Langlois on Chandler Part I

We move on to a review of Professor Richard N. Langlois and his research's application to People, Ideas & Objects. Langlois' research has been in the areas of the boundaries of firms and markets, modularity, transaction cost economics, the division of labor, capabilities and his "vanishing hand" theories. These are areas that were important in developing the Draft Specification, and as I recently noted both Professor's Carlota Perez and Richard Langlois' research have been critical in the development of People, Ideas & Objects. This review will highlight some of the key areas of Professor Langlois' research, we'll also look at a number of his recent papers that we have not discussed before, and review in detail his slide presentation.

We recently completed a review of Professor Alfred D. Chandler, and what better document to start our review of Professor Langlois then a look at his 2004 essay "Chandler in a Larger Frame: Markets, Transaction Costs and Organizational Form in History". Langlois begins;

In 1977, when Alfred D. Chandler's pathbreaking book The Visible Hand appeared, the large, vertically integrated, "Chandlerian" corporation had dominated the organizational landscape for nearly a century. In some interpretations, possibly including Chandler's own, The Visible Hand and subsequent works constitute a triumphalist account of the rise of that organizational form: the large, vertically integrated firm arose and prospered because of its inherent superiority, in all times and places, to more decentralized, market-oriented production arrangement. A quarter century later, however, the Chandlerian firm no longer dominates the landscape. It is under siege from a panoply of decentralized and market-like forms that often resemble some of the "inferior" nineteenth-century structures that the managerial enterprise had replaced. p. 355

The decline of the bureaucracy is of course the other major economic initiative that People, Ideas & Objects builds off of. Yesterday in our final review of Professor Carlota Perez' paper we defined the scope of the problem facing People, Ideas & Objects and its associated communities as being within our grasp or remaining rather distant. It is these large economic changes, the decline of the Chandlerian corporation, the great surge expected from the deployment phase of the financial crisis, that make the seemingly impossible tasks that we face, possible. Add to these economic times the impact of the Information & Communications Technology Revolution (ICTR) and we see the scope of our ambition may not be that far-reaching after all.

Moving to the Joint Operating Committee as the key organizational construct of the innovative oil and gas producer. Is a necessity to deal with the expanding earth science and engineering effort represented in each barrel of oil equivalent. Using the JOC we take the common-sense approach of aligning the bureaucracies compliance and governance frameworks with the legal, financial, operational decision making, cultural and communication frameworks of the JOC. In a world dominated by the network model of organization, why would you not integrate these frameworks in this fashion.

Critical to the success of People, Ideas & Objects is the tacit knowledge held in the user communities and Community of Independent Service Providers. To enable this knowledge requires that it be accessible in more efficient means. Tacit knowledge can not be codified and is resident only within the people who work within the oil and gas industry. Networks and tacit knowledge need to be combined through a software development capability such as that considered by People, Ideas & Objects.

Much knowledge - including, importantly, much knowledge about production - is tacit and can be acquired only through a time-consuming process of learning by doing. Moreover, knowledge about production is often essentially distributed knowledge: that is to say, knowledge that is only mobilized in the context of carrying our a multi-person productive task, that is not possessed by any single agent, and that normally requires some sort of qualitative coordination - for example, through direction and command - for its efficient use. p. 359

In People, Ideas & Objects version of an innovative oil and gas producer. Acquisition of the necessary tacit knowledge is through the marketplace metaphor represented in the Resource Marketplace Module. Langlois also notes the critical nature of tacit knowledge as a competitive advantage.

In a world of tacit and distributed knowledge - that is, of differential capabilities - having the same blueprints as one competitors is unlikely to translate into having the same costs of production. Generally, in such a world, firms will not confront the same production costs for the same type of productive activity. Moreover, the costs that can make transacting difficult, and may lead to internalization, can go beyond those that arise in the course of safeguarding against opportunism or damping moral hazard through monitoring or incentive contracts. In such a world, economic activity may be afflicted with "dynamic transaction costs," the costs that arise in real time in the process of acquiring and coordinating productive knowledge. Members of one firm may quite literally not understand what another firm wants from them (for example, in supplier contracts) or is offering them (for example, in license contracts). In this setting, the costs of making contacts with potential partners, of educating potential licensees and franchisees, of teaching suppliers what it is one needs from them, and the like become very real factors determining where the boundaries between firms will emerge. pp. 359 - 360

I have extended this situation to include each participant of a JOC may effectively apply their own strategy to the assets. This strategy may not be known by any of its partners, and indeed, only in unique situations would each producer have the same assets in the region. For example, one producer may have surplus capacity in a near-by gas plant that is their key priority to optimize, whereas another may only have an interest in the producing gas wells.

To Langlois point about the tacit knowledge and the development of capabilities. One of the problems in oil and gas is that technical capabilities are developed within each bureaucracy to deal with any and all contingencies. With BP's current environmental PR efforts, we see that this containment within the bureaucracy is a failed application of capabilities. We need to also consider that the increase in scientific demands per barrel of oil requires more tacit knowledge from a constrained resource. The Draft Specification considers that these capabilities be dynamically generated through the service industry and the human resources of the working interest partners of the JOC. Only then will the future demand on these finite engineering and science based resources approach reasonable levels.

Our appeal should be based on these eight "Focused on" priorities and values of how better the oil and gas industry and its operations could be handled. They may not initially be the right way to go, but we are committed to working with the various communities to discover and ensure the right ones are. If your an enlightened producer, an oil and gas director, investor or shareholder, who would be interested in funding these software developments and communities, please follow our Funding Policies & Procedures, and our Hardware Policies & Procedures. If your a government that collects royalties from oil and gas producers, and are concerned about the accuracy of your royalty income, please review our Royalty Policies & Procedures and email me. And if your a potential user of this software, and possibly as a member of the Community of Independent Service Providers, please join us here.

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Perez, Crisis and Innovation Part VII

Today we complete our review of Professor Carlota Perez' February 2010 paper "The financial crisis and the future of innovation: A view of technical change with the aid of history." We continue to discuss the concept of the Small Knowledge Intensive Enterprises (SKIEs) and the implications that will be faced in implementing them in oil and gas. People, Ideas & Objects as a software developer is a member of the SKIEs and we are dealing with exactly these issues here today. That is money and where it will come from. I continue to look to the $3.5 trillion in annual oil and gas revenues as the primary source of funding of all the software development costs and financial resources for the Community of Independent Service Providers.

My experience in having funding sourced from investment capital or banking has been very negative. Talking to bankers and investment houses in the Calgary area; the topic turns very quickly to the revenues that will ultimately be sourced from the oil and gas firms. If we are working to secure the revenues from the oil and gas firms as the first task in getting funding from investment houses, then why would I need the investment house? Without the oil and gas management buy-in to the overall concept, these groups generally don't bite. Therefore, little time has been wasted in trying to generate any investment capital.

Banks understand two attributes of a start-up. One is the revenues that the firm generates. The other, in the case of People, Ideas & Objects, is the intangible nature of the assets in the firm. Intellectual Property without revenues doesn't get you in the door.

I would expect the same type of responses would be provided to any of the members of the CISP, or in Professor Perez' SKIEs. The key point to remember for this project, is that nothing will happen until such time as these communities are supported financially by the oil and gas investors / shareholders themselves. Therefore, that is what I spend my time writing about. This blog has substantial leverage in terms of the number of people who visit it daily. Our growth has averaged a remarkable 25% per quarter in the past year. This is the most effective way in which to appeal to those interested parties that may be capable of support.

