Lessons learned from the auto industry

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How can this be? How can the price of a family car remain unchanged in real terms, but offer so much more value? The answer is simple - car manufacturers keep asking "can we do better?" - because not to do so is commercial suicide. And they prove that the answer to this question, year over year is demonstrably yes.

Car companies invest heavily in a wide range of systems and processes that deliver innovations in performance, cost, and customer value. And so year over year, cars gain desirable features, improve safety performance, fuel efficiency, and functionality, while delivering these for essentially the same cost.

In fact, they compete not just on value, but on the rate of value improvement.

And it's not just car manufacturers. Add most consumer product companies to the list. Every company where competition is visible, immediate, and intense asks this question and finds answers that drive higher customer value continuously. Or they fail in the market place.

The contrast with our industry's development systems is stark. Of course, we are not in the mass manufacturing world. Our volume is measured in tens or hundreds, not in millions. Our designs do not attract any external independent scrutiny of performance or value. Customers are not the general public. And of course, we don't control the price of our final product. But none of these factors prevent us from continually asking - "Can we do better?"

And emphatically, the answer to the question in the energy industry is also yes.

For the last 20 years I have been asking this question on hundreds of projects and can categorically say that there is always a better way - always more value to be captured. The challenge is not just to find this value but to position our companies and industry to pursue this value capture systematically and continuously - not just when times get tough or profits are down.

LATENT VALUE

If every time we thoughtfully ask - "can we do better" the answer is "yes", then it follows that there is value to be found in every project - whether we seek it or not. This is latent value - value that is there to be discovered if we would only ask. To paraphrase the bank-robber Willie Sutton - Why pursue latent value? Because that's where the money is.

Pursuit of latent value will require a different strategy and organization within your companies, and cascading this pursuit deeply into the supply chain.

This article outlines the primary elements of the Latent Value Capture strategy. The strategy applies to projects - defined in operator companies as hydrocarbon developments, in supplier and contractor companies as the elements of these operator projects for which they are responsible.

LATENT VALUE CAPTURE STATEGY

There are three elements to the Latent Value Capture strategy:

• The expectation for continuous Latent Value Capture
• The tools and systems that support LVC, and
• Innovation Space

STRATEGY ELEMENT 1: EXPECTATION FOR CONTINUOUS LATENT VALUE CAPTURE

Latent Value Capture starts with creating a core institutional expectation to pursue and achieve real improvement continuously. Specifically, every project should be demonstrably better than the last. For example, operators can establish the expectation that their capital efficiency per well must increase from well to well, year to year, or development to development.

This expectation must become the core culture of the organization and must be driven from the very top of your company. Belief in Latent Value Capture must be closely and deeply held and supported in order to cascade it into your company's culture and behaviors, founded on the certainty that it will create competitive advantage.

This means creating a deep expectation of your staff that gives permission and space to continually improve. This expectation becomes the credo for your company and underpins actions and behaviors that innately capture latent value. Leadership action to plan, establish, and sustain Elements 2 and 3 are the tangible evidence of Element 1.

STRATEGY ELEMENT NO. 2: SUPPORTING SYSTEMS

Oil and gas companies hire and train some of the very brightest personnel in the world. And yet to quote W. Edwards Deming - "A bad system will beat a good person every time."

The Latent Value strategy must be supported by the systems that ensure its success. Much of the commitment and investment in Latent Value Capture is in these systems, which provide both information and impetus to action. These systems fall into five groups:

• Information
• Targeting
• Delivery tools
• Organization
• People systems

INFORMATION SYSTEMS

Achieving actual improvement from project to project first demands solid information on current designs and processes. Much of this raw data already exists within your company, such as costs per completion, cost per ton of fabricated steel, etc. Be aware that these data reflect the current orthodoxies and standards for how systems are designed, built, installed, and operated, and can vary between global regions.

Beyond these essential but basic data sets, your company will need to construct additional data that directly feed improvement efforts - in terms that engineers and operators can immediately act upon. The data must provide much deeper insight, driving to true root cause understanding.

As a simple example, it is well-known in manufacturing industries that the number of parts in an assembly has a near-direct correlation to cost. Knowing this, engineers use their talents to drive to lower part count in their designs and thus drive down cost. In the oil and gas business, part count is rarely if ever discussed, let alone optimized.

Another useful metric is cost per unit of function - for example the unit cost to dehydrate gas.

Of course, this information is time and market sensitive and must be maintained to be useful.

COMPETITIVE ADVANTAGE

This data becomes your closely-guarded internal collection of insights. The extent and depth to which you define and parse these metrics will directly impact both innovation and the speed with which you innovate.

TARGETING

The core of the latent value capture strategy lies in the second system - targeting. Having developed the performance data, your company can now use these to drive growth and improvement in a continuous, thoughtful and deliberate way. This is done by setting specific improvement targets to be achieved over time. The targets translate the imperative for latent value capture into clear, specific action and innovation.

