HERIOT-WATT UNIVERSITY

STRATEGIC PLANNING FOR THE OIL AND GAS INDUSTRY DECEMBER 2021

GRADING GUIDE

The three questions have been designed to provide the candidate with the opportunity to
apply ideas from the two strategic planning courses to situations and cases in the oil and gas
industry. There is no right or wrong, and candidates are not penalised for arriving at ‘wrong’
conclusions; instead, they are rewarded for identifying that a model can be applied and
attempting to do so. Strategy models, as contained within the Strategic Planning Course,
and new models introduced in the second course such as oil price dynamics and the
industry supply chain model, are likely to be relevant and should be awarded marks
accordingly.

The main points relevant to each question are contained in the solution. However, student
answers can vary greatly in how models are applied, and often points are made in an
original fashion.

Each question is graded individually in the first instance and all three questions are given an
equal weighting. The criteria are:

• Below 50: a clear fail, but the candidate demonstrates some knowledge of the
terminology and attempts to apply ideas; the paper is of ‘compensatory’ standard, i.e. it
would be awarded a pass if the candidate were successful on all other courses.
• 50–59: a clear pass; the candidate applies one or more models such as Five Forces,
portfolio analysis, strategy process model, oil price analysis, supply chain model, etc.
There is no hard and fast rule for the minimum requirement, but it is typically fairly clear
when the student has understood the basic strategy and industry-related ideas.
• 60–69: a clear pass which contains several models applied correctly and demonstrates
some insight and/or applications.
• 70–79: as above but the argument is clear and consistent, with conclusions at each
point and drawn together to address the question. Clear understanding and good
applications throughout.
• 80 and above: application as above but with an integrated grasp of both strategy and
industry issues. Candidates in this range demonstrate a mastery of both strategy
concepts and industry-related concepts such as the supply chain and/or oil price
movements.

Do not be afraid to award high marks for good discussions. This examination is a severe test
of the student’s ability to apply relevant concepts under a time constraint. Grading is not
simply a matter of adding up the number of points made or models applied: pay attention to
the quality of the argument. A grasp of strategy issues that is integrated consistently with
industry-specific issues should be rewarded generously.

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 HERIOT-WATT UNIVERSITY

STRATEGIC PLANNING FOR THE OIL AND GAS INDUSTRY DECEMBER 2021

Question 1

Who decides to do what?

Strategists

RJH Geophysical acted as a prospector and assumed that a winning formula could be
applied elsewhere without carrying out the detailed analysis necessary to understand what
would be involved in breaking into a new market. In terms of the supply chain, RJH
Geophysical stayed within its area of expertise but failed to see the difference between land
and offshore markets.

Objectives

The objective was to break into a new market with an established product using US
management techniques. The high market share in the US may have resulted in relative cost
advantages due to economies of scale which could not be transferred to West Africa in the
short term.

Overall

The objective-setting process was weak in that it was based upon capitalising on the
perceived competitive advantage without clarifying what the basis of that advantage really
was.

Analysis

Industry environment

Five Forces analysis

The fact that it has been difficult to penetrate the West African market and that the gross
profit margin is only 16% in West Africa compared with 52% in the US suggested that there
was a significant difference in competitive conditions. This is supported by analysing the Five
Forces on the basis of the available information.

Threat of new entrants. US: low; West Africa: high. The market was still growing strongly in
West Africa when RJH Geophysical entered; therefore it is likely that RJH Geophysical was
not the only company that saw the opportunities.

Threat of substitutes. US: low; West Africa: high. West African competitors are continually
changing the characteristics of the Prospec, which was not necessary in the US; this aspect
of competitive advantage could not be exported.

Bargaining power of buyers. US: medium; West Africa: high. RJH Geophysical’s market
share in West Africa is much lower, suggesting that customers have greater choice.

Bargaining power of suppliers. US: medium; West Africa: high. With its much smaller market
share RJH Geophysical will have less buying power in West Africa.

