The Restructuring of Royal Dutch Shell - Research Paper Example

THE RESTRUCTURING OF ROYAL DUTCH SHELL: AN ASSESSMENT Introduction The global oil industry, of which Royal Dutch Shell has been a leader in the past decades, has been rudely awakened by developments in the macro economy with the nationalisation of its assets in the Middle East, the drop in oil prices years in the aftermath of the oil shocks in the 1970s, and the keen competition among the oil majors during recent years. While other members of the industry were engaged in restructuring and strategic mergers and acquisitions, Shell had failed to keep pace. Its relatively poor financial performance prodded its management to undertake an internal assessment that led to restructuring efforts beginning in the mid-1990s. This paper seeks to discuss and analyze these developments, as well as attempt to recommend further actions that Shell management could take. The company Royal Dutch Shell PLC is a multinational joint venture corporation comprising two founding companies, Royal Dutch Petroleum Co. of The Hague, Netherlands., and Shell Transport and Trading Co., PLC, of London. Although starting as rivals, the two companies merged in 1907 as Royal Dutch/Shell Group, which acquired producing concerns in the Middle East, the Americas, and Eastern Europe, including Romania and Russia. It is engaged mainly in oil and natural gas. At present its five business segments are as follows: 1) exploration and production (E&P), an upstream activity that explores, recovers, and produces oil and natural gas worldwide; 2) gas and power, where it liquifies and transports natural gas to customers, as well as turns natural gas into cleaner-burning synthetic fuels; 3) oil sands, where bitumen is extracted and converted into synthetic crude oils; 4) oil products where a range of petroleum-based products are sold for domestic, transportation and industrial use; and 5) chemicals, which produces petrochemicals for industrial use. (Company report). Renewables were recently added to its range of business activities. Originally one of the "7 Sisters" in the the global oil industry in the mid-twentieth century, the Group today ranks second to Exxon Mobil as the largest oil company in the world. Shell's Pre-1995 organisation structure: Distinctive features For most of its existence and prior to the restructuring in the mid 1990s, Royal Dutch Shell Plc may be considered to possess the following distinctive features: Complexity. The organisational structure of Royal Dutch Shell prior to 1995 was unique in its complexity: It was a joint venture that had been in existence for over a century, at the apex of which was a Committee of Managing Directors that provided a link between them. From the viewpoint of ownership and control, the CMD exercised what it referred to as governance responsibilities. The Group was managed on a day-to-day basis by officers who had been given executive responsibilities. Coordination and control were vested in the CMD, composed of 3 members from Royal Dutch Petroleum and 2 members from the Shell Transport and Trading. Chairmanship was rotated between the two counterparts. The CMD provided linkage between the formal (governance) structure and the management (executive) structure of the Group, and between the parent companies on one hand and the group holding companies on the other. The task of the Chief Executive Officer in a regular corporation was discharged by the Committee, thus the authority and responsibility were diffused instead of being vested in a single authoritative individual. The operating companies, while functioning almost autonomously in a decentralised Group setup, needed coordination in the face of technical and economic realities. The service companies provided the necessary coordination and linkages among the internal business sectors (upstream, downstream, chemicals and refining, and others). Hierarchy and international geographic dispersion. There were four types of companies in the Group's formal structure, arranged as a hierarchy. At the top were the parent companies which for decades had remained joint venture partners, which owned the shares of the group holding companies. Each of these parent companies had its own Board of Directors, and its shares were listed separately in the stock exchanges of UK and Europe. Below them were the corresponding group holding companies. These companies held proportionate shares in the service companies and operating companies, but Shell Petroleum N.V. of the Netherlands side owned the shares of Shell Petroleum Inc. of the US, a parent company for the operating company Shell Oil Company. Nine service companies which were based either in The Hague or London provided advice and services to the nearly 250 operating companies dispersed worldwide. These operating companies operated within a single country, either handling one sector or more than one sector among the portfolio of businesses in exploration and production (upstream), refining and marketing (downstream), chemical, and coal or gas. Matrix organisation. A matrix organisation had been created since the 1960s, charged with the task of coordinating the activities of the operating companies among the business, functional, and regional dimensions of its operations. The executives of the service companies served as coordinators under the matrix structure. Because the Group's leadership was a diffuse one, strong leadership and dynamism were lacking in the Group, traits that were markedly present in its competitors, among them Exxon and BP. Organisation structure vis-a-vis competitive conditions in mid-1990s Unlike other oil companies, Shell did not undertake restructuring prior to the mid-1990s. There were two major reasons for this fact: a) Shell was flexible enough, or so it claimed, to make adjustments to its environment since it was an industry leader in rationalising excess capacity in refining and shipping, in upgrading its refineries, and in taking advantage of its opportunities in natural gas and deep-water exploration; and 2) The absence of a strong and powerful CEO was not favorable to initiating a top-down restructuring that other oil companies were able to undertake. The size of the Group required