Doing more with less
At the time of this writing, West Texas Intermediate (WTI) oil price is trading at about $56/boe. As oil prices continue the slow growth trajectory, companies are looking for ways to do more with less. The need to operate efficiently at this oil price has led companies on extreme cost-cutting paths.
So how can companies not only survive but thrive in this environment to maintain their leading status? Through a combination of two things: a zero-based approach, implemented with an operations research mindset. This approach helps management identify non-working capital to reinvest and ignite the company’s growth strategy. It aims to focus on the future over the past to fuel and sustain growth and help the company remain competitive and relevant.
Successful zero-based budgeting
Zero-based budgeting (ZBB) techniques have been around for over 40 years. It is a progressive but straightforward idea to baseline budgets each year to cut unnecessary costs, rather than base them on what happened the previous year. It has evolved as companies incorporated other methods and emphasized cost savings and reinvestment using more rigorous governance, stricter policies, top-down targets and external benchmarking.
However, many companies take a siloed approach when embarking on a zero-based budgeting initiative by only looking at their supply chain cost, without considering other upstream and downstream activities of such a dynamic environment, operations, sales, marketing and finance.
Benefits of an operations research approach to ZBB
One of the methods used in operations research is mathematical optimization—the selection of the best element (regarding some criterion) from some set of available alternatives. There are three main components in optimization analysis:
- objective function: is the primary goal of the model which is to be minimized or maximized
- decision variables: control the value of the objective function
- constraints: allow the unknowns to take on specific values but exclude others
This framework helps us expand and focus on the higher benefit at the enterprise level. Optimization will trade off local benefits for global greater optimum. In other words, instead of thinking of ZBx in your supply chain (a local optimum), think about how the end-to-end value chain needs to be zero-based to obtain the overarching goal (a global optimum), using each department-wide budgeting process as a “decision variable” based on enterprise, financial and regulatory constraints.
While there are benefits from the local optimum scale reviews, there is tremendous opportunity to amplify these results by taking the winning principles and applying them across the entire Profit & Loss (P&L) and General and Administrative Expense (G&A) statements, direct and indirect labor, sales and marketing, logistics, and Cost of Goods Sold (COGS). This refers to having a zero-based mindset. Typical benefits and examples include:
The following steps should help oil and gas companies think about how to frame an end-to-end holistic approach to ZBx “a la operations research.”
- Define the global objective that the company, at the C-level, is trying to achieve from a cost optimization perspective.
- Identify and have a clear understanding of the entire spend/budget (decision variables) and the specific outcomes achieved by each component of the value chain.
- Outline all value chain constraints associated with the current allocation of budget based on enterprise, financial or regulatory mandates.
- Embark in adopting the ZBx mindset-improving agility, profitability and growth.
Companies will always need to stretch their budgets to fund essential initiatives or meet their targets, be it in a $115/boe environment or $50/boe environment. What has changed now is that savings must be bolder to fund and sustain growth. This can be achieved by embedding the ZBx mindset through operations research principles and mindset.
Success will not only be dictated by production output but by maneuvering the cyclical nature of the oil and gas industry, consistently. Like everything “new,” companies that fall behind in adopting and adapting the ZBx mindset will be left behind the rest.
As the saying goes, if you are not getting better, you are getting worse.