McKinsey have been able to provide a solid foundation for this software development project. This will be the 37th McKinsey article I have reviewed! (Click on the title for access to the document.) When it comes to organizational change and the impact of IT, McKinsey has invested heavily in this mega-trend and consistently gets it right. In applying this article to the oil and gas producer, strong support is given to the use of the Joint Operating Committee (JOC) as a key organizational construct of the industry.
This organizational blind spot, often combined with an excessive focus on short-term earnings, can produce unfortunate results, in our experience. Managers end up optimizing earnings goals at the expense of long-term growth and value creation. “We typically spend 80 percent of our time figuring out how to squeeze the economics, and only 20 percent on actual strategy, without numbers to back our decisions,” says one executive. Some readily admit to cutting back on value-creating projects in order to meet short-term earnings targets.
This is the systemic problem that all public companies face. Don't meet you targets for the quarter and you will be punished. Managing to these criteria becomes the focus and strategy that drives the management to perform at its best. It certainly leads many companies to focus on optimization at the expense of innovation and long term value generation. However, McKinsey are hitting on a key point with their definition of "value cells".
As a rule of thumb, value cells have standalone economics and must be relatively “homogeneous” in regard to their target market, business model, and peers—that is, they must have one target segment, one country or region, or one group of products. The trick is to create financial analyzes, such as P&L statements, as if a value cell were a stand-alone business. This is normally not done in a classic divisional structure, where each division’s financial's are an amalgam of different products, markets, and costs relating to shared assets. A useful litmus test is determining whether a value cell could be sold and whether there would be a clear market price for it.
A JOC does all the things that McKinsey define as required for a value cell. But their is more, McKinsey intimate that the value cells are somewhat separate from the divisional organization structure. Just as I have defined the boundaries of the firm and the JOC in the eleven module Draft Specification. The firm undertakes the role of establishing and attaining the financial targets, whereas the JOC develops the innovative ideas and builds value for the long term.
Value cells can easily coexist with the organizational structure of a division, which might need to take other factors into account, such as geographic proximity or economies of scale in common functions such as production plants, supply chain, or sales networks. As an overlay on an existing structure or a lens through which to view existing businesses, however, the cells facilitate strategic decision making.
An oil and gas firm may have hundreds of JOC's, this would cause the management workload to increase substantially. Not so McKinsey say;
In our experience, a company of above $10 billion market capitalization should probably be managed at the level of 20 to 50 value cells, rather than the more typical three to five divisions.
and
While managing so many value cells might appear to increase the CEO’s workload, the reverse is often true. Focusing more on single cells actually reduces complexity because managers find it much easier to identify and monitor the two or three operational metrics that truly drive performance, as well as to make decisions in a more straightforward way. In essence, the CEO can use value cells to take out a “disintermediation layer” between actual business decisions and the corporate planning process. Instead of aggregating strategies and economics into complex divisions and then spending lots of time understanding the overall strategy and performance, the CEO can take a larger number of more rapid, more specific, and more radical decisions at the value cell level.
This makes intuitive sense. The logic in using the JOC in the oil and gas industry is substantial. It is the financial, legal, operational decision making and cultural framework of the industry. Participants in JOC are motivated by financial rewards therefore concurrence can be easily attained. Today's Information and Communication Technologies (ICT) also enhance the expanded use of the JOC. In the Draft Specifications it is stated explicitly that the management role would increase in the redefined boundaries of the firm.
It’s worth noting that a value cells approach is meaningful only if a company has the courage to follow up on decisions to invest or divest. Managers must regularly scrutinize cells that destroy value and divest them if turnaround plans don’t materialize. They must nurture high-potential businesses aggressively and continuously. If competitors devote far more resources to a given business, for example, the real choice is exiting it or doubling down on the investment—not adapting marginally.
This however does not mean that our four little piggies can double down on their stock options. Which appears to be the only strategy in play. This next quote from McKinsey imputes the level of change that needs to be adopted within an organization. To benefit from value cells requires some major systems, organizational and people changes.
And that is what we have done in the eleven module People, Ideas & Objects
Draft Specification. Our motivation is to focus on innovation within the JOC. That is what the commodity prices are telling the producers, and providing the financial resources for, to innovate. As everyone generally agrees, the easy oil is gone and an earth science and engineering based capability is the new methodology of earning value in the oil and gas industry. As science and innovation come to influence each other, the speed of change will accelerate. The firms in the industry have lost the ability to keep up with the market demand for energy. Without the systems to support any organizational changes in place, we are relegated to manual systems or utter failure.
Using value cells to emphasize value management requires some obvious implementation challenges—creating better data, exerting pressure to collaborate, adopting incentives that reflect the value created per cell. The real change of culture and mind-set requires even more: instilling business managers with the feeling that the new process gives them more freedom and more resources for good ideas.
We also live in a time where the technologies, based on the People, Ideas & Objects
Technical Vision, will conspire to overwhelm the unprepared producer with information. Recall that Nobel Laureate Herbert Simon stated "a wealth of information creates a poverty of attention."
Focusing corporate and divisional decision processes on value and growth isn’t simple, particularly when the activities that create value are embedded in large divisions. Companies that adopt a finer-grained, granular approach can better identify and manage their value creating assets.
The performance of the oil and gas producers stock option compensation costs is the only thing spectacular coming from these firms. They have abused the trust of the investors and poorly prepared their firms for the changes brought about by the commodity prices. Potential retirement is liberating them from responsibility. The oil and gas industry has changed fundamentally? Someone should tell the management.
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