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Downstream business gets the high-tech treatment

The downstream oil industry’s traditional business model focuses on selling the output of refineries rather than on satisfying customer needs. Control over the early stages of the value chain has historically been key to long-term success and profitability for the vertically-integrated major oil companies. However, the commodity nature of many refined petroleum products, and the pressures of globalisation are forcing companies rapidly to shift their emphasis, writes Neil Thomas, manager, energy practice, Arthur D Little, London

The new e-world greatly reduces the barriers to entry for new customer-focused intermediaries in all industries. Oil and gas is no exception. Oil companies must become customer-focused, or face the risk of these new intermediaries capturing much of the added value in their businesses, reducing existing players to little more than bulk commodity suppliers.

The enhanced customer relationship management (CRM) functionality of the latest e-technologies offers an exciting opportunity for companies to break the shackles of their traditional production focus and transform large parts of their organisations into customer-focused businesses. The challenge is to do it before new entrants capture their most valuable customers.

Companies cannot afford to play a wait and see game. Estimates of the value of e-business transactions over the next few years range into trillions of dollars. This growth will be fuelled by technology advances that will dramatically increase the means and speed by which information can be accessed.

For many companies the risk is not that they fail to identify the threat, nor that they cannot implement the technology, but that the legacy of organisation structures, processes and cultures prevents them reacting with sufficient agility to change their businesses to meet the new challenges.

Current trends

Already there is evidence of the major players recognising that they need to revisit their main business processes and examine ways in which new e-technologies can improve their business, among them the savings that will be achieved by adopting e-procurement practices for routine purchases of indirect materials.

BP Amoco, for example, has started using the internet to buy basic catalogue items. These items represent only 15% of its $20bn annual procurement budget, but 50% of all transactions, and the company targeted $200m annual savings from these items alone. By the end of 2000, it aims to conduct 95% of all purchases online.

Companies are also waking up to the potential cost savings offered by transferring a typical sales transaction away from the traditional visit to the customer by a company sales representative to direct customer ordering over the internet. Research has suggested that the cost of a transaction using a field sales executive is typically around $500, whereas the same sale conducted over the internet would cost a company only $10—a 98% reduction.

E-business is also enhancing the customer management process through initiatives such as online sign-up, account status and e-billing for fuel and loyalty cardholders.

Many companies, including Texaco, offer free online journey planners that identify the location of service stations along the route.

Shell has launched free internet access to motorists visiting any of its chain of service stations across Europe. It plans to use its existing fuel payment card as a broader financial services facility that will also serve as a business-to-business e-commerce platform.

ExxonMobil has gone one step further and become the first major oil company to offer a core product directly to consumers via the internet. In addition to providing product information, its Mobil E-Store carries a range of lubricants and associated products for delivery direct to consumers' homes.

E-business is also having an impact on the main support processes in these companies. BP Amoco has signed a $600m outsourcing contract for its human resources administrative, transactional and information services to achieve what it calls E-Enabled HR.

Industry reaction

The impact of e-business will go beyond improving the efficiency of key business processes. It also has the potential to reshape the entire structure of the downstream industry. For example, imagine two scenarios for the industry in 2010: You can't pump oil through a PC and From vertical to horizontal integration.

The cautious incrementalist approach taken by the oil companies in the first scenario leads to continuing commoditisation and points to the dangers of not grasping the transformative powers of e-business. In the second scenario, companies use e-business as the catalyst to change fundamentally the industry structure and re-segment around four global segments, each of which is enabled by the new technology.

Clearly, these two scenarios are deliberate extremes between which one can imagine a number of plausible outcomes. However, if anything, they are likely to understate the degree of transformation we will witness over the next 10 years.

You can't pump oil through a PC

In the first scenario, the primary focus of the major oil companies has been on reducing costs via the improved efficiencies offered by the new e-technologies. While these initiatives have succeeded in reducing costs, the business model is much as it has been for the previous quarter of a century. The companies remain integrated, production-led organisations. Satisfying customers—formerly a basis for differentiation—has become a threshold criterion expected by all customers and delivered by all credible vendors.