Recognising intangible value

Professor Perez notes the difficulty in trying to raise capital for intangible assets. I disagree that this would bear any fruit. However, that has been my experience, yours as a member of the CISP might be different.

Naturally, the most vulnerable of all SKIEs and innovative companies are the start-ups. In the absence of venture capital, they are also the least likely to be able to obtain loans from banks, given the intangible nature of what they can usually offer as collateral. That is one of the reasons why individual “angels” and venture capital funds are the most appropriate providers of funds in those circumstances. They are often as knowledgeable as the innovators in the field of endeavour and can evaluate the likelihood of technological success and the capabilities of the project leaders. They can also complement the entrepreneurial capabilities and judge the market risk and the likely returns. p. 32

The fact of the matter is that without direct revenues being invested by the oil and gas producers themselves, no software and no supporting communities will develop. It is incumbent on these producers to make the investments and develop the capabilities that they will need. Otherwise we will continue to see management in complete control, sort of.

But policy innovations may be needed for stimulating venture capital and/or providing some other forms of direct or indirect support for innovators. p. 32

and

Whichever solutions prove to be practical, as knowledge capital becomes more prevalent, society will have to find a way of evaluating and recognising it. p. 33

Until such time as the oil and gas producers actively support this project and its communities no work will be done. Asking these communities to "put some skin in the game" is a ridiculous request. If the producers can't see any value now, then adding some volunteered time from the community will do nothing to help their focus. Let me repeat, the oil and gas industry is a $3.5 trillion / year industry. That is our initial source for funding, and as far as I'm concerned, the only viable source of funding.

Providing continuity of support along the life-cycle

It is important to keep our eye on the main point of this, up until now, exercise. It is about innovation in the oil and gas industry. An industry that is constrained by its bureaucracies. An industry who's product is the life-blood of the global economy and who's scientific demands per barrel of oil are escalating in a non-linear fashion. Having a handful of people contribute some volunteer time will not solve this problem. The scope of the problem can't be solved by some investment house or gracious banker. This needs the full and willing support of the oil and gas industry in order to be successful.

It is true that innovation requires patient capital; it is equally true that it needs continuity of support. Although it has been shown that the linear model of innovation is not valid, that the continuous flow from science to technology to engineering to innovation only holds in a few cases, there is indeed a sort of “linear model” from innovation to stable success. p. 33

And here is where I disagree with Professor Perez. Only the oil and gas industry will benefit from these direct investments in software, software development capabilities and supporting communities. Only the oil and gas industry with their $3.5 trillion annual revenue streams have the resources necessary to approach solving their problems.

However, since many research directions are uncertain and there can be serendipitous discoveries, it would be unwise to insist on a direct industry interest in all possible research projects. pp. 35 - 36

and

In finance, in particular, both the private and the public sector will need to modify or create new instruments in order to tailor them to the nature of the changing needs of innovators. Viewing networks as valid interlocutors, recognising and learning to assess intangible value, providing adequate and continuous life-cycle support and strengthening local R&D for present and future needs is in the national interest of each country and in that of the business community located on that territory. p. 37

So here we stand once again. Within grasp of solving this paradox, or another 100,000 miles to travel. Our appeal should be based on these eight "Focused on" priorities and values of how better the oil and gas industry and its operations could be handled. They may not initially be the right way to go, but we are committed to working with the various communities to discover and ensure the right ones are. If your an enlightened producer, an oil and gas director, investor or shareholder, who would be interested in funding these software developments and communities, please follow our Funding Policies & Procedures, and our Hardware Policies & Procedures. If your a government that collects royalties from oil and gas producers, and are concerned about the accuracy of your royalty income, please review our Royalty Policies & Procedures and email me. And if your a potential user of this software, and possibly as a member of the Community of Independent Service Providers, please join us here.

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Perez, Crisis and Innovation Part VI

In a number of previous posts we briefly discussed Professor Carlota Perez concept of the Small Knowledge Intensive Enterprises (SKIEs). How this concept captures the Community of Independent Service Providers that are critical to the success of the oil and gas producer and People, Ideas & Objects software developments. This post deals exclusively with the topic of SKIEs and therefore accurately details the problems that our communities face. Through out her writings Professor Perez has consistently argued the need for a different point of view. A point of view of how things need to be structured in order for the deployment phase to be realized. Whether that is realized through enhanced government or business involvement is unknown at this time. What is clear is that these problems are what we face in building this software and are unaddressed by the current bureaucracy.

My argument that the management in the industry has been overly critical of the service sector is also a part of this discussion. During the 2007 - 2008 period we heard management complain that service industry costs were escalating excessively. Some companies went as far as to state that the service providers were gouging their clients. This in an environment where the oil price was $147.00, whom was really getting greedy. In retrospect, I think that the majority of these cost increases are attributable to management's inability to see the increased effort per barrel of oil.

The other area that I would raise that is directly on point with Professor Perez' discussion. Is the fact that the energy producers collect 100% of the funds for the primary and secondary industries involved in oil and gas. This does not entitle them to hold these resources from the service industries when the times get difficult. Cutting back on field operations has consistently been damaging to the ability of the service industry to fulfill its supporting role. People have been unwilling to see the oil and gas industry as a steady employer. They also see it as a boom-bust cycle where the hours demanded are excessive and the boom cycles introduce inexperienced field personnel to dangerous situations. The oil and gas producer should analyse the damage that occurs as a result of their turning on and off the financial support for the service industry providers.

Another behavior of the oil and gas companies is the ostracizing of those with alternative ideas. I have proposed a common sense approach to resolving the issues I see in oil and gas. An approach that strikes directly at the heart of the bureaucracy and renders them redundant. I am surprised at the scope of the efforts that have aligned against me. As we move into a world of ideas it is important to remember that ideas have consequences. And those consequences are not necessarily positive for all concerned.

SKIEs, SMEs and networks

Today's discussion extends these well known behaviors of the oil and gas companies. And applies them on a pro-active basis based on the future demands of a dynamic and innovative oil and gas industry. I think much can be learned by Professor Perez research and her development of the SKIEs as a critical resource. I think this is an area where industry should take detailed notes.

In this first quotation it is important to note that People, Ideas & Objects assumes that the innovative oil and gas producer is concerned with their earth science and engineering capabilities. And these capabilities as they are directly applied to the producers asset base. The remainder of the functions that are currently handled by the firm and marketplace are moved substantially to the marketplace in the Draft Specification.

There are at least two major consequences of the fact that the global corporations and the large firms increasingly achieve flexibility and higher competitiveness by outsourcing a significant part of the peripheral and of the highly specialised (non-core) activities. This practice is bound to result in much greater proportions of (1) the working population receiving irregular incomes and (2) the part of the economy without a cushion to withstand downturns. These problems directly affect general economic policy and the social security model while they indirectly condition innovation policy. pp. 30 - 31

The bureaucracy might argue then that they will provide for the field operations themselves. That all aspects of the field operations can be conducted by their company. In 2007 this strategy was also employed by some of the larger companies by buying drilling rigs of their own. It should be clear to anyone outside of the bureaucracies that these types of operations are destined to fail. Eventually the company would need to conduct their own research in drill bit manufacturing as a result of the entire secondary support industries leaving the energy industry. What Professor Perez brings to the table is a discussion based on the reality that the future will involve many smaller companies, not more bigger companies.

