Aggressive cost-cutting can backfire

BILL ADAMS, SC&H GROUP

TODAY'S OIL AND GAS executives are at a crossroads. With an unstable global economy and increasingly volatile oil prices, chances are you're being pressured to significantly reduce costs in as many areas as possible, including headcount, capital projects, and indirect spend.

However, while some cost cutting is necessary, overly aggressive actions can backfire, undercutting your company's long-term performance, relationships, and success.

Fortunately, many executives are discovering and embracing more balanced solutions, such as auditing third-party contracts for compliance. In the end, this forward-thinking approach is improving efficiency, transparency, and earnings-without compromising future company success.

FACING DOWN MARKET CHALLENGES

Though the US economy has steadily recovered since the global recession, the oil and gas industry has tumbled by nearly 70% over the last two years.

Revenues of upstream oil and gas companies have dropped by 50%, major oil operators have lost $424 billion, and service companies have shed $110 billion, according to a recent Bain & Company report.

And the instability is hardly over. Oil prices are still half those of just two years ago, and various other market issues loom, from sub-par global economic growth to rising production costs and regulatory burdens. As a result, 50% of oil and gas companies now report worsening financial prospects, compared with 20% last year and 10% two years ago, according to a 2016 Deloitte survey.

RESIST THE URGE TO AGGRESSIVELY CUT COSTS AND HEADCOUNT

Faced with this mounting wave of market challenges, many executives are considering cost reductions as a way to sustain business growth and viability.

However, while some cost-cutting is sensible, some executives are making dramatic and potentially damaging reductions. For instance, executives slashed more than 250,000 positions in the last two years, and they cut capital expenditures by more than $200 billion in the last year alone, according to the Bain & Company report.

Meanwhile, other executives are avoiding the pitfalls of intense headcount and capital expenditure cuts by looking for savings in another industry area-the supply chain.

With the size and technical nature of today's oil and gas projects, companies require extensive support from third-parties. And with greater spend and more complex contract terms comes the potential to identify greater efficiencies as well as missed cost savings.

So, executives are exercising the right to audit their third-party contracts and validate actual performance against agreed-upon terms, most commonly with the assistance of an independent contract compliance auditor.

With the intricate nature of contracts-especially those with non-hydrocarbon parts, materials, and services vendors- periodic audits are helping executives verify compliance with negotiated terms and standard operating procedures. Also, they are improving efficiency, transparency, and internal controls as well as uncovering significant overbillings, unused funds, and other savings opportunities.

REDUCING PROCUREMENT FRAUD RISKS

In addition to achieving time- and cost-savings, executives are auditing their contracts for another reason-to reduce the financial, operational, and reputational risks associated with third-parties.

In the last year alone, the Association of Certified Fraud Examiners estimates that the typical oil and gas company lost 5% of its revenue to fraud, and it took an average of 18 months for fraudulent behavior to be detected. Further, governments have responded by increasing scrutiny, regulation, enforcement, and penalties, which have led to major financial punishments and public relations disasters.

And the risks don't stop there. As cost-cutting has accelerated and oil prices have remained low, the pressure to maintain production levels has led some suppliers to prioritize demand and revenue goals over adherence to corporate policies and contract terms.

REDUCE RISK AND COSTS WITHOUT SACRIFICING PERFORMANCE

Ultimately, contract compliance audits are helping executives to strengthen their company's supply chain-and financial performance. In fact, companies achieving strong supply chain performance are experiencing a 7% to 26% greater compound annual growth rate (CAGR) than the industry average, according to a recent Accenture report.

Instead of focusing on extreme job cuts, shelved capital expenditures, or aggressively renegotiated supplier contracts, forward-thinking executives are helping soften the blow of today's market challenges by looking at the other side of the cost ledger. By partnering with a dedicated, independent contract compliance auditor, they are gaining the insight needed to maximize third-party ROI and realize short- and long-term company success.

Bill Adams leads SC&H Group's contract compliance and audit services practice. He specializes in performing contract compliance audits that produce greater transparency, trust, efficiency, cost savings, contract strength, and accountability.