They also establish a direct link to your company's growth strategies by associating achievement of targets to the enabling of new or widened business opportunity.

Creating effective targets begins by establishing high-level ones, and then cascading these in a most deliberate way down to the individual scope elements and activities that actually impact their achievement.

Setting high-level targets for performance and cost first demands a clear strategic view of the future growth of your company and the value of potential endeavors. It is critical that this function is performed in a strategic planning group apart from the line organization responsible for project delivery.

Cascading these targets from high to low ensures that at the lowest level individual scopes have clear targets that align and support the high-level aspirations. These low-level targets must roll up into sub-systems and then systems, such that their achievement is additive and complementary. Under-achievement on one sub-target is permissible and can be compensated for by over-achievement in another, thus ensuring that the high-level target is nonetheless achieved.

Inherent in the target setting activity is a negotiation between the line organization's owners of the scope elements of a project and the strategic target setting owners and analysts.

In setting targets, your company has the opportunity to force a thoughtful challenge of current orthodoxies - from technical solutions to methods and processes. Often a large step change in performance demands jumping from one technology or method to another, and may be highly disruptive to your company and supply chain, while enabling strategic growth. Setting of well-considered yet aggressive targets is a way for your company to control your rate of innovation and latent value capture, and is thus core to the strategy as a competitive weapon.

Line accountability for the achievement of agree-upon targets is essential. Once agreed, targets are pursued to achievement by the line. Hence the criticality of the information and negotiation. There is a Golden Rule that applies in target setting: Once the high-level targets are agreed to by all parties, they must be met.

BENCHMARKING

Another shift, most notable in operator actions, is to diminish the emphasis on traditional competitive benchmark data which becomes much less useful under latent value capture. Targets for improvement are set internally based on strategic need, and so the value and meaning of aspirations to become "top quartile" relative to your peers disappears, and rightly should.

In fact, the presumption underpinning the "top quartile" strategy is fundamentally flawed in a world of latent value capture, as it yields results that are only marginally better than the others', arguably with incremental improvement over time. The strategy completely overlooks the discovery of latent value:

In the old saw of two hikers confronted by an angry bear in the wilderness, one proceeds to change his boots for running shoes. Asked by the other if doing so would help him out-run the bear, the first replies, "I don't have to out-run the bear, I just have to out-run you."

Instead, as has been suggested by many, you must become your own fiercest competitor, and move away from aspiring to be slightly ahead of what may objectively be an inwardly-focused pack. Latent Value Capture is about out-running the bear. Understanding and exploiting gaps in performance and capability must under-pin your company's action to extract the most possible value from your portfolio and resources. This is true leadership.

BENCHMARKING REVISITED

Certainly benchmarking can be used to get new ideas for your designs and processes - GM pioneered the practice of "tear-down" - a tool that is extremely common in other industries today whereby competitor products are dissected and analyzed against multiple cost-driving or performance criteria to provide one source of ideas for innovation.

Also, meaningful benchmarking of rates of improvement and innovation potential may provide insights into how much improvement can be achieved. For financial institutions, this measure is a clear indicator of the innovativeness of a potential borrower.

Targeting is the core engine directing and driving progress and growth in your company, and should command the highest levels of support and resourcing. The very brightest minds in your company should perform the targeting functions as a well-guarded core competency, such that you navigate with confidence towards your future.

DELIVERY TOOLS

Once targets are negotiated and agreed, pursuit follows. While Strategy Element 3 addresses the innovation space needed to meet targets, another important supporting system is in the tools and methods used in their pursuit. These tools are the "how" to delivering on the targets set and are thus integral to its success.

There is a veritable alphabet soup of tools available to your company to help in achieving their targets, the most common of which are Value Engineering and Kaizen. Most tools require expert application and much practice in order to maximize their effectiveness, much like any high-stakes professional service. The success of your strategy depends on how well these tools are applied. Don't leave this to amateurs.

Investment in the delivery support systems must be in developing deep, rigorous capability as a core competency in your organization. The quality of your capabilities should be judged on the business outcomes achieved.

ORGANIZATION

The Latent Value strategy must be supported by organization. Without the structure, the strategy has no delivery mechanisms and will fail.

Given the strategic consequences of the strategy, it is imperative that the Latent Value organization be positioned outside line control and instead be a part of or parallel to your company's corporate planning function. This creates maximum connectivity to company leadership and strategy, and improves the probability of achieving strategic success.

Also, by being placed outside line organizations, the negotiation of targets to be achieved creates a healthy tension between business aspirations and the delivery of results up through the highest levels of your organization.

The Latent Value organization (referred to as cost engineering in some manufacturing organizations) is responsible for five functions:

• Data and Analysis - collect, organize, and interpret cost and performance data
• Strategic Alignment and Target Setting - translates corporate aspirations into specific technical and non-technical targets, and negotiates these with line organizations
• Achievement Tools Delivery - provides line organizations with tools and expertise to help them achieve their targets
• Training - brings knowledge and guidance to line organizations on the tools and their limitations
• Strategy Renewal - devises and maintains a long-term, strategic plan for the growth of Latent Value Capture capabilities that aligns with corporate aspirations

The skill sets for each function are diverse, but must be underpinned by experience in all facets of your company's operations.