A much higher proportion of small units in the economy, taking care of a greater share of employment as well as of profits and national product, will require similar stabilising instruments to those discussed above and possibly new insurance schemes tailored to those special needs. p. 31

When we discuss the dynamic capabilities of the oil and gas industry as a whole. We are talking about the intangible nature of the services that are provided. The oil and gas industry fully understands the intangible nature of the industry. Most if not all costs of drilling a well are intangible services or unrecoverable costs. The category of costs that this project is concerned about, the CISP and People, Ideas & Objects software development costs, are going to be added to the dynamic capabilities of the oil and gas industry. These costs, like those in the secondary industries, can not be turned on and off without serious degradation and long term damage to that capability.

With the exception of companies specialising in biotech or nanotech or special materials, which may need high precision equipment, the other high cost is usually also intangible. It is the specialised software and the information services that they need to acquire to perform their job. Not meeting any of those payments can mean losing irreplaceable personnel or cutting-off the lifeline services. p. 31

The use of People, Ideas & Objects software application are free to the user communities and particularly the CISP. This however does not eliminate the argument that the producer firm will need to support the software development and cloud computing infrastructure on a go forward basis. With annual costs ranging in the $600 million to $1 billion for development and infrastructure, and several billion for the CISP, these costs are beyond what the industry has otherwise been willing to expend. However, it should be noted that the oil and gas producers are collecting over $3.5 trillion in annual revenues on oil and gas sales.

Innovative firms suffer from that problem in various ways. Specialised suppliers of Global Corporations (GCs) are expected to constantly do minor improvements and sometimes more significant ones. It can be that the user company is a partner in the innovation and jointly funds it with the supplier (it can also be a group of users) or that the supplier takes the initiative and seeks the funds. There are also suppliers whose speciality is to do development work i.e. they are innovators under contract. All those cases and many other situations can involve periods of no receipts at all (depending on the funding or contract arrangements) and also the risk of unpredictable delays. Of course, SKIEs are high profit companies and under normal circumstances would have reserves for these situations. But new forms of insurance and running lines of credit will need to appear as the number of companies with these characteristics grows. pp. 31 - 32

Much of these costs may currently be hidden in the services that are provided by employees in oil and gas companies. Employees that in this very near future will be deemed not core to the producers capabilities and asset base. And therefore become active members of the CISP.

It might be interesting to look at the network as the possible route to solving many of these new (or intensified) needs of small companies. There is already a tendency of similar companies to flock together to gain advantages of scale for certain activities that can be funded jointly such as training courses, international marketing, specialised software development, etc. The idea of collective insurance of groups of companies –in a sector or in a region– or even networks of networks, in order to increase the volume and reduce the risk premium could be an adequate direction to explore. p. 32

Our appeal should be based on these eight "Focused on" priorities and values of how better the oil and gas industry and its operations could be handled. They may not initially be the right way to go, but we are committed to working with the various communities to discover and ensure the right ones are. If your an enlightened producer, an oil and gas director, investor or shareholder, who would be interested in funding these software developments and communities, please follow our Funding Policies & Procedures, and our Hardware Policies & Procedures. If your a government that collects royalties from oil and gas producers, and are concerned about the accuracy of your royalty income, please review our Royalty Policies & Procedures and email me. And if your a potential user of this software, and possibly as a member of the Community of Independent Service Providers, please join us here.

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Perez, Crisis and Innovation Part V

In this next installment of our review of Professor Carlota Perez' paper "The financial crisis and the future of innovation: A view of technical change with the aid of history". She paints a clear picture of where we're headed in terms of economic performance. And the financial situation as it stands at People, Ideas & Objects and associated communities. I recall that Milton Friedman once stated; "Only a crisis—actual or perceived—produces real change. When that crisis occurs, the actions that are taken depend on the ideas that are lying around. That, I believe, is our basic function: to develop alternatives to existing policies, to keep them alive and available until the politically impossible becomes politically inevitable."

People, Ideas & Objects have taken a good idea in using the Joint Operating Committee, developed it fully through application of academic research, and published a vision, the Draft Specification, of how the oil and gas industry could operate. When I look around for new ideas that might compete with People, Ideas & Objects I am unable to discover any. Since these are the only ideas that are being contemplated for the oil and gas industry I fully expect they will be taken-up by the industry. Otherwise, based on the financial crisis, our current debt crisis and the looming "capabilities crisis" in oil and gas, the industry will have to come up with its own ideas. The problem with doing so will be the time necessary to fully develop them and impart a vision in which people can rally around. This process took People, Ideas & Objects seven years to complete. We are at the point where the Draft Specification is almost two years old and the communities development has been undertaken since then. I don't believe the industry has the time to come up with its own ideas. They should therefore begin financially supporting People, Ideas & Objects and the Community of Independent Service Providers (CISP).

THE POLICY CHALLENGES: Taking the paradigm and the period transition into account

Professor Friedman's message is the same message that Professor Perez echos in this section of her paper. The presence of the beginning of the deployment phase is an opportunity that is available to anyone in oil and gas who wants to participate. Now is the time and People, Ideas & Objects is the opportunity.

Institutional restructuring is what would really unleash a healthy period of prosperity, fundamentally different from that of bubble times. Whether and how such a redesign is done on the national and supranational levels, the likelihood of a successful outcome is much greater if the debate is on the table from early on and if enough concrete and viable proposals and innovative solutions are there when the decision makers are ready to act. p. 25

The Joint Operating Committee is the industry standard means of operating in the global oil and gas industry. The geographical scope of the People, Ideas & Objects application modules will be determined by the CISP in their initial analysis. Producer firms representing specific geographical areas of interest should insure their participation in the CISP and People, Ideas & Objects is substantial enough to influence the scope decisions are made with those regions included. Waiting is unproductive.

Waiting is also unproductive for those people who want to participate in the CISP. Generating a service based offering at this time in many people's life is counter to the dreams of many. Retiring and living off of one's investments is clearly not going to happen to the majority of those working in the oil and gas industry today. It's here that Professor Perez picks up an interesting and valid point of what needs to happen in the deployment phase.

The motto of ‘don’t work for money, let money work for you’, so popular in recent time, needs to sound completely unrealistic in a world where economic policies, be they regulatory, fiscal, monetary or whatever, resolutely favour working for money –and making abundant profits– through innovation, investment and job creation in the real economy. p. 25

Things have changed, and that is represented in the volumes of debt that countries, companies and individuals are carrying. This debt was accumulated because the old ways were no longer working and carrying the weight of the economy. To keep the illusion rolling along therefore required that money needed to be borrowed. These are all symptoms of how these changes require us to look at the future differently.

The safest way to approach the financing of innovation in the deployment period is to assume that the instruments that worked in the installation period [1970 - 2000] may now be inadequate. p. 29

This discussion maps out a rather robust future. But we are not there yet. As our 2010 budget drive proved, the management in oil and gas will not fund these communities and software developments. These service based offerings are not going to form until there are the necessary resources to make these alternatives real. The investor / shareholder in oil and gas is being asked to fund the development of these communities and software developments. So that they, the investor / shareholder will have the infrastructure necessary to replace the current management and operate their assets in the most profitable manner.

The opportunities for innovation are manifold, both in existing companies and for new ones, if the potential installed in the territory (and in the minds) by ICTs and their organisational paradigm finds a favourable financial and regulatory atmosphere in which to flourish. p. 29

Of the things that we do know is that oil and gas is unique unto itself. No other industry is configured in the same fashion. To proceed with building the industries infrastructure requires that software be built to identify and support the Joint Operating Committee. This is a given in the advanced economies that we find ourselves in.

