Business Strategy of Shell Group - Case Study Example

Economics of Business Strategy Introduction: Ever since the formation of the Royal Dutch Shell Group in 1907, out of the merger of Royal Dutch Petroleum that was into the extraction of oil in the East Indies and the British Shell Transport and Trading Company, vertical integration has been its primary strategic thrust. The merger was to enable the newly formed company to be able to compete with the American oil giant, Standard Oil, owned by the John D. Rockefeller (Grant 2002, p. 2). The nature of the petroleum industry that has to this day, has been characterized by oil as an energy source, contingent on geopolitical play of forces and thus, out of the reach of the perfect interplay of market forces and the high transaction costs along the supply chain, from extraction (upstream) and to refining and distribution (downstream) - allowed the company to maximize its margins and stay vertically integrated while developing a strategy in recent years to reorganize that was based less on geographical considerations, but business sector-led, one which each operation along the supply chain works to be competitive and accountable in its field (Grant 2002 p. 16). While Shell has diversified into other businesses, such as petrochemicals and renewable energy, the former is a natural extension of its involvement in oil, while forays into renewable energy forms are quite negligible to the company's overall investment and assets pie. And yet, Shell by starting to invest in cleaner, non-hydrocarbon energy will be one with among with first mover advantage, in terms of technology and know-how should the time come when such energy forms become affordable for the market, and thus, profitable, for the company. Today, Shell, operating in 140 countries, with revenues of US$318.8 billion in 2006 makes it the third biggest multinational corporation in the world and with profits of US$26 billion, the second most profitable - has stuck to its main business of exploration of oil and gas, that serves the downstream sector of the industry, including its own operations in production, processing, transportation and marketing (Royal Dutch Shell, Wikipedia entry, 2007). Shell's total oil market share as of 2004 stood at 11.6% and which in combination with those of other oil majors such as ExxonMobil, BP (British Petroleum), TFE (TotalFinaElf) and Chevron Texaco control almost 60% of the world's oil and gas markets (The Energy Insider, July14, 2004). The group seeks to capitalize on what it calls its current business strategy of "more upstream and profitable downstream" which basically sees that it would continue to look for and pursue sources of gas and oil all over the world while it considers the demand side covered by the growing appetite for oil by the developing countries, especially Asia Pacific (Shell.com 2007). Honed by 100 years of experience in oil and gas exploration, with its technological expertise, Shell's viability on both ends of the supply chain remains due very much to the continuing demand for energy mainly coming from China's growth as a manufacturing behemoth, still mainly, oil and gas. This is the reason why Shell, despite the giant mergers that occurred in the oil industry in the recent years resulting in bigger rivals, remains very much profitable. Since oil, a fuel whose sources could be depleted anytime and only found only in certain parts of the world - its supply has been subject to political forces that companies engaged in oil production naturally must build economies of scale to recover high costs of investment. At the end of the supply chain, markets are expanding in developing economies especially China which has only begun its manufacturing stage of development in which oil and gas are necessary fuels. Thus for a corporation with an international scope of operation like Shell, vertical integration remains a viable strategy. In recent decades, however, the Shell Group responded to the changes in the industry by focusing to maintain its foothold on the upstream, while downstream operations were relatively restructured to give way to a focus on core competencies. Solid hold on the upstream The Shell Group's unshakeable and steady hold on the upstream portion of the petroleum industry despite the changes in the oil industry was due largely to its supplier strength and its ability to negotiate the terms of potential barriers to entry. In the first two decades since its inception in 1907, it managed to widen its geographical production interests specifically in Romania, Russia, Egypt, the United States, Venezuela and Trinidad (Grant 2002 p. 2). By 1938, Shell's share of world oil production stood at more than 10% (Grant 2002 p. 2). After the Second World War, it built more oil fields in Venezuela, Iraq, the Sahara region, Canada, Colombia, Nigeria, Brunei and Oman. Shell's geographical reach was buttressed by locking in with the political advantages of developing relationships to maintain its upstream assets. In Iraq, for example where its hold was wrestled away by the nationalization of oil assets in 1972 - the company managed to leverage its influence either through direct negotiations with the Iraqi government or through the British and Dutch involvement in the US-led invasion of the country in 2003 where it successfully again mined relatively cheap crude oil (Victor 2007). The same tactic involves its recent forays into the development of oil and gas project in the Sakhalin Island