Rivalry. US: medium; West Africa: high. While RJH Geophysical has market leadership in
the US, it is one of many competitors in West Africa; this has resulted in a lower competitive

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price in West Africa and hence a lower return on capital.

The competitive profile which emerges for the two markets is quite different:

Competitive force US West Africa

Entrants Low High
Substitutes Low High
Buyers Medium High
Suppliers Medium High
Rivalry Medium High

The West African market was more competitive in all dimensions and together these
influences contributed to lower prices, higher costs and a lower market share than expected.
It appears that RJH Geophysical did not appreciate the difference in the two markets and
hence did not adapt its approach.

Perceived price and differentiation

Consumers in the West African market are looking for continual improvement, and since the
Prospec is not specifically designed for offshore use it is shifting towards the ‘failure likely’
area of the matrix. This weak positioning in the West African market meant that it would be
difficult to increase market share and was an indication that in West Africa the Prospec
lacked competitive advantage.

Product life cycle

The US market is in the mature stage, enabling RJH Geophysical to minimise inventories
and benefit from a stable labour force and experience effects. The West African market is
growing, hence the need for excess capacity and relatively high inventories. Since the West
African market is in the growth stage, it is to be expected that costs will be higher than in the
mature US market. The absence of development expenditure in West Africa is worrying.

Portfolio analysis

The Prospec was a cash cow in the US and this possibly contributed to complacency. The
Prospec entered the West African growing market as a question mark and has not been able
to increase its market share to become a star. The relatively low price (6% below the
competing price) and high marketing expenditure have so far not resulted in the
achievement of a significant market share. This contributes to the higher costs; these costs
cannot be reduced, because if the market matures at a low market share the Prospec will
become a dog and hence will not generate profits equivalent to those in the US.

Internal analysis

Profitability

As a whole the company is making about 5% ROTA; however, it has a negative cash flow in
West Africa – it is about to run out of cash; if this continues the West African operation will
require subsidies from the US.

Using Operating Surplus as a measure of profit, Return on Equity in the US is 17%

compared with 5% in West Africa. This is lower than the cost of capital and, given the market
analysis, it is unlikely that it will improve.

The competitive factors discussed above contribute to the significant difference in unit costs
between the US and West Africa. If West African unit cost could be brought down to the US

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benchmark level, profit would increase by about $3 million. While the competitive differences
result in a lower competitive price (and a lower price set), in West Africa there is an equal
problem on the cost side.

Product portfolio

The excess capacity in West Africa was set up together with a lower price to achieve market
entry and subsequently develop a star or question mark; if the market is at or near maturity,
production capacity will have to be reduced unless market share can be increased. But the
West African facility does not appear to be large enough to generate relative scale
economies.

Value chain

The value chain is much less effective in West Africa – there are weaknesses in marketing,
human resources, product development and procurement, while the linkage between West
Africa and the US does not seem to be productive. The strategic architecture does not add
value.

Competence

The company attempted to transfer its dominant management logic to West Africa, but this
has not been successful and the management team has not adapted to the offshore market;
this helps to account for the high overtime, attrition rates and warranty returns.

There appears to have been no core competence which could be deployed to generate
profits in the West African market. RJH Geophysical saw its competence in making
Prospecs rather than in providing tools for specific parts of the exploration market.

Development

The prospects for the HCQ are wishful thinking as far as West Africa is concerned, based on
experience so far. The forecast market share of 20% is probably unattainable; a 10%
overestimate of price and underestimate of unit cost would virtually wipe out its potential
profitability. The estimates for Russia are not based on any experience of the market and are
probably no more than wishful thinking. No account seems to have been taken of the
investment required to set up the product in Russia, which amounted to $40 million in West
Africa. It is of concern that RJH Geophysical is again trying to launch a product that will
cover both land and offshore markets without attempting to customise the product for either
market.