But innovating within a paradigm is much easier and less risky than doing so using the paradigm in another sector. This was learned by the venture capitalists in the 1990s when they tried to apply the same criteria and expectations to innovators in biotech as to those in ICT; both sides ended up frustrated and disappointed. pp. 29 - 30

Professor Perez introduced her SKIEs in our previous post. These accurately reflect the CISP in this discussion, and it is the CISP, as a subset of the SKIEs, that require the funding necessary to develop. If it is not the oil and gas investor or shareholder that supports these communities development, then whom. The bureaucracies have had the opportunity for the past seven years and have chosen to do nothing. Now these bureaucracies are beginning to fail, leaving the oil and gas shareholder / investor being the one who loses.

A large set of innovative opportunities is in the area of small knowledge intensive enterprises (SKIEs), where the intangible nature of the products and of the human capital involved presents complex issues for the traditional methods of the financial system. p. 30

The remainder of our review of this paper will focus on the development issues of the CISP and SKIEs. Our appeal should be based on these eight "Focused on" priorities and values of how better the oil and gas industry and its operations could be handled. They may not initially be the right way to go, but we are committed to working with the various communities to discover and ensure the right ones are. If your an enlightened producer, an oil and gas director, investor or shareholder, who would be interested in funding these software developments and communities, please follow our Funding Policies & Procedures, and our Hardware Policies & Procedures. If your a government that collects royalties from oil and gas producers, and are concerned about the accuracy of your royalty income, please review our Royalty Policies & Procedures and email me. And if your a potential user of this software, and possibly as a member of the Community of Independent Service Providers, please join us here.

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Our review of Alfred D. Chandler

We have now completed our review of the material of Professor Alfred D. Chandlers work. These posts can be aggregated by selecting the Chandler label. This review has provided us with some interesting breakthroughs and shown that we are on the right path to solving the issues we face in oil and gas. With this post I want to mark the completion of our review of the primary research. Summarize what we have learned, and indicate that this review of Chandler brings us back to Professor Richard N. Langlois. Much of the Draft Specification is based on the research that Professor Langlois has conducted. A quick review of Langlois' work will provide us with an understanding of many of the key differences in the Draft Specification. We will emphasize his work on the "Vanishing Hand" and review his presentation slides.

What did we learn that is directly applicable to People, Ideas & Objects and the Community of Independent Service Providers. Here are a few points;

• "Strategy follows Structure". Therefore by establishing the Joint Operating Committee as the key organizational construct of the innovative producer, strategy can be set for each unique asset.
  
• Schumpeter "Innovation drives economic development". For our global economy to grow, greater supply of energy is required. To meet this demand the energy producers must innovate.
  
• Professor William Lazonick "The optimizing firm is not an innovating firm, indeed it can be characterised as an un-innovating firm."
• The costs of innovation are an investment. However, the source of the funds to support innovation are from revenues not profits, equity or debt.
• Professor William Lazonick's "Social Conditions of Innovative Enterprise".
• Winter "To me the really powerful things in his story are path dependence and the organizational embededness of competencies and capabilities".
• Velocity, or "organizational speed" enabled size. Size does not necessarily enable speed. 
• Capital Started everything. Chandler's review of corporate history shows the role of the merchants. Investing their capital and skills, merchants were the ones that started the ball rolling.
  
• Management have no stake in the firm. If a crisis were to strike a firm, the management would resume elsewhere. It is the investor and debt holders who will shoulder the costs.
  
• Management currently hold the reigns, and are mindful that their options may lay elsewhere. Ownership, in the same fashion as the Merchants needs to start over. Starting over begins with supporting People, Ideas & Objects and the Community of Independent Service Providers.
• Chandler noted that management have failed before. During the great depression, a time when government had to increase its involvement in the economy. Management may not see the more global picture, and therefore, may fail again.
  

Our appeal should be based on these eight "Focused on" priorities and values of how better the oil and gas industry and its operations could be handled. They may not initially be the right way to go, but we are committed to working with the various communities to discover and ensure the right ones are. If your an enlightened producer, an oil and gas director, investor or shareholder, who would be interested in funding these software developments and communities, please follow our Funding Policies & Procedures, and our Hardware Policies & Procedures. If your a government that collects royalties from oil and gas producers, and are concerned about the accuracy of your royalty income, please review our Royalty Policies & Procedures and email me. And if your a potential user of this software, and possibly as a member of the Community of Independent Service Providers, please join us here.

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Perez, Crisis and Innovation Part IV

What is particularly interesting about Professor Carlota Perez' new paper "The Financial Crisis and the Future of Innovation: A view of technical change with the aid of history." Is her description of Small Knowledge Intensive Enterprises (SKIEs). In almost all respects they are the same as People, Ideas & Objects Community of Independent Service Providers (CISP). This post introduces Perez' SKIEs and we will also discuss them more extensively in a future post.

Due to the escalating efforts in the earth science and engineering contained within each barrel of oil. People, Ideas & Objects suggest the bureaucracies are too constrained to maintain their reserves and production profiles over the long term. We see symptoms of these in Encana's $5.5 billion loss, Shell's escalating costs and BP's inability to control their well in the Gulf of Mexico. Why are these incidents happening? The demands for energy, and the scientific demands of energy are beyond the strategies and capabilities of the bureaucracies. Shell recently noted their reorganization, that took several years, was recently completed. So why then have they lost control of their costs?

People, Ideas & Objects Draft Specification enables the producer firm to concentrate on the strategic needs of their asset base, at the Joint Operating Committee level, and their scientific and engineering capabilities. The producer firm is augmented by the marketplaces that support the innovative producer. The market includes the service industries and of particular interest to People, Ideas & Objects the Community of Independent Service Providers. These various communities are involved in providing many products and services that may have traditionally been done internally at the producer firm. This redrawing the boundaries of the firm is to enable the innovation in the earth science and engineering disciplines within the producer firm. And the communities to innovate in their area of expertise. Professor Perez notes;

A basic principle applied by corporations when disaggregating all their activities into separable components is distinguishing between core competences and complementary ones. The guiding idea is that the core competences are what gives the strength and the competitive edge as well as the long-term value to the company, while the other activities can in principle be outsourced without jeopardising the future. Yet, this notion of outsourcing is not about separating innovating activities from non-innovating ones. On the contrary, it is about deciding who will innovate in each area. p. 17

The net objective of defining the boundaries of the market and firm in this manner. Is that the individual Joint Operating Committee's, with their own unique strategies, are able to achieve higher throughput and innovation. Maximizing the reserves in place and optimizing their production.