an organisation that was not only hierarchical but also bureaucratic. With various levels in the hierarchy, it was inevitable that information had to be processed at many levels before they could be used at the top management level for strategic management purposes. Hence, responses to critical developments in the macro environment tended to be slow. In addition, because the operating units were dispersed geographically with a great deal of individual autonomy, many functions were duplicative and therefore wasteful or inefficient, viewed from a larger perspective. Consequently, unfavorable developments both in the external and internal environment forced the CMD to consider radical change. These developments were the drastic fall of oil prices, which meant reduced profit from its upstream business; price wars; excess capacity in refining and chemicals, and the relatively disappointing financial performance of the Group as a result. In terms of the financial repercussions, the return on equity barely covered the cost of equity. Also, the cash flow was not enough to pay for regular dividends and provide for future asset replacements. Additionally, the equity, margin, and productivity (efficiency) ratios were inferior to those of its competitors in the industry. Considering the key success factors associated with the world's oil, gas and chemicals industry in the mid-1990s, it was obvious that Royal Dutch Shell's organisational structure at the time had certain inadequacies, and that restructuring was called for. There were two reasons for the need of a major restructuring. Firstly, the Group's structure at the central headquarters and in its corporate and research functions were "bloated" compared to their counterparts in the organisational structures of its competitors. The support and guidance services provided by the divisional administration were also perceived as showing "little discernible value." In fact, as then Chairman Herkstroter noted, these services were assessed as too costly and ineffective or inefficient. Secondly, the matrix structure that had been in place for many years now failed to provide effective coordination of the operating companies. This lack of coordination resulted, for example, in the Group's UK refineries selling to Spain and Portugal, to cite just one of the anomalies. Because the organisational structure was inadequate vis-a-vis the competitive challenges, there was a need for a major restructuring and initiatives to improve productivity and cut costs. The organisation and managerial practices that had served the Group for many years "were designed for for a different era, for a different world." Duplications and confusion of roles characterised the various levels of the organisation, which would indicate that change was urgent and necessary. The Impact of the 1995-6 restructuring The reorganisation implemented in 1995-6 sought to remedy the deficiencies in the Group's structure and systems. It is the task of this paper to evaluate the outcomes. Towards the end of 1995, retrenchment began in London and The Hague central offices preparatory to the introduction of the new organisational structure at the beginning of 1996. The downsizing of central services and administrative functions within the service companies accelerated during that year. Also, one of the Group's two towers at the London Shell Center was sold. The most evident short-term impact of the reorganisation was a substantial reduction in service company staffs. However, the quest for cost reductions did not stop there; it also extended to the operating companies. Between 1995 and 1997, unit costs were reduced by 17 percent in real terms, and savings in procurement costs were substantial. A priority for the Group was rationalisation of capacity and reductions in operating costs in its downstream business. To facilitate this, Shell embarked on three major joint ventures: • The amalgamation of Shell Oil’s downstream assets in the western US with those of Texaco • The amalgamation of Shell’s European downstream businesses with those of Texaco • The merging of Shell’s Australian downstream business with that of Mobil. Other restructuring moves were the swap of the Group's oil and gas properties with Occidental and the global integration of the chemicals business. This resulted in significant cost savings and better coordination in investment decisions, citing the case of locating a new polymer plant closer to customers (in Louisiana, U.S.) instead of near the existing plant in UK. Still, as it turned out, some problems still needed to be addressed. Further organisational changes in 1997-2000 In mid-1998, against a background of declining oil and gas prices and weakening margins in refining and chemicals, Mark Moody-Stuart succeeded Herkstroter as Chairman of the CMD. Shell’s operating profit and ROCE had fallen well below the projections for 1998. Thus further organisational changes were indicated in order to resolve the remaining problems that persisted. These had to be carried out in the period 1997-2000. These were to be pursued through further organisational change and cost reduction. In September 1998 Chairman Moody-Stuart announced a series of measures aimed at reducing Shell’s cost base while reaffirming Shell’s commitment to achieve a 15 percent return on average capital employed (ROACE) by 2001. The Shellhaven refinery was closed, and the Berre refinery in France was partially shut down. The national head offices in the UK, Netherlands, Germany, and France were to be closed. The Business Committees that earlier had been set up to manage the new business sectors were replaced by Chief Executives in conjunction with the decision to replace the traditional consensus-based decision making with individual leadership and individual accountability. The CEO’s and executive committees were to run each of the following businesses: Oil Products, Exploration and Production, Gas and Coal, Chemicals, Renewables, and Shell Services International. With regard to the "committee of equals" Moody-Stuart wanted the CMD to serve more like an executive committee where members had clearly defined responsibilities. Further, Shell Oil Inc., Shell's US subsidiary, was to be integrated into