in Russia and its deal with the Iranian government to develop a major gas field in 2007 despite pressures by the U.S. not to deal with Iran, a state suspected of sponsoring terrorism (Controversies surrounding Royal Dutch Shell, Wikipedia entry, 2007). In Europe, where the industry deals with mature markets, Shell has insisted on market-induced incentives with its dealing with regulators so that oil and gas companies undertake major investments in renewable forms of energy and make improvements on technologies so that they will be more environmentally friendly (Royal Dutch Shell plc. Response to the EU Green Paper: A European Strategy for Sustainable, Competitive, and Secure Energy, n.y.). Shell managed to improve on its technology to be able to scour reliably for more oil and gas sources outside the traditional oil wells and at the same time, continue to benefit from its drilling capabilities that have been developed since its beginnings. While ownership of reserves accorded oil companies with lock-in income and profits prior to the 1980s and the development of spot markets, the succeeding decades saw multinational oil giants following a new economic model where profits became a function of the synergy of competencies along the supply chain in contrast to the previous model which strictly followed the rigidly vertical integration format for each individual company (Davis n.y., p. 6). Shell in particular, chose to focus on its expertise in deep sea drilling and offshore recovery (David citing Cibin and Grant n.y., p. 7). One of the sources currently and into the future of competitive advantage in the industry is technology and asset specificity relative to the industry even though technologies are not exactly proprietary (Davis 1999). While the commoditization of oil as a result of the nationalization of oil reserves by the Organization of Petroleum Exporting countries resulted in the relative de-integration of the industry along the supply chain, Shell immediately latched on the advantages of the new situation by locking in long-term contracts of the supply of crude oil and gas, through affiliates and joint-ventures with oil producers. Hold-up concerns moreover were solved with futures and forward market mechanisms such as the International Petroleum Exchange in London and NYMEX in New York where oil producers such as Shell could sell their crude rather than be confined to their integrated markets while refiners could predict their margins (Davis n.y.) Shell's continued commitment to more upstream assets is attested by its US$20 billion investments in 2002, up by almost three-fold than investments made in 1992 which stood at US$7 - most of these went to the upstream business according to a study (Eikeland, Hasselknippe, and Sverud 2004. p. 11). Oil production in 2002 stood at 886 mill barrels oil and 3439 bill ft3 natural gas, both indicators a close second to those of Exxon, whose size and capability made it the biggest oil company due to the merger with Mobil in 1998 - in contrast, Shell was the top producer among the oil giants, a decade ago (Eikeland, Hasselknippe, & Sverud 2004, p. 11) . A rationalized but more profitable downstream Many factors caused the massive changes that occurred in the oil industry's downstream aspects - the nationalization of oil assets especially in the Middle East, the deregulation of the gas and power industries in many countries that continue to this day, the giant mergers in the 80s and 90s, the entry of players that are focused only in a specialized portion of the industry that however went hand in hand with the fast-paced economic growth of many developing countries especially China and the rest of Asia that saw increased demand for industrial and commercial fuel. The oil majors after the oil shocks in the 1970s saw that to maximize the returns of their refined oil products, a massive restructuring of refineries must be needed (Davis n.y., p. 5). As a result, Shell, like all the oil giants either upgraded their refineries so that these could take in different grades of crude oil by investing billions in dollars or it has to close down refineries which are no longer generating the needed returns depending on the markets where they are located. It must be noted however that the volatility of oil prices led further led to commoditization of oil, in which a crude oil producer could sell to any interested buyer, rather than just pass on the crude to the producer's downstream subsidiaries. In the same manner, a refiner could purchase from any producer at lock-in prices, freeing the purchaser from negotiations from different buyers. This "vertical de-integration" has been attributed to Shell which introduced it 1982-1983 and has been adopted by the industry (Davis n.y. p.5). Economies of scale because of highly developed retail networks around the world has been always a source of advantage for Shell that even with the onslaught of other retailers and marketing companies that are not strictly oil companies, it still maintained market share wherever it is positioned. In addition, economic growth in many parts of the world especially China, Russia and the many industrialized countries in the East only enlarged the market, large enough for other entrants to operate in niche segments in the industry or by virtue of location. Some of the new players include state-owned Saudi Aramco, individual refiners such as Tosco and Valero, retailers such as Tesco and Carrefour which gained significant inroads in gasoline