to the lack of innovation and capabilities focus. The large producers don't understand why the marketplace can't accommodate its needs, and therefore feels compelled to get things done on its own. This is in essence what their large capital cost overruns are symptomatic of. Until an oil and gas producer does something to make the situation better by intervening in their suppliers marketplaces, nothing gets done.

The ability and capability of the management of the producers to deal and manage with the problems of the entire marketplace are as a result of what Langlois at al speaks of. The micromanagement of an entire industry, its suppliers and employees is not the domain of the producers hierarchical management. It is the responsibility of the market place left to resolve its own difficulties. That this has not been done for so long in the oil and gas industry only makes it look like there is strong demand for the producers management. This is false, it is an illusion. What is needed is the producers to signal to the marketplace in its entirety, that the innovative and risk oriented marketplace is what is necessary for all concerned to prosper in this new age.

Technorati Tags: Langlois, Genesys, Research, Innovation

An excellent resource that is a must read.

The title of this entry will take you to Professor Langlois Economics 486 "The Economics of Organization" which to me is a highly recommended set of slides to view. They lay out in very fine detail the beginning and current theories of the firm and markets. I hope you enjoy this resource as much as I.

Technorati Tags: Innovation, Research, Langlois, Development

Langlois has more to say on transactions.

Professor Richard N. Langlois wrote a fairly current paper on "The secret life of mundane transaction costs". Clicking on the title of this entry will enable you to download the .pdf from the Social Science Research Network.

Professor Langlois refers to Oliver Williamson for a summary of what transaction costs are, "...costs of running the economic system". (2006 pp. 1) A large part of that system is the costs associated with establishing and supporting standards. Here in Alberta we have a number of groups that have created standard ways and means of conducting business in the oil and gas industry. These standards help to form and support the culture of the industry, and that is particularly, the joint operating committee, the organizational focus of these writings.

"The modularity theory of the firm."

Dr. Langlois uses the established industry standards and the methods of enforcing compliance into the economic system to "establish and maintain a system of property rights." Langlois organizes the costs into 3 categories, I will mention those categories and then provide examples of the types of costs that are incurred in each category.

1) "Contains the fixed costs of establishing and maintaining a system of property rights."

Including the basic laws of the land, and the Alberta Governments royalty and mineral rights development laws and regulations, Petroleum Accountants Society of Canada, Canadian Association of Petroleum Landman, Public Petroleum Data Model and other standards bodies. The point in this categorization is to determine what the real fixed costs of establishing and maintaining the standards of operations of oil and gas are in Alberta and Canada. Needless to say many of these organizations are representative of larger global groups that have influence through out the global oil and gas industry.

2) "Contains costs that are paid periodically. These depend on time, but not on number or volume of transactions."

Langlois interestingly takes this categorization and classifies items like salaries of police, costs that are a function of time, in application to oil and gas, this would include the SEC, FASB, Auditors, Engineering appraisals and other compliance costs to regulations as the variable or time dependent costs of establishing and maintaining property rights in the oil and gas industry.

3) "Contains all the costs that come with the number of transactions or volumes of transfers."

The last grouping of costs Langlois sets out is the definitive variable costs of production. Based on the level of activity is the criterion that establishes the volume of costs and what Lanlois describes as "Neo-Classical T-Costs." These would include the royalties actually paid, the investment dollars spent, the costs associated with the revenue from the production of oil and gas.

Langlois has categorized these further, and are combined into the following;

• Category 1 and 2 = Costs of establishing and maintaining property rights.
• Category 3 = the Neo-Classical T-Costs mentioned.
• Category 2 and 3 = Mundane transaction costs.

It is at this point Langlois sets out to establish that these costs categories "have a secret life" and indeed "have a secret life cycle". In summary he is establishing much of the information analysis, or the tool that I previously wrote about from Baldwin and Clark. Through this the architecture of the industry is combined with the standards to form not only the encapsulated (companies) and modules (individuals) but also a means of operation via the price system.