However, while the oil companies were looking at how to conduct their business better, others were looking at how to conduct the oil business differently. By adopting new business models based on enhanced customer value propositions, new intermediaries have been able to reconfigure many of the channels to market.

In the retail sector, for example, supermarkets have linked with the major motor manufacturers to provide total motoring solutions to the most attractive segments (identified by their combined customer databases). With these companies' hassle-free offering, motorists no longer have to shop around for the best-value fuel. In-car internet technology provides Global Positioning System (GPS) directions to the nearest service station anywhere in the country—with continuously updated information on fuel prices. Customers' search costs are minimised, oil companies' profits on retail fuel sales are competed away to zero and supermarkets maintain customer loyalty by offering reward points on all transactions on in-house credit cards—including fuel bought at oil company outlets.

The oil companies' standard offering remains available at all their service station convenience stores, effectively catering to the lowest common denominator. Their belief that the convenience of their network of stations is unassailable is shattered, however, by increasingly sophisticated and widespread supermarket services that offer one-hour milk-round deliveries of core convenience items in all major urban areas.

There are new infomediaries between customers and oil product suppliers in the commercial fuel markets. Never taking title to the product, their role is to provide comprehensive customer service solutions that include guaranteed lowest prices on fuel.

Fuel storage tanks at factories and transport depots fitted with intelligent replenishment sensors are linked, via the internet, directly to these agents, who pool all their customers' requirements and seek automated bids from fuel suppliers. Similarly, in marine fuels, agents co-ordinate the fuel requirements of the major shipping companies along with their other supply needs. By pooling demand, agents are able to offer lower prices to customers while enhancing service.

This is not the stuff of Arthur C Clarke or any other science fiction author. Technology to enable these changes exists today. As a result, if the oil companies do not rise to the challenge, by 2010, large parts of the value chain will have been captured by new players.

In this scenario, downstream oil companies will have become suppliers and shippers of commodity products. Their strategy of cautious incrementalism will result in the continuation of today's trend towards commoditisation.

In the second scenario—from vertical to horizontal integration—the leading lights in the industry realised the potential of e-business to change industry structure. They were quick to identify that the key control points in the value chain would increasingly shift to the final customer interface. As a result, they organised their downstream oil businesses around four global segments: manufacturing; distribution; midstream marketing; and retail merchandising, each of which is enabled by different aspects of e-business.

Manufacturing is consolidated into a smaller number of large-scale, highly efficient integrated oil, gas and chemicals complexes.

Often owned by multiple partners, they serve a customer base including formerly competing integrated oil majors.

Procurement of feedstocks and maintenance materials is handled automatically by e-commerce systems. The internet provides a platform for global sharing of best practices with other manufacturers, suppliers and customers, making the supply chain more efficient.

Product distribution, the other asset-based segment, is handled by dedicated, scale-driven product movers. Shipping, pipelines, and rail and road transport are all handled by integrated one-stop storage and distribution providers using e-business across their operations to optimise efficiency and deliver cheaper services.

In the knowledge-based segments, midstream marketing companies focus on providing multiple energy products and services to large-volume energy consumers. Their mission is not just to sell oil products. By aggregating their customers' demand, they are able to access the most cost-efficient sources of electricity, gas and oil products.

Total e-business automation of transactions, scheduling, risk management and other support processes ensures both the cheapest and highly-developed business model.

In retail merchandising, oil companies have shifted away from selling oil products to leveraging their brands. Clearly, supplying fuel to motorists remains a core part of the offering, but it is no longer viewed as their raison d'être. E-business has allowed greater insight into customer requirements.

Companies are more sophisticated at tailoring the offering at service stations to match customer needs. To stave off the threat posed by home delivery shopping services, stations act as local collection/delivery points and increasingly focus on their advantages of speed and convenience.