The final result is that the whole network becomes an innovating machine with each part maximising its contribution and improving the whole at a much faster rate. p. 18

In this next quotation Professor Perez introduces her concept of the SKIESs. I find nothing in her definition that does not directly apply to the CISP. They are one and the same, and I assume that I was reading some previous paper of Professor Perez where the concept was developed. The only thing that I would add to her definition is that the CISP is a community that is focused on defining, building and deploying the People, Ideas & Objects application modules within the producer firms. They are dedicated to optimizing the profitable performance of the producer by using the development team and Information Technology resources made available to them. And would be considered a subset community of the greater number of communities within the definition of SKIEs

This practice of global corporations has very important consequences for the fabric of the economy. It induces the proliferation of small knowledge intensive enterprises (SKIEs) which are active innovators at the same time as they serve as a sort of technical infrastructure for attracting further user investment. The denser the fabric of SKIEs in an economy the greater will be the externalities for growth and competitiveness of the user firms. In addition, SKIEs themselves, in whatever field, are typically intense users of ICT services and of highly skilled human capital. They are also natural networkers with universities and other sources of information within and outside the country of operation. Finally, they are likely to participate in export markets, either through global corporations for whom they are suppliers or through their own efforts. That makes them key actors in the deployment of the knowledge society in each country. p. 18

It should be noted that I see many of the current producer firms employees forming SKIE's and CISP in the future. If you are an engineer or an earth scientiest I think it is fairly reasonable to assume that the producer will remain your primary employer. If you are not in those primary areas of the producer's domain of concern, employment in a SKIE or CISP is more likely. It should be clearly stated at this point that I don't see many of the CISP's being much larger then 5 to 25 people in total. Very specialized groups that are able to cater to the needs of a small hand full of producer clients. Professor Perez also sees these SKIEs as a subset of the Small and Medium sized Enterprises (SMEs).

A major consequence of this is a radical redefinition of the role of SMEs. Without ignoring the importance of the traditional small and medium firms, it would seem that the treatment of SKIEs and the catering to their support requirements, being fundamentally different from those of SMEs, will demand a different set of policies. p. 18

As we will see in a future posting, Professor Perez notes that the SKIEs need to be built in a dedicated fashion. Expecting them to spontaneously exist is dreaming. These capabilities have to be purposely set about to develop, much as People, Ideas & Objects software development capabilities, and sustained for the long term.

There is however a whole range of business-model and organisational innovations to be fostered in these sorts of services, the importance of which becomes greater the more advanced the economy. That is because they are stable employment creators (face-to-face services cannot be off-shored) and because they are possibly those that would most directly influence the quality of life in any particular locality. pp. 19 - 20

I would suspect that bureaucracies are now fully distracted by their escalating costs and flowing wells. The development of these communities and capabilities would therefore fall to the investor and shareholder in oil and gas who are expected to also support People, Ideas & Objects. BP's stock is down 15% and I would question their likely hood of being granted any future offshore leases in the U.S. With the precedent of the Exxon Valdez, this may cause serious damage to the firm. Such that the investor / shareholder might be the ultimate loser in this operational nightmare.

Thus, the hyper segmentation of markets, technologies and activities, is giving rise to an emphasis on the small business unit, be it as a direct part of a Global Corporation, as an independent or semi-independent supplier, as a start-up that can some day become a giant, as a franchisee, a member of a specialised cluster, a local provider of services or an independent expert unit in interaction with other global players in that particular niche. This not only implies giving particular importance to fulfilling the needs of SME innovation but truly paying particular attention to the different types of small companies and their specific requirements. This is part of what will be discussed in the final section. p. 20

Our appeal should be based on these eight "Focused on" priorities and values of how better the oil and gas industry and its operations could be handled. They may not initially be the right way to go, but we are committed to working with the various communities to discover and ensure the right ones are. If your an enlightened producer, an oil and gas director, investor or shareholder, who would be interested in funding these software developments and communities, please follow our Funding Policies & Procedures, and our Hardware Policies & Procedures. If your a government that collects royalties from oil and gas producers, and are concerned about the accuracy of your royalty income, please review our Royalty Policies & Procedures and email me. And if your a potential user of this software, and possibly as a member of the Community of Independent Service Providers, please join us here.

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Perez, Crisis and Innovation Part III

Continuing on with our review of Professor Carlota Perez new paper "The Financial Crisis and the Future of Innovation: A view of technical change with the aid of history". We begin to focus on the value of human capital in future organizations. The need to address the organizational structure and build systems to identify and support the Joint Operating Committee is due to a variety of issues developing in oil and gas. People, Ideas & Objects have asserted that the earth science and engineering effort per barrel of oil is escalating, and the current bureaucracies are unable to deal with the speed and the demands of the marketplace. Today the issue is evident in this BBC quotation regarding Royal Dutch Shell's 2010 first quarter earnings. "The average cost of a barrel of oil for the first three months of the year was $76. That compares with an average price of $41 a year ago." If Shell's costs have escalated 85% over one year, we are moving into our own crisis in oil and gas.

What is clear in the Shell report is that what they are doing is not working. If the trend in their costs continues and the prices remain stable, they will be losing substantial shareholder value. This is the reason that they were recently downgraded and stated in their report they were cutting staff. "Those poor results prompted Shell to announce plans to cut 2,000 jobs before the end of 2010, helping to cut a planned $1bn in costs." Essentially blaming the issue on staff shows the value of human capital is possibly lost on Shell's bureaucracy.

People, Ideas & Objects are user focused software developments. We value networked users in defining and developing the software defined in the Draft Specification. The value of human capital is also reflected in what we call the Community of Independent Service Providers (CISP). And these apply to all producers involved in oil and gas. That includes International Oil Companies (IOC's), National Oil Companies (NOC's), Independents and start-ups. Essentially any producer that uses the industry standard Joint Operating Committee. Professor Perez notes:

...but also that networks are the more adequate organisational structure to take advantage of the ICT technologies. Giant organisations –through the mediation of Internet– can now grow much larger than before but as relatively flat networks gaining all the flexibility and agility of small companies; small organisations in turn can gain the advantages of scale by joining with others to form dynamic networks. p. 12

Networks are one thing, having the software that ties together the human capital is necessary to bring the value to producers like Shell. That will only come when a software development capability as contemplated by People, Ideas & Objects is available to all producers.

Another major transformation is the new value placed on intangibles and human capital. Whereas in the previous four surges technology was usually embodied in tangible equipment or manufactured products, the area of intangible products, from services to information itself is now an increasing part of value added, of investment and naturally of innovation. The fact that the notion of human capital is replacing that of human resources is itself a signal of the deep change that has already occurred and is likely to intensify in the Deployment period. p. 12

What Professor Perez is noting here is that the changes that are occurring in the marketplaces are not part of the same old economy. Things have changed and the old approaches are not working. What is needed is a decidedly aggressive move to rebuild the industry, literally brick-by-brick and stick-by-stick around People, Ideas & Objects and the CISP's use of the Joint Operating Committee. The other solution is that Shell begins to sell unprofitable properties to groups of investors who see how the assets could be turned around. Investors that have answered the call to action and built the People, Ideas & Objects software application modules.

Thus, when there is a massive change in the prevailing technologies, there is an associated transformation not only in production and consumption patterns but also in the forms of organisation and competition, in the structure of markets and in the way the fabric of the economy is woven. p. 13

The fact of the matter is that it is Shell's management that needs to make the choice. Do they fund this software development, or begin handing over the assets to the shareholder groups in as little as a year. Our appeal should be based on these eight "Focused on" priorities and values of how better the oil and gas industry and its operations could be handled. They may not initially be the right way to go, but we are committed to working with the various communities to discover and ensure the right ones are. If your an enlightened producer, an oil and gas director, investor or shareholder, who would be interested in funding these software developments and communities, please follow our Funding Policies & Procedures, and our Hardware Policies & Procedures. If your a government that collects royalties from oil and gas producers, and are concerned about the accuracy of your royalty income, please review our Royalty Policies & Procedures and email me. And if your a potential user of this software, and possibly as a member of the Community of Independent Service Providers, please join us here.