There are also differences in the point on the product life cycle when the HCQ will be
launched in two years. The market at launch as a percentage of the market peak is:

US 75%
West Africa 50%
Russia 62%

This means that HCQ will be launched into a relatively mature US market compared with a
much earlier stage in the West African market. Broadly speaking, the more mature the
market the more difficult it will be to enter and hence the probability of success is much lower
in the US and Russia than West Africa.

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Competitive position

The attempt to transfer competitive advantage between countries and markets has not been
successful. The international product portfolio is now composed of a cash cow and a
question mark which is danger of becoming a dog; this has seriously weakened the financial
underpinnings of the company and constrained its potential for future developments. It is
doubtful whether the launch of the HCQ will strengthen the competitive position.

Choice

Generic alternatives

At the corporate level the company expanded into international markets. The West African
development of the Prospec was expansion of an existing product into a new market, i.e.
market development. But this involved international market entry and it does not appear that
a proper analysis of the target market was carried out. RJH Geophysical has also failed to
appreciate the difference between the land and offshore markets. The HCQ will be related
diversification but, given RJH Geophysical’s inability to generate competitive advantage
internationally for the Prospec, the prospects for the HCQ are not optimistic.

At the business level in West Africa the Prospec has become stuck in the middle with neither
low costs nor a differentiated product.
Strategy variations

The variation selected was international expansion, given that the Prospec was a cash cow
in the US and hence expansion in the home market would have been difficult. It was decided
to undertake international expansion by local production. However, there are other less high-
risk approaches to international expansion, such as exporting from the home base.

RJH Geophysical did not fully follow the approach of ‘think global, act local’ by utilising US
rather than West African managers, and did not appreciate that the offshore market
demanded different product characteristics.

Choice

The choice was made to expand the existing product into new markets. In the event this led
to a high-risk positioning in the familiarity matrix because so little was known about the West
African market, and the product was in fact inappropriate for that market.

Overall strategic choice

The choice process was not effective, and it was not clear that alternatives had been
properly considered.

Implementation

Resources and structure

It appears that management treated West Africa as just another US division in spite of the
difference in market conditions. Management also treated land and offshore markets as
having the same requirements.

Resource allocation

The return on resources was very much lower in West Africa; the criteria for allocating
resources internationally were not explicit.

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Evaluation and control

The monitoring and control systems should have alerted management to the problems
before this: three years is a long time to let things go on.

Overall implementation

Once the strategy had been decided on, it appears that little attention was paid to potential
implementation difficulties. The attempt to enter the West African market with a poorly
differentiated product may have been doomed from the start, but it was not helped by the
attempt to apply US management approaches.

Feedback

The fact that RJH Geophysical was pressing ahead with the HCQ with a view to launching
not only in the US and West Africa but also in Russia suggested that the hard lessons of the
West African experience were not being taken into account. It could be argued that the fact
that a consultant was being employed to tell RJH Geophysical what the management should
already be aware of was indicative that this is not a learning organisation.

Overall strategic process

The difficulties in West Africa were due to a combination of poor market analysis and
subsequent management ineffectiveness. There are many weaknesses in the strategic
process and it is unlikely that the company will resolve the issues presented by failure in
West Africa without reconsidering the process itself. The prospects for the HCQ do not look
promising.

To identify how to overcome these problems a SWOT analysis of the following type is
carried out.

Strengths
Cash cow in US
Core competence in the US
HCQ under development (conduct payback,
break-even and sensitivity analyses)
Weaknesses
High gearing in West Africa
High unit cost in West Africa
Cash flow in West Africa a drain on
company
Lack of land vs offshore customisation
Opportunities
Differentiate Prospec in US and West Africa
Improve productivity in West Africa
Launch HCQ sooner
Threats
Prospec product life cycle
Increased competition in West Africa
Unknown competition in Europe
RJH Geophysical will run out of finance
unless West Africa improves

It is important to ensure that the short- and long-term measures do not conflict.