Dr. Langlois quotes Hayek in this regard; it is a salient point;

"The whole acts as one market, not because any of its members survey the whole field, but because their limited individual fields of vision sufficiently overlap so that through many intermediaries the relevant information is communicated to all. ...The most significant fact about this system is the economy of knowledge with which it operates, or how little the individual participants need to know in order to be able to take the right action. In abbreviated form, by a kind of symbol, only the most essential information passed on and passed on only to those concerned. It is more that a metaphor to describe the price system as a kind of machinery for registering change, or a system of telecommunications which enables individual producers to watch merely the movement of a few pointers, as an engineer might watch the hands of a few dials, in order to adjust their activities to changes of which they may never know more that is reflected in the price movement." (Hayek 1945, pp. 526 - 527)

The architecture of the industry is what I have asserted is broken. Represented by the hierarchy, the oil and gas industry has been able to establish the appropriate standards and therefore maintain the property rights that are so critical to the development of the oil and gas industry. What is now redundant is the level of capability that is built up within each of the producers. Hierarchies have focused on their own needs and capabilities within the firm itself. Building extensive capacities to accommodate all of the needs that are associated with the category 1) 2) and 3) cost. What is needed is to conduct the analysis on the standards such that the efficient point of each transaction becomes the point of transfer. The tools to use are contained within these two documents of Langlois, Baldwin and Clark. This in a nutshell is the purpose and desired outcome of the development of the Genesys application. A reorganization, and a re-architecture of the oil and gas industry on a global basis.

Ensuring the necessary level of hidden information in each transaction is critical according to Langlois.

"Indeed, as the field of object-oriented programming has taught us, these hidden design parameters generally must not be communicated to others. This is the principle of encapsulation and information hiding. To allow another module knowledge of an access to one's inner workings is to invite those other modules to tinker - and thus to invite butterfly effects."

"The secret life"

Professor Langlois notes the friction that is created in transactions. The costs of standardization, counting and compensation when the tasks are assigned to a third party, or as Coase stated "the costs of using the price mechanism." These "friction" costs are incurred in the transaction as opposed to asking that the work be completed within the firm itself which Langlois suggests it simply doesn't pay to simplify and standardize the transactions, that the coordination costs can be limited by the market size, or if the transactions are more dynamic in nature and are subject to frequent change.

"The secret life cycle."

"With a larger extent of the market, and in the absence of any other kind of transaction costs, it starts to pay not only to subdivide tasks further but also to turn more transfers into transactions." pp. 26

And provides a necessary caution;

"But this is not the same thing as saying that we should observe vertical disintegration in a growing industry. Growth takes place in disequilibrium. And disequilibrium can lead to dynamic transaction costs, especially when the increase in the extent of the market calls for a systemic reorganization of the task-and-transfer system." pp. 27

As time passes, the volume of transactions increase, and the volume of dynamic transaction cost decrease. This makes inherent sense in that the ability to build an industry would require more transfers to mitigate the costs of un-standardized transaction costs. However, after time the reverse becomes the norm in that "thick markets will increasingly come to supplant management as a mechanism for buffering uncertainty". pp. 30 This phenomenon is what Langlois has called "The Vanishing Hand".

Technorati Tags: Development, Langlois, Research, Strategy

Determining transactions, transfers and the division of labor.

Clicking on the title of this entry will enable you to download an article from the Social Science Research Network. This article was noted on Professor Langlois' guest blogging posts on Organizations and Markets and is a continuation of my research into his thinking. The article is written by Carliss Y. Baldwin and Kim B. Clark and is entitled:

"Where do organizations come from? A network design perspective of the theory of the firm."

The article discusses transactions and transfers of value in the business setting. A rather boring topic however, I think this article is of value in defining a tool for a company such as Genesys, with the means to analyze and develop new divisions of labor in oil and gas.

The approach that I am making here is based on the need to expand the growth opportunities of the oil and gas industry. Agreement amongst most economists would reflect that the expansion of Adam Smith's division of labor is the means to enhance the productivity of the oil and gas worker and the industry as a whole. Enabled by the new technologies, and reflected in the different make-up of markets as I proposed in the Human Resource Marketplace and Petroleum Lease Marketplace. The division of labor will need to be "adjusted" for every process, transaction, transfer and job. The tool that is defined in this paper provides us with the means to do this analysis.

