Time for Innovation in the Oil Industry - Dissertation Example

Business Information and Analysis of the Oil Industry The oil industry is one of the most competitive industries in the business world. The industry is controlled few large and well established companies. One of the leading companies in the industry is Royal Dutch Shell plc (RDS). The company is headquartered in The Hague, Netherlands and operates in over 140 countries with over 112000 employees (Datamonitor, 2011). The main source of force and power for effective mobilisation of tangible and intangible products for the organisations in the oil industry is the strategy. Attainment of competitiveness and sustainable development requires the company to utilise technology, knowledge and strategy. The essay below focuses on the strategy applied by the companies operating in the oil industry with the focus on Royal Dutch Shell plc. Porter’s Five Forces Analysis Threat of New Entrants The structure of the energy industry makes it difficult for the new entrants to venture. The industry is characterised by remoteness in sources of production and markets as well as the high cost of the infrastructural requirements used for initial establishment (Heinzel, 2009). These features act as the barriers to the entry of the new entrepreneurs. The barriers vary depending on the market location of the company. The machinery required for oil exploration depends on the site. Some of the areas of oil drilling requires different expertise i.e. specialised workers are required to make key drilling decisions and operate the equipment. Such conditions denote that investment in the oil industry requires immense resources of which few investors can afford. Therefore, the already established companies such as the Royal Dutch Shell have no reason to worry about the threat of the new entrants. This is why the number of the leading competitors in the industry is low. Barriers are further caused by the limited access of the new entrants to the mineral reserves as well as the involvement of the governments in the oil business. This because governments have a tendency to ignore the new and small companies through restricting their business involvement to national and the well established companies (Ross, 2009). In the Royal Dutch Shell plc’s case, a solid foundation against the threats of new entrants was established through leveraging of the company’s reputation. The company’s management minimised the threat of the new entrants in the industry through; increasing the efficiency of its operations, promoting its cohesiveness and image with distributors and suppliers, protecting its properties, retaliation tactics as well as establishment of trustful and competitive image to its customers. The advanced technology that the company employed created a competitive advantage and a better market position compared to the technological level of the new entrants in the industry. The technology enables them to manufacture products and offer services with superior quality compared to their competitors. The company has portrayed competitiveness in gas to liquids technology that produces ultra-clean fuels. According to Jensen (2004), the technology has led to the development of floating liquefied natural gas facilities that enhanced the exploration of marine off-shore mineral deposits. Distinction has been created by the company’s capability to explore the deep-sea reserves that most of their competitors have not been able to access. External Environment Analysis The oil/energy industry is characterised by numerous barriers to entry. According to Heinzel (2009), venturing into the oil industry is risky due to the current shift in the bargaining power from the suppliers to consumers. The major competitor of Royal Dutch Shell plc is the ExxonMobil that uses of the same business strategies (Jonker et al., 2009). The external environment analysis of the company involves focus on the Porter’s five market forces and this is elaborated in Appendix 1. Bargaining Power of Suppliers The bargaining power of the suppliers is regulated by the fact that companies in the oil industry views suppliers as assets; not threats. The expansive nature of the oil industry and the immense assets that the leading companies own attract many investors. In the case of the Shell Company, the supplier power affects the main competitors; BP and ExxonMobil (Ivythesis, 2008). However, the differentiation strategy of the Royal Dutch Shell plc is not significantly superior compared to that of the major competitors. Differentiation enhances investment making decisions by the suppliers/investors. Although the competitors in the oil industry have no unique or superior differentiation strategy, the industry experiences low threat for the bargaining power of suppliers due to partnerships, training, dependency and chain management (Jefferson and Voudouris, 2011; Datamonitor, 2011). Bargaining Power of the Consumers Consumers will always opt for less expensive oil products considering that oil products are essential to their lives. These prices are normally affected by the control in oil supply spearheaded by the Organisation of the Petroleum Exporting Countries (OPEC). The regulatory frame work normally intervenes in controlling the oil supply because consumers have minimal power in influencing the process of the product (Berkeley et al, 2009). A company cannot exist without customers. The Royal Dutch Shell serves over 25 million consumers daily in over 56 000 service stations globally. The cohesive loyalty between sellers and buyers of energy in the industry is related to several factors such as attractive