Short run

There seems limited scope for action in West Africa to improve profits in the short run, while
it will be difficult to achieve increased market penetration of the Prospec in the US. The
priority is to focus on efficiency measures which will reduce the cash drain in West Africa;
the highest returns would be achieved by reducing unit cost in West Africa without
compromising competitive advantage. Carry out sensitivity analysis on the HCQ in all three
markets to help determine whether more resources should be allocated to it in order to
increase differentiation and reduce the time to market. The gearing ratio is a constraint on
increased investment at the moment – unless West African costs can be reduced.

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Long run

At the corporate level the strategic prospects for the product portfolio in the international
dimension need to be resolved. If it is decided that the Prospec is likely to become a dog in
West Africa it makes sense to retrench from West Africa and focus on the US market. It
might be possible to sell the operations to a more successful company which could generate
scale economies. On the other hand, RJH Geophysical might consider an acquisition in
West Africa to generate scale economies and capitalise on its excess capacity, but the
gearing ratio and negative cash flow are serious constraints. The HCQ appears to offer the
prospect of synergy and hopefully it will be launched as a rising star to complement the
Prospec in the product portfolio.

At the business level the Prospec life cycle may be under threat if US consumers start to
behave in the same way as West African consumers, and in this case it would require
significant product development to maintain its market position. If the decision is made to
remain in the West African market it will be necessary to shift the Prospec from being ‘stuck
in the middle’. At the moment its cost leadership approach is not succeeding; it needs to
consider further differentiation in West Africa with a view to shifting its position in the
perceived price and differentiation matrix. It may be possible to capitalise on the possibilities
of the HCQ, but it will be important not to end up with the two products in competition.

(Total 100 marks)

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Question 2

1) The volatility of the oil price can be explained using a number of models:

• Overshooting and undershooting

• Cobweb model
• Elasticity of supply and demand

The key point is that managers with a basic understanding of these models should
not have been surprised by the rapid fall in the price.

2) Examples of value chain aspects that Mr Hayward improved are:

Primary Activities

Operations: Hayward improved the company’s operations around the world by

standardising procedures and placing the emphasis on the front line. This expedited
various large projects, which increased production levels.

Support Activities

Procurement: Hayward renegotiated contracts and managed to cut costs

considerably in the face of an industry downturn. The finance and control function
served to integrate the different parts of the organisation.

Technology Development: Capital expenditure levels were maintained through the

downturn, resulting in increasing production levels. Latterly the focus of development
shifted away from renewable energy to concentrate firmly on oil and gas.

Human Resource Management: The number of support staff was cut and an
integrated human resources function was introduced across the various segments.

Management Systems: Standardised operating procedures, integrated digital

infrastructure and a common code of conduct strengthened the linkages between the
business activities in different parts of the world.

Overall

Hayward’s restructuring simplified the support activities in the BP value chain, which
strengthened the linkages between the different activities.

3) Who decides to do what?

Strategists

Hayward was a defender who strengthened BP in its core areas and divested
unprofitable activities.

Objectives

Hayward revisited BP’s business definition and decided to focus on the company’s
core competence.

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Overall WDTDW

Hayward took firm control of BP and had very clear objectives.

Analysis and Diagnosis

Macro-environment

Political – Difficult political situation around the world and diverse operating
environments were a considerable source of risk for BP. Hayward standardised
operations and safety standards across the company in order to mitigate this risk.

Economic – The fluctuating oil price had a positive impact on the company until it
started to fall in late 2008. In response to this, Hayward aggressively cut costs and
renegotiated contracts.

Social – The alternative energy image developed by Lord Browne helped to improve
BP’s reputation as consumers became more environmentally conscious, but this had
been hampered by the company’s poor safety record. Hayward’s new systems
helped to improve BP’s safety record and reduce adverse publicity.

Technological – Hayward directed 75% of the company’s capital expenditure towards

upstream development when the oil price was rising and continued to invest through
the downturn.

The PEST factors above represent a high-risk profile for BP and Hayward took action
to mitigate these risks.