Tearing into the document we find the articles definition of a transaction is:

"...objects that are transacted must be standardized and counted to the mutual satisfaction of the parties involved. Also in a transaction, there must be valuation on both sides and a backward, compensatory transfer - consideration paid by the buyer to the seller. Each of these activities - standardizing, counting, valuing, compensating - adds a new set of task and transfers to the overall task and transfer network. Thus it is costly to convert even the simplest transfer into a transaction."

The authors provide us with an appropriate definition. I would also assert the makeup and origin of these transactions might change due to the available information technologies. Oil and gas will have new more efficient means and methods to conduct transactions, and that is where the focus and value of this blog’s concepts are concerned. Does it make sense that a "Production Accountant" focus only on their employer’s production, or would it be more valuable to have the "Production Accountant" work for a variety of Joint Operating Committee's in a specific geographical area? "What would the revised job consist of..." is how we could analyze the changes with this tool.

The authors then introduce two concepts that are of critical competitive value, "Information Hiding" and "Thin Crossing Points". These two concepts define the need for the transaction and transfer to occur at the point where the simplest interface between the two parties exists. This "Thin Crossing Point" provides both vendor and purchaser with the ability to hide information from each other and still achieve the greatest level of efficiency in conducting the transaction, asserting that:

"The user and Producer need to deploy knowledgeable in their own domains, but each needs only a little knowledge about the other's. If labor is divided between two domains and most task-relevant information hidden with each one, then only a few, relatively simple transfers of material, energy and information need to pass between the domains." pp. 17

Using the example of the "Production Accountant" we can now analyze whether the transactions of his / her efforts should be conducted at the simplest point. This is because the transactions that are involved are standardized, counted, valued and compensated on the basis of (here in Canada) the EUB, the Accounting and Operating Procedures as defined and agreed to by the Joint Operating Committee.

The reason that I have selected the Production Accountant is due to the fact that there are never enough of them. A position that requires specific skills that always seems to be in short supply. The industry as I have suggested throughout these writings needs to undertake a revolutionary new approach to the business of oil and gas. Based on the science and engineering, it's obvious that wells will be drilled at a faster rate and the decline in reserves will continue to accererate. Therefore to sustain and grow the base of oil and gas production will require more Production Accountants, or, as I have proposed a different way of accounting for the production.

The authors then note:

"Placing a transaction - a shared definition, a means of counting, and a means of payment - at the completed transfer point allows the decentralized magic of the price system to go to work." pp.22

Intuitively Langlois was correct in his assertion that the decentralized production methods were more efficient then the high throughput production methods the industry is configured around. Therefore this last quotation provides a very detailed tool to determine the division of labor of the "revised" oil and gas industries. From this process the authors note:

"The most significant fact about this system, is the economy of knowledge with which it operates, or how little the individual participants need to know in order to be able to take the right action. In abbreviated form, by a kind of symbol, only the most essential information is passed on..." Frederick Hayek (1945)

The authors provide another definition and concept:

"Encapsulated Network in a larger system of production is to facilitate complex transfers without making all of them transactions". pp 28

Which to my mind shows where the real value in this entire process is not only would the encapsulated network achieve the greatest efficiencies in the transfer and transaction. It would enable the participants to focus on their unique competitive advantages. I have suggested in previous postings and the research documents that the oil and gas industries competitive advantages lie in the oil and gas leases in which they own. The ability to find, develop and produce those reserves are the critical activity that the company is evaluated on. The producer should consider these assets and skills as the key point of where their competitive advantages are. The direct employment of production accountants within each company does not provide any value to the producer.

Therefore, the make or buy solution provides the justification for the new approach to defining the Production Accountants job, organization and processes. The ability to buy the services would offload the need to have each company with adequate production accountants to complete the required reporting. This assumes of course that the production accountants would be able to organize themselves in some manner that provided a greater overall capacity then what is currently available, and that is what the division of labor sets out to provide, an increased throughput from the same resource.