incentives, supply chain management, partnering as well as value added services and processes. According to Jonker et al (2009), many stakeholders and investors have recently expressed satisfaction with the company’s services, a clear indication that the consumer-relations policies being applied by the company are effective. Jefferson and Voudouris (2011), also agrees that the enhanced technology and diversification that characterises Royal Dutch Shell plc enhance customer satisfaction. Diversification and technological advancement has led to the production of high quality products and services at a customer friendly price. Royal Dutch Shell plc underwent management restructuring that reduced costs. This enhanced the development of an efficient view on profitability, shares repurchase and financial discipline; thus, improving the customer confidence as well as loyalty. Most of the products offered by the companies in the oil industry provide the consumers with high returns during their cycle. Additionally, the industry’s ability to influence and maintain a political clout has enhanced predominance of business operations in many major markets such as Russia, China and the Middle East (Jefferson and Voudouris, 2011). Threat of Substitutes The reasons why customers switch products emanates from both internal and external factors of the company. The most crucial factor in relation to the oil industry is the price of oil. According to a 2008 article on The Making of the European Energy Market: the Interplay of Governance and Government, the threat of substitutes in the energy sector is experienced in the form of the variation in price. The customer will always develop second thought in sticking to a product that has increased its cost value. The prices of the nature of products that Royal Dutch Shell plc handles are affected by social and/or political factors. The threat of substitutes is minimised by switching costs, research on the preferences, alliances, differentiation and entry into the substitute markets. According to Ross (2009), the natural gas provides consumers with the most viable substitute to oil products since it is cheaper. The low prices of the gas products are due to the economic recession, numerous investments in the gas production projects and abundance of the gas reserves in major countries such as the US. The threat of substitutes force affects the company at varying levels, depending on the line of specialisation that is being considered; Royal Dutch Shell plc offers a wide range of products and services. Rivalry between the Existing Players The companies in the oil industry leverage competition though effective management of improvement strategies in order to leverage products. This indicates that although the industry players may exhibit rivalry in the development of new markets, they normally operate in a cooperative manner. Diversification, differentiation, segmentation, maintaining environmental health and healthy communication with consumers enhances the company’s competiveness (Stephanie, Jennifer and John, 2009). The major competitor for the Royal Dutch Company is ExxonMobil Corporation. The company’s production level is superior compared to that of the major competitor. ExxonMobil uses the same business strategies that are applied by Royal Dutch Shell e.g. globalisation is being achieved through liaising with Qatar Petroleum in building integrated chains to expand markets in Europe, Asia and the United States and investing in shipping. According to Datamonitor (2011), the company has also invested in Germany, Netherlands and the North Sea. Although the prices of the company products are reasonable, its competitive strength is not wholly due to reduced prices. Important Forces The forces with significant impact for organisations in energy industry include competitive rivalry and the power of suppliers. The suppliers for the oil industry include extraction firms and the oil mining companies. The buyers in the industry include both the individual and industrial consumers. The power of buyers denotes the influence that the buyers have on the oil companies. According to Hults, Thurber and Victor (2012), it is difficult for the balance of power to shift towards buyers in the oil industry due to the presence of the supply regulatory bodies. Oil is a common commodity and the oil drilling services are normally the same; lacks differentiation advantage. This implies that buyers are at liberty to choose among oil providers without focus on the benefits accrued from better prices or quality. The strong power of the buyer in other company products and services other than oil leads to monopsony; a market dominated by many suppliers with few buyers. Under such conditions, buyers set the prices. For the products that are not subject to price regulations, the impact of this force is highly witnessed in situations where: buyers are concentrated with few of them having a significant market share; purchase a significant proportion of the output; and possess a credible backward integration (Report2010). However, most established companies such as Royal Dutch Shell plc have applied the necessary mechanisms to curb the impact of this force through collaboration in price regulation. The rivalry in the oil industry is aggravated by the presence of more than 12 000 dealers, with the competition being projected to continue rising. This is due to the global rise in the demand for oil products. According to IBIS World (1999), “Price competition is often the primary factor in determining which contractor is awarded a contract, although quality of service, operational and safety performance, equipment