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McKinsey Conversation with Andrew Gould

Just a quick post today to highlight a McKinsey "conversation with global leaders" Mr. Andrew Gould CEO of oil field supply firm Schlumberger. Of particular interest to me was his discussion of his Research & Development efforts. (Note his M & A groups appear to be part of his R & D.)

We’ve had a separate M&A group. And the M&A group has two functions. The first is normal M&A. But the second is it has a group of technologists within it who just spend their time identifying and following up on small companies. And actually, we have, for the last four or five years, been making step investments into technologies that we think are interesting.

Interesting from the point of view that the head of the largest oil field supply firm is actively acquiring technology groups. This signals to me that the movement to a more innovative footing across the industry is beginning to develop. Add to that this next quotation regarding the complexity shows the opportunity for Schlumberger is clearly identified.

I think that projects are going to get bigger and they’re going to get more complex. They also, to a certain extent, are becoming more remote. In other words, when you see people starting to drill offshore in Greenland, or offshore in New Zealand for that matter, then the remoteness and the logistical complexity and cost of those projects are such that I think the traditional model of procuring each individual service from different vendors and then doing all the integration oneself is going to diminish.

The point of course is that the opportunity for firms, groups and communities of all types in oil and gas are as strong as they ever have been. I have talked about the performance of Agile / Scrum software development teams. As Agile developers we expect to develop software at approximately 500% of the traditional software development methodologies. Schlumberger is experiencing similar performance metrics.

So in China, funnily enough, at the moment our big research-and-development investment is in software. We decided we were too late to go to India. So we built a lab, which is on the campus of Tsinghua University in Beijing. So we basically hire from the two universities, Beijing and Tsinghua. And it’s now at 350 people. The average age is probably about 30. And the creativity and the productivity, the level of productivity, of that lab is incredible. It’s scary. It really is scary.

I mean, we took a program from the US, which was going really badly, and gave it to Beijing. And Beijing’s first reaction was, “You’re trying to kill us, huh? You’re trying to kill this lab.” Then they buckled down and they did it. I mean, it was extraordinary.

and

And I’m afraid it’s something that the West has, you know, not lost, but we better wake up.

Our appeal should be based on these eight "Focused on" priorities and values of how better the oil and gas industry and its operations could be handled. They may not initially be the right way to go, but we are committed to working with the various communities to discover and ensure the right ones are. If your an enlightened producer, an oil and gas director, investor or shareholder, who would be interested in funding these software developments and communities, please follow our Funding Policies & Procedures, and our Hardware Policies & Procedures. If your a government that collects royalties from oil and gas producers, and are concerned about the accuracy of your royalty income, please review our Royalty Policies & Procedures and email me. And if your a potential user of this software, and possibly as a member of the Community of Independent Service Providers, please join us here.

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Perez, Crisis and Innovation Part II

People, Ideas & Objects is about developing software that identifies and supports the energy industries standard Joint Operating Committee (JOC). The purpose in developing this software is to create the ways and means for the oil and gas producer to facilitate innovation in the expanding earth science and engineering disciplines. We are not about the latest version of Oracle's impressive database or some other technology. That is Oracle's business and we will implement these technologies in our software offering in innovative ways. The technology is not the critical element. We don't see significant levels of innovation being generated in the technology itself, they are mature and are not critical to the producers innovation. The innovation we are seeking is in the organizational methods that identify and support iterative development of the earth science and engineering capabilities of the producer firms and markets.

Installation and Deployment: different drivers of innovation

This difference between innovating on the Information Technologies and innovation in the producer firms is an important clarification of what we are doing. What I had not fully realized until reading Professor Carlota Perez' February 2010 paper is the clear distinction between the two types of innovation in the Information Technology & Communications Revolution (ICTR). With the two major phases of each "great surge of development" the "Installation Period" and the "Deployment Period", bring about two distinct types of innovation in the marketplace. Professor Perez notes;

Distinguishing between innovation in the core new industries themselves and in the industries or activities that apply the new technologies to innovate is important for understanding the main differences between Installation and Deployment as regards the rhythm and direction of technical change. p. 8

That we are innovating in "the industries or activities that apply the new technologies to innovate" is proof that we are in the deployment phase. This deployment phase is what Professor Perez compares to other golden ages and calls the "Sustainable global knowledge-society". A time when IT applied to traditional industries brings about the value creating activities that will sustain the globalized economy. Professor Perez contrasts the two periods.

The high and growing valuations of telecom and Internet-related companies during the NASDAQ bubble facilitated the completion of a global fibre optic network that has become the foundation of the globalisation process. p. 8

and

The deployment period is the time when the modernised companies across all sectors innovate using the power of the technologies of the revolution and of the new –by then, established– paradigm. It is a time of expansion, extension and multiplication of possibilities in the whole spectrum; it is also a time for social innovation in order to spread more widely across society the benefits of the vast wealth creating potential. p. 9

We have always considered, since the Preliminary Research Report, that high energy prices are the reallocation of the financial resources towards innovation. The investments in innovation by the oil and gas producers are not to be made through debt or equity or earnings but through the allocation of revenues to the appropriate areas. This reflects the high costs of innovation and the need to build capabilities within the producer firm and marketplace. Of note People, Ideas & Objects have developed a new classification of oil and gas workers that we call the Community of Independent Service Providers (CISP). These people are the critical resources that provide People, Ideas & Objects with the direction of our software developments. They are the ones that anticipate the needs of the producer firms they represent, and work with our developers to build the tools needed to support the user communities involved in oil and gas. It is the revenues of the producers that will go toward development of the capabilities within the producer firms, markets, the CISP and these software developments.

In sum, there is a changing of the innovation guard with the Turning Point. During Installation the innovation drivers are the new technological entrepreneurs and the financiers while the State has a service and facilitating role with a laissez faire attitude. During Deployment, the State comes back actively and serves as innovation driver together with production capital, which takes the helm of investment while financial capital serves as support. p. 9

I read "production capital" as the reallocation of the oil and gas revenues to the service industries to support the producers innovations. These are predominately service based businesses that provide a supporting role to the producers. "Production capital" denotes somewhat of an investment, whereas I see a long term relationship between the producers, their markets and communities. This restructuring of the oil and gas industry does not provide those, producers or otherwise, that may have invested "production capital" with any return. The continued expectation that the oil and gas industry will become innovative by the service industries investments and developments of technologies is fool-hardy. It may be debated whether that expectation is fool-hardy or not, but I can assure you that it is ridiculous when it is considered the oil and gas producers generate the entire revenue base of the producers, markets, service industry, CISP and People, Ideas & Objects. Continually squeezing the service industries for more has as much to do with the failure of the bureaucracies that control these financial flows, as the need for real reform in this area. I see the producers themselves spending this "production capital" on these markets and communities to support their own capabilities. Professor Perez has much more to say on this point later in this paper. We will revisit this point at that time.

The other process typical of the aftermath of technology bubbles that was already taking place during the second boom is the restructuring of one industry after another and the definition of new boundaries through mergers and acquisitions. p. 11

These changes in the industry structure underlay the revised focus on the demand for energy.

As will be discussed below, though, the hyper-segmentation of markets and the flexibility of ICT is likely to change the way of defining industries and the markets in which they compete, in order to focus on the demand sectors rather than on the supply ones. p. 11

If we are looking at this deployment period lasting another thirty years, re-structuring of the industry in some fashion to deal with these issues is necessary. And as I have noted in each of these posts, we will work with the producers and communities to determine which methods are the right ones and build the software on that basis. Professor Perez notes that these are consistent with the history she has studied.