The global brand is seen as a hub onto which are attached the spokes of products and services. For example, oil companies have formed alliances with major vehicle retailers and manufacturers, providers of repair, maintenance and car care services, banks and finance companies, even major supermarkets.

These alliances are bound together by e-business systems into a virtual company of impressive scale and scope. The potential for merchandising is limited only by the value-generating market segments they choose to capture.

If they have not already started, oil companies must begin immediately to look at all business processes to explore opportunities for efficiency gains through the power of the internet. Beyond this, companies must also look to e-business to transform large parts of the industry value chain and for new approaches to value creation.

Improving business processes

The sheer size of oil companies' capital and expenditure budgets means that the opportunities for cost savings through e-procurement are large. Many of the oil companies' major commercial customers are already demanding that their suppliers meet their online buying needs. The efficiency of product distribution can be improved through online links from service stations and other end-use customers right back to the refinery, via the various distribution depots.

Online ordering and intelligent replenishment sensors can reduce working capital and allow more flexible refinery production. The customer management process can also be transformed through streamlined transactions, sales management, and better customer communication and loyalty programmes.

But redefining business processes alone is not sufficient; other changes are needed as oil companies apply the tools of e-business directly to their core product/service supply chain, improving the efficiency of their supply and trading activities. New e-markets will be established along the lines that are already evident in related industries, such as chemicals.

The transition is likely to be fastest for crude oil trading and commoditised futures, swaps and options, although refined oil products will rapidly follow as new, virtual, oil markets and auction sites are established.

Refining will benefit from the effects of e-procurement and the advantages offered by real-time information.

Although the physical nature of energy industry products means that there are roles for product movers, oil companies need not be structured around this physical supply chain. They must control the commercial interaction and continuous communication with customers. Rational decisions can then be taken on the best way to move the product.

Four levels of e-business innovation have been identified by Arthur D Little, ranging from the provision of enhanced customer information on simple web pages to business models that utilise the transformative powers of e-business to shift value creation significantly.

Leading companies are well under way in achieving the first level of e-business innovation, namely marketing innovation, through initiatives such as online provision of service station locations and product specifications. Some are taking the first steps to a second level, channel innovation, by beginning to sell products and to process orders over the web. However, these are tentative steps, involving direct sales offered in parallel to the more traditional sales channels, and are already leading to concerns over channel conflict. While oil companies are right to have these internal debates, they risk becoming moribund.

Competitive advantage

New start-ups are not burdened by the debate on how to deal with a legacy of traditionally loyal partners. Their competitive advantage lies in their ability to adopt the third level of e-business innovation from the outset. This product/service innovation is likely to involve intermediaries aggregating petroleum and other energy-related products from multiple suppliers, and bundling them for sale to customers with better service and lower costs enabled by e-business.

The question now is whether or not the traditional oil companies respond to the threat posed by these potential new entrants with an even more innovative approach. A fourth level, business model transformation, will require a new kind of thinking. Five years ago, Arthur D Little proposed the idea of the Virtual Oil Company as a means of challenging industry strategic thinking and to push scenario visioning to the limit. The idea is no longer seen as quite so laughable. Indeed, the domain name,, has been registered, but who will have the vision to take the concept to its full potential?

Oil companies that look to e-business simply to improve current business processes will undoubtedly benefit in the short term, but may be sowing the seeds of their longer-term demise. The organisations that look beyond current industry structures and relationships have a tremendous opportunity for profitable growth.

To succeed, companies will need to take a hard look at their competency platforms and work on their willingness and ability to operate an extended enterprise. However, these new business models and value propositions must be based on reality—investors tempted by new dot com start-ups proposing to refill motorists' fuel tanks with unleaded gasoline over the internet should proceed with extreme caution. But who knows what tricks Bill Gates has up his sleeve for the launch of Windows 2010?

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