suitability and availability, reputation, and technical expertise are also factors.” The business rivalry or competition level in the industry is high because the market is commodity-based. According to Jefferson and Voudouris (2011), the competition is also inter-industry i.e. additional rivalry can also emanate from other industries that supply chemical, fuel and energy for both the individual and the industrial consumers. The industry has continued to grow continuously, with the growth rate estimated at 1.9% in 2008, without posing extra threats or opportunities (Ivythesis, 2008). Additionally, since the oil industry is commodity-based, the competiveness is related to the ability of the organisation to apply cost-effective measures in production. Most of the companies in the oil industry are faced with challenges related to slow industry growth and exit barriers. For instance, the 1970s oil shock in the US led to the increased refinery capacity whereby the oil production exceeded the demand even though no new refineries were built (Hults, Thurber and Victor, 2012). This was as a result of the enhanced conservation efforts. The cost of exit for the oil industry is also high due to the scrap value of the equipment and the low value of the dilapidated refineries that lacks value-adding capability. The only thing that the refineries are suitable for is refining oil. Some of the prominent competitors in the industry include Conoco Phillips, Royal Dutch Shell, BP, ExxonMobil and Chevron (Datamonitor, 2011). The impact of the availability of substitutes, threat of new entrants and power of buyers in the oil industry is insignificant (Berkeley et al, 2009). The industrial buyer power is low in the energy sector because the established suppliers have an advantage of limiting the supply with the intent of maintaining the prices high. According to Ivythesis (2008), the threat of substitutes in the oil industry is minimal because of the limitations in the supply of these substitutes such as nuclear power, solar, photovoltaic, biomass, geothermal, nuclear power and wind among others. The reason for the insignificance of the threat of the new entrants is because oil industry possesses numerous barriers to entry that scares most of the investors. Outside-In Approach to Strategy Formulation The Outside-in approach is associated with Michael Porter and contributed immensely to the enhancement of competitiveness among companies. The outside-in approach to strategy is related to the positioning of the organisation in the environment and shaping it to overcome the externally-imposed pressures (Roy, 2011). The approach is based on structure-conduct-performance set-up as illustrated in the Fig. 1 below: Figure 1: Structure-Conduct-Performance Set-Up Companies in the oil industry such as Royal Dutch Shell plc should clearly understand the structure of the industry for strategic positioning and outperforming the competitors. Success should involve competitive exploitation of the internal economic factors that affects the oil industry (e.g. the business scope). The competitive utilisation of these resources should be carried out overtime to ensure prolonged and sustainable competitive advantage. The act of identifying the strategies that frustrates the challenges posed by the external environment shows the company’s commitment to outside-in approach. The outside-in approach cannot succeed without adequate positioning. Just like Mintzberg’s view on business strategy (plan and ploy), the analysis of the underlying economic issues of a company exemplifies the application of outside-in approach. This is because the approach also supports focus on planning to improve the business activities and establish a competitive advantage. However, the planning strategies purported by the inside-out strategy are normally focused on the measures necessary to adapt and emerge competitive in the external environment. As Mintzberg posits, a business strategy is characterised by patterns of behaviour that occur occasionally in a normal organisational set-up (Mintzberg, 1987). The pattern of behaviour applied by the outside-in approach relates to the structure, conduct and performance (Porter, 2008). In the outside-in approach, the positioning approach starts with the analysis of the external environment. The five-force framework is used to identify the source of the business challenges in the industry while the strategic group analysis is undertaken to enhance understanding of the strategic characteristics involved in identification of the specific competitors (Porter, 2008). This supports the concept of Mintzberg’s fourth ‘P’ that exemplifies the business strategy as position i.e. the company’s position in relation to the competitors. However, the outside-in approach does not lay focused attention on the internal levels of strategic formulation. The competitiveness of the management functions in the oil industry is crucial in enhancing the survival and the competitiveness of these companies. Jonker et al, (2009) asserts that the Shell Company management team is hired through analysis of wide variety of competencies and experiences that have enabled the company become one of the bigwigs in the oil industry. According to Abraham Maslow’s hierarchy of needs, inefficient hierarchy levels of strategy makes the companies loose their competitiveness, especially in the competitive oil industry (Holzknecht et al, 2007). These strategies originate from the enterprise level and trickles down to corporate, business and functional levels. Another model that is relevant in improving the competitiveness of the companies operating in the oil