Such sectoral redefinitions have occurred with every paradigm shift and the trace is kept –with delay– in the changes of statistical categories across history. Since such changes take time and occur as a result of trial and error strategies and competition, they can only be recognized in the statistics when they have already become the norm in practice. But being alert to these processes is crucial both for companies and for governments, because they provide important signals for innovation and growth paths. p. 11

and

But with Deployment comes a fundamental shift of focus. Rather than looking at the potential of technologies, the focus switches to the opportunities defined by markets and by growth possibilities. p. 11

Our appeal should be based on these eight "Focused on" priorities and values of how better the oil and gas industry and its operations could be handled. They may not initially be the right way to go, but we are committed to working with the various communities to discover and ensure the right ones are. If your an enlightened producer, an oil and gas director, investor or shareholder, who would be interested in funding these software developments and communities, please follow our Funding Policies & Procedures, and our Hardware Policies & Procedures. If your a government that collects royalties from oil and gas producers, and are concerned about the accuracy of your royalty income, please review our Royalty Policies & Procedures and email me. And if your a potential user of this software, and possibly as a member of the Community of Independent Service Providers, please join us here.

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Perez, Crisis and Innovation Part I

We begin our review of Professor Carlota Perez new paper "The Financial Crisis and Innovation: A view of technical change with the aid of history". I would find it difficult to choose whom has had a greater influence on People, Ideas & Objects, Professor Carlota Perez or Professor Richard Langlois. Professor Langlois has helped to define the Draft Specification with his research in Modularity, Boundaries of the Firm, Transaction Cost Economics and his "Vanishing Hand". Whereas Professor Perez has established the context of the economic times that we find ourselves in. Particularly what we can expect as a result of the Information & Communications Technology Revolution (ICTR). I am grateful for both of their work.

This February 2010 paper of Professor Perez' is quite probably the most important, critical and timely paper we could ever review. There are many new and valuable findings within the document and it is of particular value to what we at People, Ideas & Objects call our Community of Independent Service Providers. We will be reviewing this paper in detail in several parts, today being a fresh look at some of her past work.

Professor Perez begins with a summary that sets the tone for the document. Emphasis is mine.

This essay locates the current financial crisis and its consequences in a historical context. It briefly outlines the difference in patterns of innovation between the first two or three decades of each technological revolution –regularly ending in a major financial collapse– and the next two or three decades of diffusion, until maturity is reached. With this historical experience in mind, the essay discusses the opportunity space for innovation across the production spectrum taking into account the specificity of the Information and Communications Technology (ICT) paradigm and the increasing social and environmental pressures in the context of a global economy. Finally, there is a brief look at the sorts of institutional innovations that would be required to provide adequate finance to take full advantage of those opportunities. p. 2

There has been much we have reviewed of Professor Perez' work. This next quotation appears new to me, however, it is so obvious now that I think she needed to state it clearly for us to fully appreciate our situation.

Nevertheless, globalisation is a fact and the new emerging economies will change the shape of the world to come. p. 3

From an oil and gas perspective, our focus on demand is justified. The volume of supply of oil and gas will be a constraint to the global economy. The demand for innovation from the oil and gas producer will reach significant proportions. Operating within the global economy will also bring the full scope of the political, geographical, logistical and science based issues to the forefront of everyone in the industry. Organizing for this purpose is what we have been writing about, and preparing the communities for, at People, Ideas & Objects.

In the past I have shied away from the discussion of political points of view with respect to Professor Perez' work. I am a free market kind of guy and her views on the role of government in solving the economic problems have caused me difficulty. I think however, that I have been incorrect in not attributing the role of government to moving away from the casino atmosphere of financial capital, and the need for production capital to take the lead. This paper clearly states her values and the need for this transition to be aided by the role of government. The partisan nature of the discussion in the U.S. however, I think needs to adopt more of the attitudes and thinking of Professor Perez.

The other consequence of the bust, which could in some sense be defined as ‘positive’, is that by revealing all the crooked ways of the financial world during the boom, it has broken the myth of an ideal ‘free market’ and brought back the State into an active role in the economy. Such a come back is not limited to restraining the abuses of finance but extends to favouring the expansion of production and job creating activities over speculation and to spreading the benefits of growth more widely across society. p. 3

I highly recommend that everyone download this paper and print it out in hard copy. It is something that will be valuable as a frequent reference over the next number of years. Professor Perez' work has substantial value to anyone and everyone that will live in this globalized economy, this paper summarizes her work in a very substantial way.

To highlight the review of her theories and terminology I include the following definitions that frame our economic times. [Time frame]

This is the Installation period, [approximately 1971 - 2000] which begins in the midst of a mature economy in decline and ends with a frenzied prosperity characterised by the triumph of the new paradigm, the emergence of new giants and the development and collapse of a major financial bubble. p. 6

The second period brings to fruition all the potential opened up by the new technologies. It is the Deployment period [current to 2040?] when the new production giants serve as engines of growth. It is a time of ‘creative construction’ involving the expansion of both the new and the rejuvenated sectors and usually spreading the benefits of growth much more widely than during Installation. Production capital is then at the helm of investment decisions and finance adapts (or is induced to adapt) to serve those longer-term objectives and benefits from them. p. 6

The years between the bust and the unleashing of Deployment (from two years to as much as thirteen, as was the case in the 1930s) [2000 to current] constitute the Turning Point, referring to the shift in conditions and leading role from one period to the other. p. 7

In a previous post I quoted Professor Ralph Raico who stated the following about Professor Ludwig von Mises.

Back in the early 1700's there were slums, people were poor, people died, every possible plague. Mises says you cannot understand the industrial revolution without understanding the western world was undergoing an un-precedented population explosion. For example, England in 1750 had a population of about 6 million; by 1850 the population was 24 million. The question was how would these new tens and tens of millions of people survive? Mises said the industrial revolution was the answer to the population explosion. That's how they survived, by society becoming immensely more productive.

The industrial revolution was the solution to the population explosion and issues of the day. We now stand at a point in time where the benefits of the Information & Communication Technology Revolution are available to solve the problems that we face today. With the research of Professor Perez we can see clearly that now is the beginning of this trend, and the only thing that is stopping us is ourselves. From her paper.

In 2009 the world is going through the Turning Point and deciding the global and national context for the full Deployment of the ICT surge. Understanding the nature and direction of the changes required is a crucial input for designing institutional and policy innovation and increases the probability of taking best advantage of the new wealth creating potential of the new paradigm. p. 7

Our appeal should be based on these eight "Focused on" priorities and values of how better the oil and gas industry and its operations could be handled. They may not initially be the right way to go, but we are committed to working with the various communities to discover and ensure the right ones are. If your an enlightened producer, an oil and gas director, investor or shareholder, who would be interested in funding these software developments and communities, please follow our Funding Policies & Procedures, and our Hardware Policies & Procedures. If your a government that collects royalties from oil and gas producers, and are concerned about the accuracy of your royalty income, please review our Royalty Policies & Procedures and email me. And if your a potential user of this software, and possibly as a member of the Community of Independent Service Providers, please join us here.