PEOPLE SYSTEMS

Without personal motivations, the strategy will likewise fail. All of your staffs must be aligned around the strategy through inter-depended recognitions and rewards. These must directly connect to the achievement of agreed targets, while giving "permission" to your staffs to innovate and reject risk aversion and complacency.

At the highest corporate levels, this means recognition for the rate of improvement actually achieved, while at lower levels, this means enabling improvement through innovation, the successful achievement of targets and the application of improvements in projects. The key is to create inter-dependency that drives success.

As an example of interdependent motivations in found in BMW, the German car manufacturer, the owners of specific models ("series") are required to have a certain, objectively measurable level of innovation in the next model release, while the innovation developers are tasked with "selling" acceptable ideas to the model owners. This system creates both "pull" and "push" for innovative yet marketable ideas.

For example, in our industry, the owners of a particular function (drilling, production, construction…) or product (compressor, completion system….) would be required to achieve specific, measurable innovations in the next development or system generation. Suppliers and technologists are tasked with and measured on how well they identify and "sell" acceptable ideas to the owners. Yin and Yang.

"Meaningful benchmarking of rates of improvement and innovation potential may provide insights into how much improvement can be achieved. For financial institutions, this measure is a clear indicator of the innovativeness of a potential borrower." - Robert Orlean

STRATEGY ELEMENT 3: INNOVATION SPACE

The biggest barriers to latent value capture are the stage-gate processes used by most operators and suppliers to deliver their projects.

Under these processes, projects favor and select concepts that are proven and have a high probability of being delivered on time and on budget. While worthy and logical goals, they establish a classic perceived "tyranny of the OR" - either the project uses known, proven designs and systems and delivers on time and budget, or they adopt new technologies and processes that may improve projects but add risks to cost, schedule, or performance that are disallowed under stage gate rules.

Innovation to capture latent value must come from elsewhere in your organization, outside projects delivery. The third element of the Latent Value Capture strategy is the space to incubate and perfect improvements outside the constraints of the stage gate processes.

Most operators and major suppliers maintain technology centers that can fill this role. The key to successfully engaging technology centers is to link the latent value capture strategy and the targets it generates directly to the efforts of these centers. Development efforts are not restricted to technology plays, but can equally address processes, tools, and other enabling capabilities.

Several alternative development vehicles exist that can also be used within the innovation processes - for example, through contractors, suppliers, third parties, industry projects, and academia.

As an example, in the automotive world driven by the need for increasing fuel efficiency, car manufacturers in the US teamed up with their suppliers, universities, and government labs to create the US Council for Automotive Research (USCAR). Their efforts resulted in concepts for vehicles that are up to 40% lighter through new manufacturing techniques, new materials, and new manufacturing methods.

In our industry, a recently announced MOU establishes engineering standards across the industry for bulk materials and equipment, construction, and qualification procedures and documentation with the aim of reducing costs and increasing predictability.

The ultimate measure of success of your innovation efforts is that no line project suffers recycle or delay as a result of unmet economic or performance hurdles when reviewed at the stage gates.

For financial institutions supporting oil and gas, measuring the effectiveness of this third element of the Latent Value Strategy is a key indicator of their clients' ability to support innovative improvements, and therefore growth.

CLOSE

Latent Value Capture as a strategy works. It is the proven competitive imperative in manufacturing industries and can be adapted to ours.

With low oil and gas prices causing a re-calibration of our industry, we now have the opportunity to stabilize our actions by adopting this strategy. No longer should we wait until the price of oil collapses before we ask if drastic cost reductions are possible. Also, pursuing this strategy provides a rational basis for making investments in your company.

More importantly, we have the opportunity to fundamentally change how we compete - not on economic acceptability, but rather on the rate at which we can innovate.

But you can't "surge" Latent Value Capture. You can, however, embark on a strategic journey - one that will transform your company and our industry - a multi-year endeavor. Each system within the strategy will take time and resources to establish, demanding a long-term plan that creates and evolves capabilities towards the success is therefore essential.

Don't believe that Latent Value Capture can work? The next round of car shows starts in January.

ABOUT THE AUTHOR

Robert Orlean founded Orlean Technical Solutions in 1998. The company helps its clients craft strategies and capture dramatic improvements in their projects, designs, and services. Customers include most major oil companies, equipment suppliers, and contractors. Orlean is a graduate mechanical engineer from the University of London's Imperial College. He is also a Certified Value Specialist by SAVE International and is certified as an Innovation Master by the Invention Machine Corporation IHS. Before founding his company, Orlean worked for Shell Oil Company on a variety of onshore and offshore design and construction projects as an engineer, researcher, and manager.