industry is the SWOT analysis i.e. analysis of the strengths, weaknesses, opportunities and threats of the company. According to Elearn (2012), undertaking the SWOT analysis can help in the effective application of the outside-in model. This is because SWOT strategy formulation involves the analysis of both internal and external environment. The SWOT strategy is simple and involves the identification of the external opportunities and capitalising on them to establish a competitive advantage. The results of this analysis lead to weighing of the various courses of action whereby the best alternative is chosen. The outside-in approach also puts both external and internal business environments into consideration. However, the outside-in approach is different because the internal and external company conditions are analysed in levels i.e. from the structure, conduct and performance. However, the SWOT analysis involves the all-inclusive one-time analysis of the internal and external industry environment and the comprehensive results applied in the formulation of the improvement strategy. Although the SWOT analysis seems sensible and simple strategy to conduct when analysing the oil industry, it is associated with numerous challenges compared to the outside-in approach. One of the challenges is that some aspects of the oil industry may occur as both strengths and weaknesses depending on how the future environment has been projected e.g. the dominance of Royal Dutch Company plc can be viewed as both a weakness and strength; other competitors apply the same marketing strategies that weakens their competitiveness while its large size can be harnessed in creating competitiveness. On the other hand, the inside-out approach is anchored on the premise that it is the internal environment that determines the success of the improvement strategies applied by firms and not the external environment as the outside-in approach asserts. However, the Boston Consulting Group (BCG) matrix proposes a different view. According to the BCG matrix, companies in the oil industry can sustain the price war longer than their competitors if they invest heavily in business activities to attain the status of market. The price-based competition strategy acts as an impediment for entry, mobility and growth of other potential competitors. The outside-in approach can assist the company position itself in the industry to enhance competitive pricing. The BCG matrix supports the low cost leader strategy that allows the companies in the oil industry such as Royal Dutch Company plc attain price competitiveness (Woodside, Marshall & Spanier, 2012). Price competitiveness enables the company achieve a competitive advantage as well as profitability over its competitors in the industry (Roy, 2011). Royal Dutch Shell plc is positioned to achieve competitiveness because of its capacity to achieve the economies of large scale, wide scope services and products as well as the possession of necessary experience for outsmarting most of their competitors. The Schumpeterian Competition concept rejects the idea that the competitive level of a company can be determined by position, price and the alignment of the internal resources (Kurz, 2011). This contrasts to outside-in strategy that focuses on the internal realignments and company positioning as the crucial factors necessary for enhancing competitiveness. Schumpeterian argued that technological advancement is the major driver of the industry and the progressive competitive behaviour. This is true for the oil industry as heavy machineries and infrastructural facilities are required for attaining competitiveness in the industry. According to Datamonitor, (2011), the Royal Dutch Company plc invested in machinery and infrastructural development; that gave the company a competitive advantage over their competitors. Revolutions in technology can be applied by companies in the oil industry as the foundation for establishment of new competitive edge. The marketing strategies that emanate from application of the Schumpeterian perspective develop at a sustainable and gradual pace without reference to the company that initiated them. For example, it might be hard to identify the pioneer company for the same marketing strategies applied by Royal Dutch Company plc and Exxon Mobil, but they promote the competiveness of the two companies. Once the revolution is adopted, the inherent forces of the industry as well as the requirements of the companies wishing to venture in these businesses scare away the new entrants. The occurrence of Schumpeterian revolution makes the companies respond in either Outside-in or inside-out approach to the creation of competitiveness (Kurz, 2011). The companies can decide to assume that what goes on internally is more important than the external environment (inside-out approach) or identify and exploit a business opportunity by configuring the internal business environment to exploit it. Recommendations After identifying the required strategy, the company is tasked to consider the mechanisms of implementing the chosen strategy. According to Porter’s argument, the activities that the company handles and the manner, in which they are linked i.e. depending on the value chain analysis, can enhance the strategy, provided they utilise the value added and the cost efficiency strategies available (Porter, 2008). Appendix 2 affirms that the company can concentrate on the critical activities and linkages for the maximum utilisation of the differentiation and cost drivers through harnessing the sources of its competitive advantage such as economies of scale and image. The successful application