Western companies are losing ground to newcomers from the emerging countries. Nowhere is this more apparent than in the petroleum sector where the integrated oil and gas majors - led by Exxon Mobil, Royal Dutch Shell, BP, Chevron, Total, Conoco Phillips, and Eni, are increasingly playing a secondary role to the national oil companies (NOCs) owned by producer governments.
Financially, the majors are enjoying unprecedented prosperity. The leading group of seven have earned a return on capital employed averaging 24.2% over the past three years, and shareholder returns averaged over 20% per annum during this period. Exxon is America's largest company in terms of market capitalization as is BP in the UK, Total in France Royal Dutch Shell in the Netherlands and Eni in Italy. Exxon's $404 billion of revenue last year exceeded the GDPs of all but the world's 25 richest countries.
Yet behind the financial numbers, the picture is not so rosy. Last week Petroleum Intelligence Weekly listed the world's leading petroleum companies according to operational performance. Among the top 25 companies, 16 are national oil companies - companies wholly or majority owned by their governments. In terms of petroleum reserves, the contrast is even more striking. The world's 12 largest owners of petroleum reserves are all NOCs. Exxon Mobil ranks #16 with a mere 4% of the reserves of the leader, Saudi Aramco, and 8% of the reserves of Qatar Petroleum.
During the past year, the strategic weakness of the majors has become increasingly apparent. Bolivia and Venezuela have nationalized the assets of foreign majors. In Russia Shell and BP have relinquished control of their huge gas field projects to Gazprom. Nigeria, Ecuador, and Kazakhstan have forced the majors to renegotiate production sharing agreements. Throughout the Middle East and Latin America the majors' access to new exploration has become increasingly restricted.
The declining status of the majors is primarily the result of: increased dependence of the Western countries on foreign petroleum, a global shortage of production capacity in the face of rising demand, and resurgent nationalism among several oil producing countries. However, the strategies pursued by majors have also contributed greatly to their relinquishing the strategic high ground of their industry.
For two decades, the strategies of the majors have been oriented towards the quest for shareholder value. The result has been extensive restructuring involving cost cutting, outsourcing, and the subjection of investment and R&D expenditures to more stringent financial appraisal. Although successful at squeezing costs and boosting profits, the majors' technical capabilities have progressively eroded. Leadership in upstream technology has shifted from Exxon, Shell and BP to the oilfield service companies, led by Schlumberger, Halliburton, and Baker Hughes. During 2000-2007 these three oil service suppliers spent, proportionately to their sales, around ten times what the majors did on R&D and each received more patents than any of the majors. Outsourcing also encouraged the majors to reduce their investment in human capital - leading to an acute shortage of technically-trained manpower.
In pleasing the financial markets, the majors have diminished their attractiveness as partners for the NOCs. In making production sharing agreements with the majors, producer governments are less interested in the financial strength of the majors and more interested in their technical capabilities. As these capabilities have shrunk so producer governments have become less interested in the majors and more interested in the oilfield service companies. Although most western oil and gas companies have been squeezed out of Russia, Schlumberger has 14,000 employees there.
The extensive decentralization and delayering by the oil majors of their managerial structures may also have limited their capacity to respond to the needs of producer countries. Producer government objectives are seldom limited to revenues from oil and gas production - they extend to broader economic development goals. The downside of delayering is the loss of the integrative capacity needed to structure and deliver the complex combinations of capabilities, services, and infrastructure that may include oil and gas field development; pipelines; downstream developments in refining, petrochemicals, and distribution; electricity production; and possibly extend to public infrastructure as well.
The merger wave which combined Exxon and Mobil, BP and Amoco, Chevron and Texaco, and Total, Elf, and Fina into "supermajors," may also be viewed as an extension of restructuring and cost cutting policies that further diverted them from building long-term competitive advantage. The propensity for the leading companies in an industry to pursue near-identical strategies - even when the strategic logic of these strategies is questionable - points to the remarkable power of imitative behavior in groups. (The current sub-prime loans crisis impacting commercial banks worldwide manifests the same phenomenon.)
Yet, it is also possible for top management to avoid the herd mentality that induces companies to follow the industry leader. (In the oil and gas sector Exxon and BP have been the most imitated of the majors.) Despite its need to establish its credentials as a shareholder-focused company, Eni has avoided several of the strategy bandwagons that encouraged convergence around particular "industry recipes" have swept the industry. Instead of outsourcing, it has continued to develop its technical capabilities in engineering and oilfield services (primarily through its associated companies Snamprogetti and Saipem) and it has resisted mergers and large-scale acquisitions. Its vertically-integrated gas strategy and its focus on countries with challenging political environments has resulted in a strategy that is distinct from its fellow majors and is closely aligned with its distinctive capabilities.
In an uncertain, competitive environment, companies should resist the temptation to imitate their industry leaders - the result is likely to be strategies that are ill-fitting and backward looking. Successful strategies are likely to be built upon differences rather than similarities. Strategy formulation should give careful attention to the identity of the company and to the resources and capabilities that distinguish it from its competitors.
by Robert Grant,
Eni Chair of Strategic Management in the Energy Sector, Università Bocconi