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Encana's Form of Corporate Socialism

This past week we saw a number of 2009 annual reports being published. The majority of them reflecting the difficulty in the oil and gas business during the "great recession". One particular company, Encana Corporation caught my attention. There are a family of 800 pound Gorilla's in their report, one issue stands above the rest, which ties into a paper that I recently read. The paper is written by Professor David Bardolet of Bocconi University, Professor Dan Lovallo of the University of Sydney, and Professor Richard Rummelt of UCLA. The paper is entitled "The Hand of Corporate Management in Capital Allocations: patterns of investment in multi- and single- business firms." This is another paper from the April 2010 edition of the Oxford Journal of Industrial and Corporate Change .

So why does Encana get singled out for this special treatment? Simply this issue needs to be addressed, and they did everything they could to avoid addressing it. Looking at the report their is no discussion of this issue in the message from the CEO. There is no discussion of the issue in the Management Discussion and Analysis. Only in the notes to the financial statements will the issue be brought up, and none of the press releases reflect the point.

The issue is that for U.S. Generally Accepted Accounting Principles (GAAP) their is a $14.6 billion write down of the assets. This creates a $5.5 billion loss for all of 2009. However, as a Canadian company they have the option to report under Canadian GAAP rules and these show a profit of $1.862 billion. Just a small variance. Those that understand accounting for oil and gas will appreciate the ceiling test under Full Cost accounting. Both countries apply the same general principles for the ceiling test, the U.S. system has fewer exceptions and that is the cause of the $14.6 billion difference. What the management don't seem to realize is they will need to be explaining this anomaly in their reporting until such time as the timing differences in the Canadian reporting system expire. That could be as little as one year, or as much as the natural life of the firm, who knows, apparently not the management.

Reviewing the other Canadian firms that may report similar differences in the timing of their ceiling test write downs. I found no other material anomalies between Canada and U.S. reporting. So why has Encana been affected so materially whereas their peers have no such effect? Is it because they are "un-conventional" gas producers? Is there something inherently different in that classification that would cause these write-downs? We'll never know. As the management, led by the CEO, have taken the opportunity to be completely silent as to the anomaly. Why not take this as a teaching moment to inform and educate your investors as to why their assets have been impaired? Management doesn't think that way. They prefer to cower in the corner hoping that no one notices.

Encana defines it's strategy as a "low cost, margin maximizing natural gas producer". Whatever that means. The point of this post, and the branding of Encana as a form of corporate socialism, is based on the one size fits all strategy of this large bureaucracy. I will assert that the write down of $14.6 billion of its assets is a major hit to the firm. One that places them in the position of having to seriously address their asset base. An asset base where  its natural gas production declined by 3%. If "non-conventional" gas is such a lucrative and valuable business model, why are the reserve valuations and production in such decline. From the paper.

One possibility is that our study of “averages” misses the blockbusters. That is, multi-business firms might subsidize CNU businesses because, once in a while, one of them really takes off. We cannot completely discount this possibility or measure precisely the extent of this phenomenon. However, our study of the dynamics of these segments in Section VI suggests that multi-business firms are really not that successful in finding and nurturing these blockbusters. p. 19

By using the Joint Operating Committee as the key organizational construct, strategy can be set at the asset level. If the "low cost, margin maximizing natural gas producer" strategy doesn't fit the asset, a more appropriate one can be set for that asset. This assumes that we build the Draft Specification for the innovative oil and gas producer. Enabling them to manage their assets in that fashion. The use of generic global strategies is what firms did in the twentieth century, not today.

Our results are roughly consistent with the account of “corporate socialism” developed in the corporate finance literature. Some of the work in this line (e.g. Wulf, 1999; Rajan et al., 2000; Scharfstein and Stein, 2000) stresses the agency conflict between division managers and corporate headquarters. Division managers are portrayed as rent-seeking agents that try to obtain additional compensation (in the form of extra capital allocations, among others) from corporate headquarters. They try to do so by overstating their divisions’ prospects or by engaging in direct lobbying. In turn, corporate headquarters might decide that avoiding this inefficiency in resource allocation is not worth the cost of increased monitoring or low morale and thus accede to their demands. In particular, Scharfstein and Stein (2000) make the point that managers from weaker divisions have a stronger incentive to engage in firm politics given that their demands for capital investment cannot be argued so effectively solely on the base of a prospect’s quality. Therefore, those managers end up receiving more investment capital than they should and that creates the comparative difference with their stand-alone peers in the same industry.

The corporate socialism argument rests on a complex set of relationships among various agents within the corporation. A simpler theory is offered by the literature on cognitive biases. In particular, the allocations observed in this study can be explained as a consequence of behaviors called “naive diversification” and “partition dependence”. Naive diversification (Benartzi and Thaler, 2001)—also known as the “1/n heuristic”—is the tendency for individuals to be biased toward even allocations. p. 19

Just to be clear the authors point out that this applies to oil and gas as much as it does any other business.

Partition dependence is a consequence of naive diversification when the decision-maker faces a particular partition of the set of choices. In the case of capital allocations, this partition of choices would be the organization of the business units within the company. p. 19

And here the authors make it abundantly clear how these decisions are made.

Naive diversification and partition dependence are well-observed phenomena in other fields of human decision-making. For example, Benartzi and Thaler (2001) found a similar effect in both laboratory and field data studies of investment in 401(k) plans. When asked to choose between investing in a stock or bond fund, many individuals choose to invest 50% in each. When asked to choose between two stock funds and a bond fund, many individuals choose to spread allocations equally among the three funds, which creates an aggregate investment that is more heavily weighted (2/3) to stocks. Bardolet et al. (2009) found strong naive diversification and partition dependence effects in managers facing hypothetical capital allocation tasks. The naive diversification account applied to internal capital markets would predict a tendency toward equal allocation among all the business units in a firm, thus underweighting factors that would demand more uneven allocations (such as growth rates, profitability, etc). The experimental character of Bardolet, Fox and Lovallo’s study shows that even in situations where social and political factors are not in play (i.e. a laboratory environment) those two biases are enough to cause a tendency toward even capital allocations among all business units, thus corporate socialism is a sufficient but not necessary explanation of inefficient allocations. pp. 19 - 20

What I am asserting is that the capital allocations at Encana fall within the corporate socialism phenomenon. This has led to bad capital allocation decisions being made across the organization. Either too much capital was used in the development of the reserves, or the capital spent did not develop enough reserves to support the costs. Now those chickens have come home to roost in that the capital costs are too high to support the reserves held, forcing the write down. Those familiar with the nuances of the Full Cost ceiling test will realize the material nature of Encana's problem.

Further research on the anomalies we have identified seems warranted. In particular, it seems worthwhile to try to identify the relative importance of incentives, inertia, and biases towards even allocations in driving this result. One step in this direction would be a study which included data on corporate incentive mechanisms and changes in administration. p. 20

If they wanted to study Encana, one should also study the cognitive bias towards promoting pretty young blonde's to executive vice-president positions. Our appeal should be based on these eight "Focused on" priorities and values of how better the oil and gas industry and its operations could be handled. They may not initially be the right way to go, but we are committed to working with the various communities to discover and ensure the right ones are. If your an enlightened producer, an oil and gas director, investor or shareholder, who would be interested in funding these software developments and communities, please follow our Funding Policies & Procedures, and our Hardware Policies & Procedures. If your a government that collects royalties from oil and gas producers, and are concerned about the accuracy of your royalty income, please review our Royalty Policies & Procedures and email me. And if your a potential user of this software, and possibly as a member of the Community of Independent Service Providers, please join us here.

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