Industry Environment

Five Forces

It is not possible to comment on the competitive forces facing BP as a whole due to

the fact that it covers most of the oil supply chain, but the bargaining power of
suppliers – machinery suppliers, contractors and managers/workers as suppliers of
labour – was extremely high at the peak of the oil price cycle, evidenced by rising
costs and lavish retention packages. When the price of oil fell rapidly, the situation
was reversed and Hayward took advantage of this by aggressively renegotiating
contracts with suppliers and cutting jobs across the organisation.

BCG

Hayward rationalised the Alternative Energy division, selling off unprofitable

businesses. Given the general high growth of most renewable energy technologies,
he was selling off Question Marks that would have required significant investment to
become Stars.

He also sold off the chain of fuel retailers in the US – given the competitive and
localised nature of fuel retail, this is a low share of a low-growth market – a Dog.
Hayward, therefore, examined BP’s portfolio and attempted to ‘weed out’ some of the
poor performers.

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Internal

Value Chain

Hayward’s actions strengthened the linkages across the different activities in BP – in

particular he used strong and streamlined support services to link the different
business units together.

Finances

Hayward focused on costs during the downturn, and the series of large finds helped
to boost BP’s market value.

Competitive Position

Hayward’s actions improved BP’s competitive position and regained competitive

advantage in oil and gas activities.

Overall Analysis and Diagnosis

Overall, Hayward’s restructuring during the upturn and quick reaction to the fall in the
price of oil left BP in a stronger competitive position than its nearest rival, Shell.

Strategy Choice

Generic Strategy

Hayward chose a Retrenchment strategy, restructuring internally in order to take

better advantage of the assets BP had under its control and divesting non-core
businesses. In attacking high costs, he aimed for a cost leadership approach when
the downturn came.

Strategy Variations

Hayward retained the vertically integrated structure but notably divested some
downstream interests in the form of US fuel retail outlets in the face of the falling oil
price.

Choice

As a defender, Hayward encouraged a task culture that resulted in BP becoming

more standardised and more flexible.

Implementation

Resources and Structure

Implementation had been poor in BP before Hayward took over – the company had a
large portfolio of assets that was being poorly utilised. This was due to the complex
structure. He aligned the structure of the company to its objectives of focusing on oil
and gas activities.

Resource Allocation

He poured resources into Exploration and Production and diverted resources from
non-core activities such as renewables. He also reallocated resources from support

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functions to operational activities.

Evaluation and Control

Hayward can be placed on the tight financial area of the planning and control matrix
– he standardised procedures and required managers around the world to follow
standard operating codes of practice.

Feedback

By simplifying the management structure and reducing the number of managers

between the CEO and the front line, and also encouraging managers to listen to
front-line staff, Hayward put in place more open lines of communication, resulting in
better feedback.

Overall Strategy Process

Hayward had a significant impact on all aspects of the strategy process, resulting in
BP being in a strong position after the industry downturn. How this affects the
organisation in the long run remains to be seen.

(Total 100 marks)

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Question 3
Bill Up
Strategists Bill is used to playing a
dominant role in determining
SBU strategy but this is
within the overall strategic
framework set at the
corporate level.
Objectives Because of the limited
industry supply chain stage
coverage and single-country
operation, there is likely to
be a definable set of
objectives.
Overall who Bill has little experience of
decides to do complex principal–agent
what problems, delegation and
defining multiple objectives.
The leadership qualities
required for the corporate
level are quite different.
Macro- Focus is on conditions in a
environment single economy and their
impact on a small number of
supply chain segments.
Industry Familiar with market
environment conditions and competition
for a single market.
Internal analysis The answers obtained from
financial analysis are
unambiguous; value chains
can be identified and there is
one organisational structure.
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Jane Tech
Jane is used to dealing with
corporate-level strategy and
delegating SBU strategy to the SBU
CEOs.
Has been answerable to
shareholders and judged on stock
market performance.
Has probably had to deal with
complex principal–agent problems in
the past.
Jane has managed a diversified
multinational, successfully dealing
with corporate strategy and
disaggregation of objectives to SBU
level.
An integrated major oil and gas
company is similar to a large
diversified multinational. Jane has
experience of managing such a
company and has the upper hand
here.
Conditions vary among countries and
exchange rate movements can affect
profits significantly in different
markets. Macro-conditions can have
a significant impact on competitive
position of different businesses, and
different areas of the supply chain are
affected in different ways.
More specialists and a lot more
information available. Conflicting
information and conclusions:
necessary to integrate and resolve.
Competitive conditions vary by
product and location and require
different reactions. Identifying the
implications of changing economic
conditions for overall competitive
advantage is extremely difficult.
The basis for competitive advantage
depends on the value added by
diversification. Some of the issues
which arise here are:
• balanced portfolio
• synergy
• economies of scope
• risk spreading
• dominant management logic
• corporate identity
• parenting advantage