Technorati Tags: Innovation, Langlois, Research

Photo Courtesy Guileite

A quick note...

Clicking on the title of this entry will enable you to download the paper that Professor Langlois won for Shumpeter Prize, entitled. The Dynamics of Industrial Capitalism: Schumpeter, Chandler, and the New Economy.

Technorati Tags: Langlois, Research

Langlois provides more food for thought.

Dr. Richard N. Langlois has, to my mind, hit a few more balls out of the park. They come from "Chapter 4 The rise of the corporation." In it he suggests the organizations that developed over the past centuries sought "buffers" in order to mitigate the variances in markets. These buffers include inventories and in oil and gas commercial storage has been an area of significant investment over the past decade. These "buffers" help to offset the difficulties of the business and make the potential variances dissipate in terms of their magnitude and frequency. Langlois notes that buffers come with the cost of a lack of operational flexibility.

In the last three days the price of oil has fallen almost $8.00 or 12.5%. It is fair to assume that the costs of production have not declined by that amount, but what will we see the producers do from this price decline? They will probably revisit their capital budgets for the next year and slash them based on this new pricing information. The ability to reduce production, particularly from the fields that are high cost, and may now be losing money, does not exist.

Langlois states the concentration of high throughput production, the current industry makeup, is contrasted to the decentralized production model.

"In a world of decentralized production, most costs are variable costs; so, when variations or interruptions in product flow interfere with output, costs decline more or less in line with revenues. But when high-throughput production is accomplished by means of high-fixed-cost machinery and organization, variations and interruptions leave significant overheads uncovered." pp.58

What would be required to transform the industry from a concentration of high throughput production to an industry using the decentralized production model?

With the radical shifts in the commodity prices the industry adopts one of two positions, full production with no capital expenditures or full production with full capital expenditures. Leading only to further and further problems down the road. What is needed is what Langlois suggests, a move to a decentralized production model, which to me sounds like the joint operating committee. Without the ability to limit the production of a facility that has begun costing due to the commodity price declines. The industry will forever be subject to wild swings in the prices of their commodities.

The scaling back of production based on its contribution is a scenario that I can easily see the ownership consensus of the joint operating committee attaining. Methods and procedures to map the costs to the prices and ensure that the facility is not run at a deficit in terms of its earnings. This would have the immediate effect of removing the high cost production from the market, so that the market could adjust based on that information. Is this not what OPEC has been doing in the last year?

Currently the greatest influence on the price of oil and gas is the 5 day weather forecast. This strikes me as insane. I am asserting the oil and gas industry is failing as a high throughput production type of industry. Langlois states that there is a process to enable these changes.

"Economic growth occurs at the hands of entrepreneurs, who bring into the system knowledge that is quantitatively new - knowledge not contained in the existing economic configuration." pp.27.

I can only hope that industry will accept these facts and proceed with this project. As next week marks the start of the marketing of these concepts we will know fairly soon.

Technorati Tags: Call-to-action, development, Langlois, Research, strategy

"Economic growth is about the evolution of a complex structure"

In his book "The Dynamics of Industrial Capitalism" Richard N. Langlois, Professor of Economics at the University of Connecticut stated, "Economic growth is about the evolution of a complex structure". This expands on Adam Smith's theory of the division of labor.

If the energy industry is going to increase its output, the first order of business is to settle on a new form of organizational structure. In oil and gas the joint operating committee is the legal, financial, operational decision making and cultural frameworks of the industry. This is on a global basis. Once the software is built to explicitly support the joint operating committee, recall that software defines and constrains the organization; the industry can then proceed to expand its output. I am at a loss to determine what other means could be used to increase the capacity output?

Here we have further academic support for using the Joint Operating Committee. With over 230 years since Adam Smith wrote his theory on the division of labor, it is a testament to the strength of his thinking that we quote him so frequently. Dr. Langlois' quotation provides further evidence that the ability to expand will first and foremost require new organizational forms to institute growth. To me the choice is very simple.

Technorati Tags: Call-to-action, Military-Command, Research