the global structure. With the implementation of these decisions, the chemicals sector, by the end of 1998, was a truly global division, and by early 1999 upstream operations in the US had been integrated into the global exploration and production sector. The hitherto separate Shell Oil corporate office in Houston became integrated within Shell’s Corporate Center and Professional Services organisation. Shell Oil’s Human Resource function staff became part of a new global Shell People Services organisation, while its Finance, Tax, Legal, and Corporate Affairs were also integrated with their counterparts in London. The President and CEO of Shell Oil, Inc. became an ex-officio member of the CMD. The complex matrix system, normally used in project management as a temporary arrangement, was used by the Group for years, but it had exhausted its usefulness. Shell was looking for a better and swifter way of responding to uncertainties and discontinuous changes that were affecting the oil industry. By simplifying its administrative structure at the central offices, eliminating regional coordinating staffs, by closing and selling some its biggest headquarters, among other measures, Shell had demonstrated a strong resolve and decisiveness that were unprecedented in its long history as an oil industry leader. It was rather ironic that the Group that pioneered in scenario planning and organisational thinking should lag behind other industry giants in terms of restructuring for quicker responses to the challenges in the external environment. The results that followed the first stage of the restructuring were evident but not achieving its objectives quickly enough, hence the need to complete the transformation process. With the global businesses already headed by personally accountable CEOs, reporting lines are direct and uncomplicated, in contrast to the former bureaucracy. Other changes included the introduction of incentive pay and stock options, a policy of competition for project capital by business units and for positions within the Group, with hiring from the outside now being practiced in addition to internal hiring and promotions. All these changes have resulted in a significant improvement in the level and stability of earnings, increased oil production and sales for most products amid a reduced work force. Capital had moved away from the poor performers and declining areas to new opportunities. The restructuring extended to Shell’s downstream and chemicals businesses. Some refineries had to be closed or sold. Complexity had been reduced through fewer plants and product lines throughout Europe, Asia Pacific, and the Americas. Despite all these radical changes, Shell still retained some aspects the old structure. The decision was made to retain the a joint venture characteristic wherein the Committee of Managing Directors was composed of board members from its dual parent companies. The principle of rotating leadership between the two parents with fixed single terms of office for the CMD Chairman was still intact. While the operating units were less decentralised and more integrated globally into the operations of the Group, this relic of the past could not be cast away. Additional changes that may be considered. Because the CEO is the Chairman of the Committee of Managing Directors, it is not clear to what extent he is empowered to act quickly and proactively without consultation. Mr. Moody-Stuart should strive to get an absolute mandate whereby he can act in the same way as a CEO of a single corporation. He should ask for a large measure of independent power in consonance with greater responsiveness to cope with competition under the principle of single-point accountability. The case is silent as to the presence in the organisation structure of a staff unit that is engaged exclusively in receiving and processing information and data that top management can use for the purpose of designing business and corporate strategy. Despite the fact that the Group was an industry pioneer in the use of scenario planning (and organisation learning), it is not clear whether this activity is a continuing process. The problems encountered by the Group leading to the restructuring indicates that the activity and the people engaged in scenario planning did not generate effective influence in the strategic decision making processes of the organisation. A strategic analysis unit that serves the CMD should be made a permanent fixture in the organisation so that a continuous monitoring and review of the Group's macro environment and assessment of internal strengths, resources, and capabilities, can be made in relation to the problems and opportunities found in the larger environment. Contingency planning should also be part of the tasks of that unit. The environmental impacts of the Group's new projects can be studied with a view to preventing or mitigating the negative externalities (such as water and air pollution) that they can generate and that can be harmful to local communities. The objective will be to avoid public pressure and litigations that can cause public image problems and can cost millions of dollars to the stockholders in terms of penalties and court-awarded damages. With these recommended changes, we hope that management will experience less incidence of shocks and surprises and be able to move forward as a profitable company, leader of the world oil industry, and a good global corporate citizen. Conclusion Royal Dutch Shell has emerged from the two-stage restructuring in the last decade of the past century hopefully achieving more flexibility and dynamism removed from the encrusted corporate bureaucracy of the past. The change process was difficult but necessary. What is perhaps more important is that the Group should continue with its internal self-assessment together with a reliable environment scanning mechanism. What it needs is an embedding of strategic planning, fully supported by top management, within the organisation as part of the corporate continuing practice. Works cited Company report, RDS. Moneycentral website http://moneycentral.msn.com/companyreport?Symbol=US%3aRDS.A Hill, Charles W.L. & Gareth R. Jones. 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