Competitive Competitive advantage can
position be assessed in terms of
relative market share, cost
per unit and so on.
Overall analysis Bill will not have
and diagnosis encountered the problems
posed by international
transactions and varying
cultural and economic
conditions. The demands of
dealing with information
generated by highly
experienced functional
specialists will be unfamiliar.
Generic strategy The corporate generic
alternatives strategy is predefined and
the business strategy will be
approved within certain
parameters.
Strategy The single-market division
variations has most probably grown
organically.
Choice The business and corporate
strategy choices are closely
linked. Bill has limited scope
for strategy choice.
Overall choice Bill’s experience of making
the type of complex strategic
decisions required in an
integrated oil multinational is
limited.
Resources and There is a clear line of
structure command because it is a
single SBU.
Resource Resources are allocated
allocation among functions.
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• core competence
• peak load resource allocation
• sharing functional specialities
• the corporate value chain.
The basis of competitive advantage
may be obscure because of the
difficulty in identifying how value is
created in a diversified company.
Jane is used to dealing with analyses
by functional experts that may be
conflicting and can integrate and
resolve them. She has experience of
corporate as opposed to business
strategy issues.
The corporate generic strategy is
likely to be a combination; business
generic strategies will be dependent
on individual competitive conditions
along the industry supply chain.
A large corporation diversifies and
grows by mergers, acquisitions,
alliances.
The options are not clear cut because
it is necessary to make decisions for
a number of products in a number of
markets. There are likely to be
conflicts of interest among the SBUs.
To make rational choices it is
necessary to be able to manage a
dynamic diversified portfolio and pay
attention to
• internal cash flows
• linkages among portfolio
components
• dominant management logic.
Jane has experience of making
complex strategic decisions and
dealing with conflicting objectives of
different SBUs.
It is necessary to manage SBUs
which may in turn be organised into
geographical and supply-chain-based
groups. An effective divisional or
matrix structure needs to be devised.
Resources are allocated among
competing SBUs, typically within an
overall budget constraint.
 Evaluation and The control systems
control generate unambiguous
information. There may be
few formal controls, a small
hierarchy and no
bureaucracy.
Overall Bill has no experience of
implementation determining the
effectiveness of a large
multinational organisation
operating throughout the
industry supply chain.
Feedback It is possible for Bill to find
out what is happening by
‘walking about’.
There is less direct control over
resources, and it may be difficult to
relate resource use and deployment
back to the original strategy choice. It
is necessary to utilise sophisticated
monitoring systems, financial
controls, internal pricing and so on.
Jane has significant experience of
determining the effectiveness of a
large multinational.
Because of the size, complexity,
hierarchy and bureaucracy,
communication is a particular
problem. Unless there is a formalised
structure for communication it may
not occur.

Jane’s experience is far more suited to taking over as the new CEO of Buchanan
Resources. In every part of the strategy process her experience of running a large
multinational gives her the skills required to take over the job. While Bill may be successful,
his lack of experience of running a large multinational means any success would be down to
luck.

(Total 100 marks)

© Heriot-Watt University, December 2021

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