retailing and used to include the defunct Enron Corporation which at one time was a leading gas marketer and retailer, power generator and retailer (Davies 1999). Shell has recently announced that it will close down refineries in saturated markets and focus on growing markets such as China, India, Turkey, Indonesia, Malaysia, Russia, Ukraine and Thailand (Chinadaily.com, October 30, 2007). Rob Routs, executive downstream director of the Shell Group said that China's open economy has led to the expansion of the downstream business that will include fuels, lubricants, bitumen and chemicals businesses (Chinadaily.com, October 30, 2007). It may be however inferred that less regulatory restrictions found in developing countries especially with regards to environmental standards may be a motivation for Shell to invest in other parts of the world away from increasingly activist consumer markets in the United States and Europe where lawsuits have caused the Shell Group billions in dollars worth in reparations and settlements (Controversies surrounding Royal Dutch Shell, Wikipedia entry, 2007). Conclusion: Organizational restructuring and global scenarios While the Shell Group as a player in the oil industry proved flexible to adjust and to implement necessary changes in order to remain competitive largely in part to its practice of engaging in a forward-looking scenario-based strategic development, its organizational structure since its formation in 1907 virtually remained unchanged until 1995. The internal change was largely prompted by the dissatisfaction of shareholders in its financial performance vis--vis other players in the industry (Grant 2002, p. 7). Before the oil industry was shaken by major changes in the 1970s and the recent two decades, Shell, like oil majors had a geography-based operations, where decisions were made and implemented by local and regional executives. However, in response to bigger rivals in the industry as well regulatory challenges that have resulted in lesser returns to shareholders, the company has recently engaged in organizational restructuring that would still allow it to be a vertically integrated company, but with a more centralized form of decision making (Grant 2002, p. 6). Over 1,000 corporate positions were slashed and the management are now directly overseen from London (for downstream and related businesses) and from The Hague in the Netherlands (for upstream operations). Strategic "global" assets have been identified that will produce a much more limited product line (Grant 2002, p. 16). Shell is still mainly a vertically integrated gas and oil company but by some indicators it wants to become eventually a vertically integrated energy company. Over the years it has made substantial investments not only in power generation and sales that are asset-efficient but also in renewable forms of energy (solar, wind power) that have significantly required altogether new investments in terms of technology. Already Shell is among the top producers and market leaders in the latter (Eikeland, Hasselknippe, and Sverud 2004, p. 26-32). However, the Shell Group maintains that in the near future, renewables because they are not as technologically and commercially viable would not be able to solve any energy crisis due to the demand that will continue to grow in the next 30 years from developing countries (Mortished 2007). This less-than-rosy outlook for the popular switch to renewable forms of energy is part of the Shell Group's 20-year scenario outlook that has been its traditional practice in charting its strategic development where instead of forecasts, the company looks at two or three scenarios in the future given certain factors and variables (Shell.com 2007). References: Chinadaily.com 2007, 'Shell to focus on China as part of growing-markets strategy' (Xinhua), October 30, 2007. Available from [November 20, 2007]. Davies, P. 1999, 'The Changing World Petroleum Industry - Bigger Fish in a Larger Pond', Paper presented to the British Institute of Energy Economics Conference St. John's College, Oxford. 21 September, 1999. Available from [November 20, 2007]. Davis, J. n.y. 'And then there were four..' A thumbnail history of oil industry restructuring, 1971-2005, in The Changing World of Oil. Available from [November 20, 2007]. Eikeland, P. Hasselknippe, H. & Sverud, I.A. 2004, Energy sector integration in Europe: The role of leading upstream oil & gas companies (Summary version) FNI Report 20/2004. Fridtjof Nansen Institute. Available from: [November 20, 2007]. Enerdynamics, 2004, 'Is big oil poised to become big energy' The Energy Insider, July 14, 2004. Available from [November 20, 2007]. Grant, R. 2002, 'Case seven: Organizational restructuring within the Royal Dutch Shell Group.' Available from:< http://www.blackwellpublishing.com/grant/docs/07Shell.pdf> [November 19, 2007]. Lajili, K. Madunic, M. & Mahoney, J. 2007, Testing Organizational Economics Theories of Vertical Integration. Available from [November 20, 2007]. Mortished, C. 2007. 'Energy crisis cannot be solved by renewables, oil chiefs say.' The Times, June 25, 207. Available from [November 20, 2007]. Royal Dutch Shell plc n.y., Response to the EU Green Paper: A European Strategy for Sustainable, Competitive, and Secure Energy. Available from: [November 20, 2007]. Shell.com 2007, More upstream and profitable downstream. Available from [November 20, 2007]. Shell.com 2007, Introduction to Shell Global Scenarios to 2025. Available from Read More