of the outside-in approach is dependent on the company’s adaptation to the generic strategic frame work. The strategy clock, developed by Cliff Bowman, can be applied in enabling the company position itself through focus on customer-oriented factors i.e. price and the perceived quality (Cox, 2003). Application of these two dimensions leads to identification of the generic options for an industry. Use of the clock analogy identifies five potentially successful routes, with the other three doomed to fail. According to the diagram, each of the successful routes is characterised by elements of differentiation, low cost and the scope as seen in Appendix 3. Conclusion Being controlled by the few large and well established companies, the oil industry is one of the most competitive industries in the business world. The Porter’s five forces affecting the strategy for the oil industry include threat of new entrants, external environment analysis, bargaining power of suppliers, bargaining power of the consumers, threat of substitutes and the rivalry between the existing players. The forces with significant impact for organisations in energy industry include competitive rivalry and the power of suppliers. The impact of the availability of substitutes, threat of new entrants and power of buyers in the oil industry is insignificant. The outside-in approach to strategy is related to the positioning of the organisation in the environment and shaping it to overcome the externally-imposed pressures. References Berkeley L., Smith, B., Wright, E., Evans, D., Wood, F. & Venkatech, B. (2009) Renewable energy and efficiency modelling analysis partnership: an analysis of how different energy models addressed a common high renewable energy penetration scenario in 2025, Berkeley, Calif: Lawrence Berkeley National Laboratory, Environmental Energy Technologies Division. Cox, T. (2003) Clock Tower 3: Official strategy guide Indianapolis, Ind, BradyGames. Datamonitor (2011) Royal Dutch Shell plc: Research and Markets, viewed 15 Jan 2013 from . Elearn, F. (2012) Business Environment Revised Edition Hoboken: Taylor & Francis. Heinzel, C. (2009) Distorted time preferences and structural change in the energy industry: A theoretical and applied environmental-economic analysis, Heidelberg, Physical. Holzknecht, J., Butler, J. S., Hoffman, E., Prager, K. J., Raghunathan, R., & Smith, S. M.(2007) Maslows hierarchy of needs Austin, Tex?: Castalia Media. Hults, D.R., Thurber, M.C. & Victor, D.G. (2012) Oil and governance: state-owned enterprises and the world energy supply, Cambridge, UK, Cambridge University Press. IBIS Business Information. (1999). IBIS World. Melbourne: IBIS Business Information Pty. Ltd. Ivythesis, (2008) DutchShell Porter’s five forces, viewed 15 Jan 2013 from . Jefferson, M. & Voudouris, V. (2011) ‘Oil scenarios for long-term business planning: Royal Dutch Shell and generative explanation, 1960-2010’ CIBS Working Papers Series no. 18 pp. 1-40. Jensen, J. (2004) The development of a global LNG Market, is it likely? If so when? Oxford Institute for Energy Studies, Oxford. Jonker, J., Zanden, J.L., Howarth, S. & Sluyterman, K.E. (2009) A history of Royal Dutch Shell, Oxford, Oxford University Press. Kurz, Heinz D. (2011) Innovations and Profits Schumpeter and the Classical Heritage Vereinigtes Königreich. Mintzberg, H. (1987) ‘The strategy concept 1: Five Ps for strategy’, California Management Review, 30 (1): 11-24. Porter, M.E. (2008) On competition, Boston, MA, Harvard Business School Pub. Report2010, (2010) Sustainable development and our business strategy, viewed 15 Jan 2013 from . Ross, C. (2009) ‘Time for Innovation in LNG’ Petroleum Economist, vol. 76, no. 6, p. 11. Roy, S. (2011) ‘Competitiveness in Service Sector’ Global Business Review, vol. 12, no. 1, pp. 51-69. Stephanie, S.P.H., Jennifer, D.O. & John, H.H. (2009) ‘Historical, practical, and theoretical perspectives on green management: An exploratory analysis’ Management Decision, vol. 47, no. 7, pp. 1041-1055. Woodside, A., Marshall, R., & Spanier, N. (2012) Competence and incompetence training, impact on executive decision-making capability: advancing theory and testing AUT University. Appendices Appendix 1: Elements of Industry Structure Source: Porter, 1985, p.6 < http://www.google.co.ke/url?sa=t&rct=j&q=&esrc=s&source=web&cd=5&cad=rja&ved=0CFMQFjAE&url=http%3A%2F%2Fwww.stanford.edu%2Fclass%2Fmsande473%2F483primerV3.doc&ei=rx32UOzJBsrirAec4oGIDg&usg=AFQjCNGsOIqwYVSuuEokceAtl2G45i-3-g&bvm=bv.41018144,d.bmk> Appendix 2 – Generic Strategies and Value Chain Activities and Linkages LOW COST STRATEGY DIFFERENTIATION STRATEGY Critical Activities Efficient operations Low cost logistics & distribution Process Design - efficient processes Product Design - easy to make products HRM - good labour supervision Critical Activities Product design - innovative products Marketing - brand image promotion Service - quality customer service HRM - staff training Operations - quality assurance Cost Drivers Economies of scale Economies of scope Experience curve Supply costs Differentiation Drivers Service quality and levels Product features Delivery times Image Source: http://www.google.co.ke/url?sa=t&rct=j&q=&esrc=s&source=web&cd=1&cad=rja&ved=0CDIQFjAA&url=http%3A%2F%2Fwww.dur.ac.uk%2Fp.j.allen%2FSib08.doc&ei=SyD2UJS-N8rmrAe984CACA&usg=AFQjCNGojQQuk5VbJaRu7Tz9X58igUriKw&bvm=bv.41018144,d.bmk Appendix 3: The Analogy Clock Source: http://www.google.co.ke/url?sa=t&rct=j&q=&esrc=s&source=web&cd=1&cad=rja&ved=0CDIQFjAA&url=http%3A%2F%2Fwww.dur.ac.uk%2Fp.j.allen%2FSib08.doc&ei=SyD2UJS-N8rmrAe984CACA&usg=AFQjCNGojQQuk5VbJaRu7Tz9X58igUriKw&bvm=bv.41018144,d.bmk Read More